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American Society of Business and Behavioral Sciences Conference page i

Proceedings of the American Society of Business and Behavioral Sciences, Volume 7, Number 1 Las Vegas, 2000

PROCEEDINGS OF THE AMERICAN SOCIETY OF BUSINESS AND BEHAVIORAL SCIENCES TRACK

SECTION OF ACCOUNTING

February 17-21, 2000 Las Vegas, Nevada

Steven Hall Editor

Texas A&M University-Corpus Christi

Dawn Martin Co-Editor


American Society of Business and Behavioral Sciences Conference page ii


PROCEEDINGS OF THE AMERICAN SOCIETY OF BUSINESSAND BEHAVIORAL SCIENCES TRACK

SECTION OF ACCOUNTINGTABLE OF CONTENTS

A COMPARISON OF FACTORS CONSIDREDBY ACCOUNTANTS AND BANKERS IN MAKINGMATERIALITY DECISIONS……………………………………………………………………..1

Treba Lilley Marsh, Stephen F. Austin State UniversityThomas J. Phillips, Louisiana Tech University

A COMPARISON OF THE IMPACT OF ACCOUNTINGRESEARCH STUDY NO.3 “A TENTATIVE SET OF BROADACCOUNTING PRINCIPLES FOR BUSINESS ENTERPRISES”AND ACCOUNTING RESEARCH STUDY NO.7 “INVENTORY OFGENERALLY ACCEPTED ACCOUNTING PRINCIPLES FORBUSINESS ENTERPRISES”………………………………………………………………………2

Teresa T. King, Wesleyan CollegeElliot L. Slocum, Georgia State University

A CUSTOMER-DESIGNED ACCOUNTINGINFORMATION SYSTEMS CURRICULUM…………………………………………………….20

Alan B. Deck, Bellarmine CollegeMichael D. Mattei, Bellarmine College

A DIFFERENT VIEW ON TEACHING THESTATEMENT OF CASH FLOWS…………………………………………………………………23

Charles Alworth, Texas A&M University-KingsvilleJack Shorter, Texas A&M University-KingsvilleNeal VanZante, Texas A&M University-Kingsville

“A PATH ANALYTIC MODEL OF MUNICIPALBUDGETARY SLACK BEHAVIOR”……………………………………………………………..29

Walter B. Moore, Nova Southeastern UniversityPeter J. Poznanski, Cleveland State UniversityRichard Kelsey, Nova Southeastern University

A VISUAL APPROACH TO TEACHING THEREA ACCOUNTING MODEL……………………………………………………………………..44

Galen L. Rupp, Pittsburg State UniversityJ. Russell Hardin, Pittsburg State University

ACCOUNTING FOR DECISION MAKERS:A NEW STRATEGY TO EMBRACE NON-BUSINESSAND BUSINESS RELATED MAJORS……………………………………………………………45

Susan Conway, Slippery Rock UniversityLori Zulauf, Slippery Rock University

ACCOUNTING FOR STOCK OPTIONS:THE CONTROVERSY CONTINUES……………………………………………………………...60

Dr. Nicholas G. Apostolou, CPA, Louisiana State UnversityDr. D. Larry Crumbley, CPA, Louisiana State University

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ACCOUNTING METHOD NEGOTIATIONS BETWEENCORPORATE AND TAX AUTHORITIES: A HISTORICALPERSPECTIVE BASED ON THE 1944 TAX AUDIT OFTHE SPRINGFIELD STREET RAILWAY COMPANY…………………………………………...65

Sharon Bruns, Northeastern UniversityTimothy Rupert, Northeastern University

AN EXAMINATION OF VALIDITY OF ACCOUNTINGMEASURES IN THE VALUATION OF R&DINTENSIVE FIRMS…………………………………………………………………………………..71

George Joseph, Savannah State University

AN EXPERIMENTAL STUDY OF THE OPTIMALLEVEL OF BUDGETARY GOAL DIFFICULTY……………………………………………………81

Joe E. Dowd, Eastern Washington University

ASSESSING THE ACCOUNTING PROGRAM:MANDATED EXERCISE OR LEARNING EXPERIENCE?………………………………………..82

Theresa J. Hrneir, Southeastern Oklahoma State UniversityRobert E. Oliver, Southeastern Oklahoma State University

EVIDENCE OF THE SIGNIFCANCE OF THEAICPA’S COMPREHENSIVE MODEL OFBUSINESS REPORTING FINANCIAL ANALYSTSINFERENTIAL DECISION MAKING PROCESSES………………………………………………..89

Lizabeth Anne Austen, University of Arkansas

THE SUPREME COURT’S CENTRAL BANKDECISION: ASSESSING THE IMPACT ONAUDITOR LITIGATION…………………………………………………………………………….109

David L. Gilbertson, Western Washington University

CHECKSHEETS: A VALUABLE COMPONENTOF ON-LINE EDUCATION………………………………………………………………………….126

Rubik Atamian, Ph.D, University of Texas-Pan American

COST ACCOUNTING TECHNIQUES USEDBY THE UNION ARMY DURING THECIVIL WAR……………………………………………………………………………………………141

Darwin L. King, St. Bonaventure University

CPA ELDERCARE ASSURANCE: AN AGENDA FORACADEMIC AND MARKET RESEARCH…………………………………………………………..148

Edward R. Walker, University of Texas-Pan American

DETERMINANTS OF SHORT-TERM ANDLONG-TERM CEO PAY………………………………………………………………………………154

Vinita M. Ramaswamy, University of St. Thomas, TXRamon Fernandez, University of St. Thomas, TXC. Joe Ueng, University of St. Thomas, TX

DETERMINING FACTORS IN THE STUDENTDECISIONS TO CHANGE MAJORS INCOLLEGES OF BUSINESS……………………………………………………………………………163

Beth Finch, Southern University, Baton RougeGisele Moss, Lamar University

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DISCLOSURE OF ETHICAL ISSUES: PHARMACEUTICALCOMPANIES UNDER SCRUTINY……………………………………………………………………164

Evelyn C. Hume, University of Texas-Pan AmericanAileen Smith, Stephen F. Austin State UniversityViolet Rogers, Stephen F. Austin State University

DOES CULTURE OR PERSONALITY TRAIT INFLUENCECAREER CHOICES, A STUDY OF VENEZUELA, UNITEDKINGDOM, AND UNITED STATES PROFESSIONALACCOUNTANTS…………………………………………………………….…………………………169

Stephen Laribee, Eastern Illinois University

ELDERCARE ASSURANCE SERVICES: SHOULD ACPA FIRM IMPLEMENT THEM?……………………………………………………………………..175

Edward R. Walker, University of Texas-Pan American

E-MAIL: ACCOUNTING STUDENTS HAVE ALOW-COST INTERNATIONAL EDUCATION EXPERIENCE--A REPORT ON AN EXPLORATORY PROJECT……………………………………………………181

Wendell E. Edwards, Ph.D, CPA, Texas A&M University-Commerce

ENVIRONMENTAL INFLUENCES OF ACCOUNTINGSYSTEMS IN LATIN AMERICA vs U.S.A……………………………………………………………188

Peter Aghimien, Indiana University South Bend

FACTORS IMPEDING THE HARMONIZATION OFINTERNATIONAL ACCOUNTING STANDARDS…………………………………………………..189

Judy Ramage, Christian Brothers UniversityPeter Stromberg, Christian Brothers UniversityHoward Lawrence, Christian Brothers University

FIGHTING POVERTY THROUGH NEGATIVE INCOMETAXATION: THE SUGGESTIONS OF A COMPUTATIONALMODEL………………………………………………………………………………………………….197

Jon Neill, Western Michigan University

GENDER DISCRIMATION IN THE RECRUITMENTOF ENTRY-LEVEL ACCOUNTANTS………………………………………………………………...207

J. Russell Hardin, Pittsburg State UniversityKurt F. Reding, Pittsburg State UniversityMorris H. Stocks, University of Mississippi

PERFORMANCE MEASURES IN HOSPITALS………………………………………………………208Melissa Ann Smith, Stephen F. Austin State UniversityTreba Lilley Marsh, Stephen F. Austin State University

HOW MUCH IS AN ACCOUNTING PUBLICATIONWORTH?…………………………………………………………………………………………………209

Todd L. Sayre, University of San FranciscoFrederick W. Rankin, Washington UniversityJames R. Hasselback, Florida State University

INDEPENDENCE ISSUES FOR THE 21ST CENTURY:CONSIDERATION OF A CROSS-CULTURAL BIAS…………………………………………………218

David Lavin, Florida International UniversityWilliam Hillison, Florida State University

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INFORMATION SKILLS ACCOUNTING GRADUATESNEED TO HAVE-SOME PRELIMINARY RESULTS…………………………………………………..229

Lawrence S. Corman, Fort Lewis CollegeReed McKnight, Fort Lewis College

INTERMEDIATE ACCOUNTING: AN EXAMINATIONOF THE BENEFITS OF A TEAM LEARNING ENVIRONMENT……………………………………...238

D.J. Parker, University of Washington, TacomaDeb Prentice, University of Washington, Tacoma

INTERNET ASSIGNMENTS IN INTRODUCTORYACCOUNTING: LEARNING FOR THE NEW MILLENNIUM………………………………………...240

Jessica Johnson Frazier, D.B.A, Eastern Kentucky UniversityPatricia H. Mounce, Ph.D., Eastern Kentucky University

INTRODUCING THE CPA VISION TO FUTUREACCOUNTING PROFESSIONALS: A CASE STUDY………………………………………………….249

Carol M. Fischer, St. Bonaventure UniverstiyMichael J. Fischer, St. Bonaventure UniverstiyLarry L. Orsini, St. Bonaventure Universtiy

INVESTIGATING THE PERSONALITY OFACCOUNTING STUDENTS……………………………………………………………………………..256

Deb Prentice, University of Washington, TacomaD.J. Parker, University of Washington, Tacoma

IS THERE AN ASSOCIATION BETWEENPERFORMANCE AND GRADING SCALE?…………………………………………………………..258

Fara Elikai, University of North Carolina-WilmingtonJohn Marts, University of North Carolina-Wilmington

FOCUS, AND CURRICULUM ISSUES:STUDENT PERCEPTIONS……………………………………………………………………………..259

James L. Bush, Jr., Middle Tennessee State UniversityLarry E. Farmer, Middle Tennessee State UniversityR. Wayne Gober, Middle Tennessee State University

MAJOR CHANGES IN THE ACCOUNTING PROFESSION?AN UPDATED ASSESSMENT OF THE UNIFORMACCOUTANCY ACT………………………………………………………………………………….265

Paul Cameron, Texas A&M University-Corpus ChristiCheryl Hein, Texas A&M University-Corpus Christi

HOW CONSERVATIVE ACCOUNTING PRACTICESINFLATE TWO IMPORTANT FINANCIAL RATIOS……………………………………………….273

Robert McDonald, University of New Haven

ADDRESSING TAX AND LEGAL ISSUES FORNOT-FOR PROFITS IN THE GOVERNMENTAL ANDNOT-FOR-PROFIT ACCOUNTING COURSE………………………………………………………..279

George Sanderson, Moorhead State UniversityCynthia Phillips, Moorhead State University

NOTES TO FINANCIAL STATEMENTS:INTENTIONS VS. PERCEPTIONS…………………………………………………………………….284

Dr. David Bean, Iona College

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OLD WINE IN NEW BOTTLES: THE RISKS ANDBENEFITS OF NEW TRADING OUTLETS………………………………………………………….288

Mark C. Mitschow, SUNY College at Geneseo

INTERNAL CONTROL EVALUATIONS IN THEFIXED ASSETS SYSTEM: A COMPARISON OF THEJUDGEMENTS OF HONG KONG AND CHINESE AUDITORS……………………………………289

Shifei Chung, Rowan UniversityRamesh Narasimhan, Montclair State University

PENSION ACCOUNTING CHOICE: A NEURALFUZZY APPROACH……………………………………………………………………………………298

Jerry W. Lin, University of Minnesota-DuluthMark I. Hwang, Central Michigan University

PREDICTING PERFORMANCE IN THE FIRSTMBA-LEVEL ACCOUNTING COURSE………………………………………………………………308

Fred Petro, Pepperdine University

COMMERCIAL LENDING AND FINANCIALREPORTING STANDARDS……………………………………………………………………………316

Nasrollah Ahadiat, California State Polytechnic University

SEC ENFORCEMENT ACTIONS IN THE AREA OFBILL AND HOLD TRANSACTIONS………………………………………………………………….320

Frank E. Ryerson, University of Montevallo

SMALL BUSINESS ACCOUNTING INFORMATIONSYSTEMS DILEMMAS: HOW MUCH IS TOO MUCH?HOW MUCH IS NOT ENOUGH?………………………………………………………………………325

Kimberly L. Glidden, Moorhead State University

STUDENT HOMEWORK EFFORT AND THEINTRODUCTORY FINANCIAL ACCOUNTING COURSE………………………………………….331

Michelle McEacharn, University of Louisiana at Monroe

STUDENT PERCEPTIONS OF THE IMPORTANCE OFORAL COMMUNICATION IN THE ACCOUNTINGPROFESSION……………………………………………………………………………………………337

Elsie Ameen, Sam Houston State UniversitySimeon Chow, Audits and Surveys WorldwideCynthia Jackson, Northeastern University

STUDENT PERCEPTIONS ON THE IMPORTANCE OFCOURSE SYLLABI……………………………………………………………………………………..341

Allen J. Rubenfield, Clark Atlanta UniversityBrian H. Nagle, Duquesne UniversityGanesh M. Pandit, Clark Atlanta University

GOING ON SABBATICAL?: RECENT CHANGES INTHE FOREIGN EARNED INCOME EXCLUSION FORU.S. CITIZENS LIVING ABROAD……………………………………………………………………...346

Stephen Blythe, American University of Sharjah

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THE ADOPTION TAX CREDIT AND EXCLUSION: POLICYCONSIDERATIONS AND BEHAVIORAL IMPLICATIONS………………………………………….350

Sheldon R. Smith, Brigham Young University-Hawaii

THE CHANGING CONCEPT OF AUDITOR INDEPENDECE-PAST, PRESENT, FUTURE……………………………………………………………………………..356

Darlene Kausch, Andrews University

THE CHANGING STRATEGY OF THE PUBLICACCOUNTING PROFESSION AND ACCOUNTINGEDUCATORS……………………………………………………………………………………………366

John C. Borke, University of Wisonsin-PlattevilleM. Jamir Uddin, University of Wisonsin-Platteville

THE EFFECT OF AUDITOR INVOLVEMENT WITHPROJECTED FINANCIAL STATEMENTS ON LOAN OFFICERS’LENDING DECISIONS FOR START-UP COMPANIES……………………………………………….370

Susan L Swanger, Western Carolina UniversityF. Todd DeZoort, University of South Carolina

THE EFFECTIVENESS OF ACCOUNTING LAS ININTRODUCTORY ACCOUNTING CLASSES: ANEMPIRICAL ANALYSIS…………………………………………………………………………………388

Dr. Nat R. Briscoe, Northwestern State UniversityDr. Terry W. Bechtel, Northwestern State UniversityMs. Melissa Aldredge, Northwestern State University

THE EFFECTS OF PEER INFLUENCE ONTAXPAYERS’ COMPLIANCE DECISIONS…………………………………………………………….392

James J. Maroney, Northeastern UniversityTimothy J. Rupert, Northeastern University

THE GENDER DIFFERENCE IN THE DURATIONOF FACULTY EMPLOYMENT IN THE NEWYORK STATE……………………………………………………………………………………………..401

Joan M. Magratten, Pace University

THE GRINCH WHO STOLE POST-RETIREMENTBENEFITS…………………………………………………………………………………………………402

Richard English, Augustana College

THE IMPLICATIONS OF ACCOUNTANT’ AWARENESSAND ATTITUDES TOWARDS INTERNATIONALQUALITY STANDARDS…………………………………………………………………………………410

Roberta J. Cable, Ph.D, CMA, Pace UniversityPatricia Healy, CPA, CMA, Pace University

THE INFORMATIONAL CONTENT OF ACCOUNTINGFOR DERIVATIVES AND HEDGING ACTIVITIES…………………………………………………...411

Sharon Seay, Mississippi CollegeMarcelo Eduardo, Mississippi College

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THE PRIMARY ATTRIBUTES OF ACCOUNTING GRADUATES:WHEN SHOULD THEY BE TAUGHT IN THE CLASSROOM……………………………………….418

William Wilcom, Bradley UniversityJon Carpenter, University of South DakotaThomas Davies, University of South DakotaDavid Moen, University of South Dakota

THE PUBLICATION PRODUCTIVITY OF ACCOUNTINGFACULTY: FURTHER EVIDENCE…………………………………………………………………….428

Brian W. Carpenter, University of ScrantonDaniel P. Mahoney, University of Scranton

THE QUALITIES OF A GOOD ACCOUNTINGPROFESSOR: STUDENT PERCEPTIONS………………………………………………………………431

Jack R. Fay, Ph.D., Pittsburg State UniversityJ. Russell Hardin, Pittsburg State University

THE RELATIONSHIP BETWEEN RACE, SEX AND BUSINESSSIZE IN THE UTILIZATION OF COMPUTER ACCOUNTINGAND PRODUCTIVITY SOFTWARE BY SMALL BUSINESSESIN SOUTHEASTERN VIRGINIA………………………………………………………………………440

Allan Unseth, Norfolk State UniversityJon Stuart, Norfolk State UniversityRaymond Laverdiere, Norfolk State UniversityMichael Chester, Norfolk State University

THE RELOCATION DECISIONS OF AACCOUNTING FACULTY………………………………………………………………………………446

Michael E. Bitter, Stetson University

USING ACL SOFTWARE IN THE AUDITING CLASSROOM:PREPRING STUDENTS FOR THE NEW MILLENNIUM……………………………………………...452

Ulric Gelinas, Bentley CollegeElliott Levy, Bentley CollegeJay Thibodeau, Bentley College

USING VIRTUAL TOURS TO IMPROVE STUDENTS’CRITICAL THINKING SKILLS…………………………………………………………………………457

Virginia Bachman, Arkansas Tech UniversityHans Johnson, Arkansas Tech University

“WILL SHIFTING CPA FUNCTIONS AFFECT THEACCOUNTING CURRICULUM?”………………………………………………………………………460

Stuart Shough, University of South Carolina SpartanburgDonald Yates, University of South Carolina Spartanburg

WORK/LIFE BALANCE AND CAREER PROGRESSIONIN PUBLIC ACCOUNTING FIRMS……………………………………………………………………463

Mary S. Doucet, California State University-BakersfieldThomas A. Doucet, California State University-BakersfieldKaren L. Hooks, Florida Atlantic University

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A COMPARISON OF FACTORS CONSIDERED BY ACCOUNTANTS AND BANKERS IN MAKING

MATERIALITY DECISIONS

Marsh, Treba Lilley Stephen F. Austin State University

[email protected]

Phillips, Jr., Thomas J. Louisiana Tech University

ABSTRACT

There is a lack of consensus among CPAs and users in the area of materiality judgments. The objective of this study was to determine the factors used in materiality judgments. Common factor analysis was used to examine the interrelationships among a large number of variables and explain these variables in terms of their common underlying, but unobservable, dimensions. Accountants and bankers reduced the 75 original variables under consideration to three variables that influenced their decision-making process. The results of these factor analyses showed consistency with prior observations by the FASB and others that materiality had both qualitative and quantitative dimensions. The results provided insight into the respondents' perceptions of materiality decisions; additionally, they indicated that bankers and accountants used different factors in their materiality decisions. Bankers tended to focus on the raw dollar account size and how these dollar amounts compared to other areas. Accountants tended to focus on situations that often bring about professional liability issues.



A COMPARISON OF THE IMPACT OF ACCOUNTING RESEARCH STUDY NO.3 "A TENTATIVE SET OF BROAD ACCOUNTING

PRINCIPLES FOR BUSINESS ENTERPRISES" AND ACCOUNTING RESEARCH STUDY NO.7

"INVENTORY OF GENERALLY ACCEPTED ACCOUNTING PRINCIPLES FOR BUSINESS

ENTERPRISES"

King, Teresa T. Wesleyan college

[email protected]

Slocum, Elliott L. Georgia State University

[email protected]

ABSTRACT This paper traces the development of Accounting Research Studies No. 3 and No. 7. A brief background on the authors of the studies and a study of the political and economic environment of the time is presented. A comparison is made of the impact of the studies at their time of publication and an initial analysis is presented of the lasting impact of the studies in light of current Generally Accepted Accounting Principles.

INTRODUCTION

The Centennial issue of the Journal of Accountancy identified fourteen leaders of the Accounting profession who have made significant contributions to the evolution of Accountancy. These individuals were viewed as having “…made especially important contributions to the betterment of the profession.” [Zeff, 1987] Among the fourteen individuals cited is the author of Accounting Research Study No.7, Paul F. Grady. Not included among the fourteen leaders cited are the authors of Accounting Research Study No. 3, Robert T. Sprouse and Maurice Moonitz. It is important to note that the authors of two studies that had the same fundamental purpose are remembered so differently.

This paper examines the development of Accounting Research Studies No. 3 and No. 7. A brief examination of the personal background of the authors of the studies is presented to provide a comprehensive assessment of the evolution of the studies. In order to place the development of the studies in their historical context, the events surrounding the promulgation of accounting principles from the late 1930s to the mid 1960s are briefly discussed. Each study is assessed and critiqued for its contribution at the time of its publication, and an initial comparison of the lasting impact of the studies is made.

THE COMMITTEE ON ACCOUNTING PROCEDURE

The American Institute of Accountants (Institute, AIA) was reluctant to acknowledge the practicality or the desirability of establishing accounting standards prior to the 1930s. [Van Riper, 1994]



Previts and Merino [1998] observe that the accounting profession spent much of the 1930s "refusing greater responsibility for the content of financial statements, while stressing the limitations of audits and the subjectivity of financial reports." [p. 271]

The first formal attempt to set accounting principles resulted from the Institute's Special Committee on Cooperation with Stock Exchanges’ work with the New York Stock Exchange (NYSE) in 1933. [Flegm, 1984] From this effort, five broad principles were proposed and a rationale for financial reporting established which included the following major elements: (1) principles need justification from practical utility and cannot be determined from pure reasoning, (2) prescription of a uniform set of rules for all corporations of a category would be retrogressive, (3) management of a corporation should be able to choose the accounting methods used, although these should be disclosed and consistently applied, and (4) a framework of a relatively few broad principles should be adopted on which validity of special applications could be tested. [Carey, 1970] These major elements represent the thinking of the accounting profession and would influence efforts to establish accounting principles for much of the remainder of this century. As the result of a paper by A. A. Berle, Jr. entitled, "Public Interest in Accountancy" read at the 1933 annual meeting of the Institute, some members of the Institute actively encouraged the Institute to take positive action to issue official pronouncements on the many issues of accounting procedure that were not yet established. Berle had observed that the growing importance of accounting in the economy would likely subject accounting principles to a test of public opinion regarding their desirability and effectiveness. Although Berle suggested that principles be established in the private sector through the Institute, he questioned whether the Institute could do the job alone and maintain complete impartiality. Berle predicted a governmental agency would be needed to standardize accounting practices in various industries. [Carey, 1969] A Special Committee on Development of Accounting Principles was appointed with George O. May as its chairman. At the Institute’s 1934 annual meeting, May reported for the special committee. [Carey, 1969] The approval of the report by the Council placed the Institute on course to develop accounting procedures based on the practice or experience based model. Also, the Institute recognized the need for authoritative support based on courts and cooperation with groups or agencies that had legal authority. In particular, May recognized the need for cooperative relations with the Securities and Exchange Commission (SEC) which had the legislative authority to prescribe the form and content of financial statements of publicly held companies required to register with the SEC. However, little was accomplished in the three years following the passage of the Securities Acts. Carmen G. Blough, SEC chief accountant, observed that the accountants’ lack of agreement on important principles made it difficult for the Commission. Principles, which he thought were definitely accepted among members of the profession, are violated almost daily, and a review of financial statements suggests there are few principles of accounting in which accountants are in agreement. [Carey, 1970] Blough [Flegm, 1984] lost patience with the Institute in 1937. He said that reduction of differences in accounting methods was vital. Although he believed it preferred that the profession take the steps needed to reduce the accounting differences, the SEC would, if he profession did not.

The American Accounting Association (AAA) challenged the practicing profession about the lack of an authoritative statement of essential principles on which to base accounting records and statements. [Carey, 1970] The AAA ["A Statement of Objectives . . . ," March, 1936] stated that the social implications of large-scale business enterprises could no longer be overlooked. Public accounting must assume full responsibility for preparation of sound and informative financial reports or look toward a time when rigid governmental control would become a fact. The AAA [“A Tentative Statement . . .,” June, 1936] published, “A Tentative Statement of Accounting Principles Affecting Corporate Reports,” in which was stated: “Every corporate report should be based on accounting principles which are sufficiently uniform and well understood to justify the forming of opinions as to the condition and progress of the business enterprise behind it” [p. 187]. The Institute responded by publishing, “A Statement of Accounting Principles,” by Thomas H. Sanders, Henry Rand Hatfield, and Underhill Moore [1939]. Sanders had criticized the AAA’s report as a departure from best practices and for banning all charges to surplus and recommending of the all-inclusive concept of income. [Previts and Merino, 1998] The authors focused on the codification of accounting practices rather than reexamination of individual practices, leading to a largely uncritical acceptance of existing methods [Carey, 1970]. After publication of the study, Hatfield said that he disapproved of the positive approach and efforts to use a tabulation of practices as real accounting principles. However, the



study apparently was used as an authoritative source for many members of the Committee on Accounting Procedures (CAP). [Previts and Merino, 1998] Although the AAA and SEC criticized the profession, the SEC voted 3-2 in 1938 to place reliance on the private accounting sector to establish accounting rules. [Van Riper, 1994] With issuance of Accounting Series Release (ASR) No. 4, authority was delegated to the Institute to establish accounting principles and to achieve greater uniformity in accounting methodology and financial reporting. However, accounting practitioners continued to display an unwillingness to make “preferability decisions,” and they continued to advocate management’s fundamental right to choose accounting practices and content of financial statements. [Previts and Merino, 1998] The Institute’s eight member Committee on Accounting Procedure [Carey, 1970] had issued no specific recommendations for several years and had no technical staff.

In 1938, the CAP [AIA, 1938 Yearbook] recognized the widespread demand for greater uniformity in accounting, and recommended the committee be enlarged, and a research division be established to prepare studies on particular questions and ultimately to formulate pronouncements on specific procedures and practices. The Council authorized action along the lines suggested. [Carey, 1970] The CAP [Van Riper, 1994] was charged with the identification of “acceptable” accounting practices and alternative practices rather than the establishment of standards or rules. The CAP [American Institute of Certified Public Accountants (AICPA), Accounting Research and Terminology Bulletins, 1961] stated its principal objective to be that of narrowing "areas of difference and inconsistency in accounting practices, and to further the development and recognition of generally accepted accounting principles, " [p. 8] by issuing opinions and recommendations which would serve as a criteria for choosing accounting practices used in financial statements of commercial and industrial companies. As the Accounting Research Bulletins (ARB) [Carey, 1970] became available to the accounting profession and business during the next twenty years, corporate accounting was visibly influenced and alternative practices gradually narrowed. The SEC's insistence that registrants generally follow the recommended practices added authority to the CAP's Bulletins. While a "statutory" body of accounting principles was lacking, accounting practices improved and a pattern for development of accounting was established for the next 25 years. A "piecemeal" approach to establishing accounting principles was followed in order to give immediate help to practicing accountants faced with special problems. As each special topic was considered, the CAP recommended one or more alternative methods or procedures as superior to others formerly regarded as acceptable. The SEC continued its case-by-case approach in exercising its authority, and continued to pressure the CAP [Carey, 1970] to eliminate alternative methods of accounting for similar transactions in order to achieve comparability. Generally, the Commission enforced the ARBs, but in rare situations disagreed. Where the SEC issued an ASR, it had the authority of rule. However, Previts and Merino [1998] suggest that securities legislation appeared to be a symbolic effort to placate public concern because the passage of securities legislation should have changed relationships between accountants and management. The stated objectives of the legislation, which were to curb managerial power, to promulgate uniform reporting rules, and to provide information that was useful to investors for decision-making, were not implemented. Management "continued to have great flexibility in selection of accounting principles; acceptance of the concepts of consistency and conservatism did not increase the usefulness of financial reports to the 'average' small investor." [p. 271] The CAP did permit the profession to maintain the right to set accounting standards. Pronouncements involving form, disclosure, and levels of detail were acceptable, but those regarding asset or liability valuation and related revenue and expense recognition failed. The process was more political than theoretical. [Previts and Merino, 1998] Storey [June 1964] said the piecemeal approach of the Institute had made significant contribution in the past, but its contribution in the future was likely to be limited because of the inability to "lay a general conceptual foundation for accounting practice." [p.52] Thus, the same problems were continually reconsidered and other problems resulting from the piecemeal approach were unsolved.

No comprehensive statement of accounting principles had been prepared on which accountants and users of financial statements could rely. Only the AAA had attempted a comprehensive statement of accounting principles, and it did not provide adequately for practitioner’s needs. [“Accounting Research and Accounting Principles,” December, 1958] CAP had briefly discussed in 1938 the desirability of preparing a comprehensive statement of accounting principles, but quickly rejected the idea. It decided that such an effort would take too long a time to prepare and to obtain agreement, and doubted whether a



statement of accounting principles could be prepared that would be sufficiently comprehensive to afford a practical guide to settling a very large number of accounting problems. Accordingly, the committee decided to deal with specific areas of difference. [“History of the Accounting Procedure Committee—from the Final Report,” November, 1959, p. 70] In 1956, the Institute’s Executive Committee urged the CAP to attempt to establish a comprehensive statement of accounting principles. The effort proved to be impractical. [“Accounting Research and Accounting Principle,” December, 1958]

ACCOUNTING PRINCIPLES BOARD: A NEW APPROACH

Shortly following the end of World War II, accountancy again was faced with an increasingly more complex business environment. Aggressive governmental agencies and public concern about the quality of financial reporting brought heavy pressure on the profession from regulators, academics, financial analysts, financial press, and from within the profession to achieve greater uniformity or comparability in financial statements. The problems of fraud and lack of uniformity continued to plague the profession and led to the downfall of the CAP. [Flegm, 1984]

Storey [1964] noted that a significant, though almost imperceptible, change in attitude occurred in the mid-fifties. The change was based on an increased concern for those users of financial statements outside of the firm and manifested in the insistence that such statements be fair to all users. Accountants talked about comparability of accounting statements rather than uniformity of accounting principles. Many accountants focused their criticism on such issues as the cost principle and conservatism in the belief that accounting had not done enough to inform the public of the nature of free enterprise or, on the other hand, used accepted practices to overstate profits of business. Others feared that accounting was too investor-oriented, or worst, client-oriented, and sought greater social responsibility. Storey [1964] stated that:

Accountants are now discovering something that is known in many other fields, i.e., that "Principles" distilled from practice are capable of leading so far, and no further. A point is reached at which principles of this type become meaningless unless and until a conceptual framework is developed which gives meaning to the procedures followed, or points out that the procedures followed do not make sense and should be replaced by others which do. Building a conceptual framework, which will be at once both the reasoning underlying procedures and a standard by which procedures are judged is a long-run process." [pp. 60-61]

The ARBs were generally accepted as authoritative and approved by the SEC [“The Accounting Procedure Committee,” September, 1959], and the goal of narrowing diversity of accounting practice had been partially achieved. However, the piece-meal approach was unsatisfactory, and the part-time research efforts were inadequate. [Jennings, January, 1958] Leonard Spacek [December, 1958] of Arthur Andersen & Co. was representative of those within accountancy who were intensively critical of public accounting profession for its failure to define generally accepted accounting principles. Many in accounting, business, and academics expressed concern whether the private sector would be replaced by government intervention in establishing accounting principles. Some openly questioned whether the SEC’s traditional restraint was in the public interest of investors. [“SEC Commissioner Seeks More Uniformity in Accounting Practice,” March, 1963] The accounting profession was in a difficult position, with criticism on all fronts, and the Institute leadership knew that action was needed. Alvin R. Jennings [January, 1958], president of the Institute, proposed that the research program be restudied. In particular, he recommended that: (1) development of accounting principles should be regarded as pure research, (2) a new adjunct research organization should be established as a Research Foundation and be funded by industry and the profession, (3) a full-time staff of the research organization should have proper academic and practical experience, and (4) two-thirds approval by the Council would make statements binding. Clearly Jennings’ recommendations were radical for the time because the expected research process would depart from the traditional experienced based or inductive research approach.

Alvin R. Jennings’ [January, 1958] proposal that the research program be restudied led the Executive Committee to appoint a Special Committee on Research Program in December, 1957. [“Special Committee on Accounting Research Program,” August, 1958] The special committee was charged to “consider a new approach to the means whereby accounting research should be undertaken, accounting principles should be promulgated, and adherence to them should be secured.” [“Report to Council of the Special Committee on Research Program,” December, 1958, p. 62] Weldon Powell chaired the special committee which included the following distinguished membership: Andrew Barr, Carmen Blough,



Dudley Browne, Paul Grady, Robert Mautz, Leonard Spacek, William Werntz, and Arthur Canon. The special committee completed its report in 1958. The special committee's report said that the Institute’s general purpose should be to advance the written expression of generally accepted accounting principles, and established generally accepted principles should be more than a survey of existing practice [“Report to Council of the Special Committee on Research Program, December, 1958]. Clearly the Institute viewed the new research program to be a critical component of the process to establish accounting principles and that the research effort should be a departure from the inductive/practice based approach traditionally used by the Institute. A conditional endorsement of the normative approach to research was given. [Previts and Merino, 1998]

The Accounting Principles Board (APB, Board), established in 1959, was not much different from the CAP. A more elaborate set of rules governing procedures was established, and a more elaborate research program was expected to establish a general conceptual framework of accounting. [Carey, 1970; Flegm, 1984] The Research Division and the Conceptual Foundation

The special committee recommended a conceptual structure of financial accounting that involved four levels: postulates, principles, and rules or other guides, and research. Postulates were basic assumptions viewed as few in number and derived from the economic and political environment and modes of thought and customs of business. The postulates were to be the basis on which to formulate a statement of broad accounting principles similar in scope to that issued by the AAA. Such postulates and principles were to serve as the framework from which detailed problems would be solved. Rules and guidelines, which were flexible and comparable to the current ARBs, would be developed in relation to postulates and principles. Independent research would become the basis for all pronouncements. Thus, the research component was expected to produce a series of Accounting Research Studies (ARS) and a series of statements on generally accepted accounting principles which as authoritative written expressions would achieve acceptance through persuasion or consensus. [“Report to Council of the Special Committee on Research Program,” December, 1958]

The special committee identified the following projects as needing the immediate attention of the Research Division: (1) to develop a set of postulates (concepts) underlying financial statements and (2) to study broad principles of accounting. The APB would issue Generally Accepted Accounting Principles; these statements would be authoritative. According to the special committee, GAAP would be based on the results of the Accounting Research Studies (ARS) conducted by the Research Division. Paul Grady, who was a member of the special committee, stated that the research studies should provide a useful way to focus the views and wisdom of the accounting profession and the APB on the process of forming conclusions about the subjects. [Grady, May, 1962] The report of the special committee served to identify basic levels of accounting theory (i.e., postulates, principles, rules, and research) and to recommend a blending of deductive/normative and inductive/practice based research methodologies in the first real effort by the accounting profession to establish a conceptual framework.

MAURICE MOONITZ

Maurice Moonitz was born on October 31, 1910 in Cincinnati, Ohio. After attending the University of Cincinnati for two years, Moonitz withdrew from the University because of financial reasons and worked for a bank in Sacramento, California. In 1931, Moonitz continued his college education at the University of California, Berkeley and received the Baccalaureate degree in 1933. [Tomassini, 1997]

Moonitz worked for a year in accounting at the Federal Land Bank of Berkley before returning to the University of California to complete his Master’s degree and his Doctorate. During his pursuit of the advanced degrees, Moonitz taught at the University of Santa Clara. Moonitz completed his Doctorate in 1941 and in 1942, he began teaching at Stanford University where he remained until 1944. In 1944 Moonitz left the teaching profession to work with Arthur Andersen & Co. in its San Francisco office. [Dykxhoorn, 1989] Moonitz returned to teaching in1947 at the University of California, Berkeley. He remained at Berkeley until 1978 when he retired as Professor Emeritus.

Moonitz was a prolific writer. He published over 50 articles, books, texts, and monographs. One of Moonitz’s greatest concerns was the lack of a set of accounting principles. [Dykxhoorn, 1989] Moonitz was asked by the Institute’s Special Committee on Research Programs to develop a set of basic postulates underlying accounting principles. His efforts resulted in the first Accounting Research Study “The Basic



Postulates of Accounting.” Accounting Research Study No.1 was published in 1961. Moonitz later co-authored with Robert T. Sprouse Accounting Research Study No.3, “A Tentative Set of Broad Accounting Principles for Business Enterprises.” Moonitz remained active in the profession’s efforts to develop accounting principles.

ROBERT T. SPROUSE

Robert T. Sprouse was born in 1922 in San Diego. He completed two years at San Diego State College, and then worked in a grocery store and a flower shop until he was drafted into the Army in 1942. He returned to San Diego State University in 1949 and completed his Baccalaureate degree. He attended the University of Minnesota for his graduate studies, after which he joined the faculty at University of California, Berkeley. It was at the University of California, Berkeley that Sprouse had the opportunity to meet and work with Maurice Moonitz. Moonitz invited Sprouse to assist in the preparation of two research studies that were commissioned at the time the AICPA’s Accounting Principles Board was created. He co-authored the second, Accounting Research Study No. 3. [Sprouse, 1994]

Sprouse’s academic career included positions at Harvard University and Stanford University. In 1973, Sprouse was selected to serve on the Financial Accounting Standards Board, a post he held for 13 years. He served as the Board’s Vice Chairman for 11 of those years. [Tomassini, 1997]

Sprouse is recognized for the numerous articles and texts that he wrote during his lifetime. Colleagues identify him as “intelligent, good humored, gentlemanly, a good listener, articulate, and fun to be with.” [Horngren, 1994] Sprouse never became a CPA nor did he practice in public accounting. Never the less, he held many positions in professional organizations and was president of the America Accounting Association from 1972 to 973.

PAUL F. GRADY

Paul F. Grady, born on May 19, 1900 in southern Illinois, graduated with high scholastic honors

from the University of Illinois in 1923. He joined the accounting firm of Arthur Andersen & Co. and was certified as a CPA in 1923. Grady was made partner in 1932. Grady recognized the value of experience derived from certain client situations and professional activities. [Zimmerman, 1978] During his work with Arthur Andersen in New York, Grady came into contact with numerous members of the accounting profession, and the Securities and Exchange Commission (SEC). Grady participated with members of the American Institute of Accountants (AIA, Institute) and the New York Stock Exchange in 1933-34 in which the early development of accounting principles was discussed. [King, 1989]

Grady left the firm of Arthur Andersen & Co. in 1942 to work with the U.S. Navy Department in organizing the Navy cost inspection service. He received accolades for his work with the Navy including being awarded the Navy Distinguished Service Civilian Service Award and the Presidential Award of Merit. [Tomassini, 1997]

After concluding his work with the Navy, Grady accepted a position with Price Waterhouse & Co.; He became a partner on January 1, 1944. [Demond, 1951] From 1944 through 1948, Grady served as Chairman of the Committee on Accounting Procedure (Committee, CAP). During his tenure, the Committee produced two landmark documents: Generally Accepted Auditing Standards: Their Significance and Scope and Internal Control: Elements of a Co-Ordinated System and Its Importance to Management and the Public Accountant. The documents were strongly influenced by Grady’s experiences at Arthur Andersen & Co. His views provided the foundation for the Committee’s work on both projects, and he developed the definition of internal control that was included in the Internal Control publication. Grady indicated that he considered the Internal Control publication to be one of his greatest accomplishments and it served as the profession’s guideline for several decades. [Zimmerman, 1978]

During his years at Price Waterhouse, Grady served on a number of Institute committees, working with the Securities and Exchange Commission, General Accounting Office, Congressional Appropriations, National Defense and others. Certainly, Grady was well recognized for his accomplishments prior to devoting his attention to the issue of “generally accepted accounting principles.” [King, 1989]

One can conclude after comparing the backgrounds of the three aforementioned accountants that their different life experiences would influence their views on the development of accounting principles. Paul Grady was an accounting practitioner. He spent his accounting career addressing the issues of clients



in two of the largest CPA firms. Grady had personal knowledge of the deficiencies of financial reporting and the need for a comprehensive set of accounting principles. Moreover, Grady had worked with government and regulatory officials and had insight into their concerns/criticisms of financial accounting. Moonitz and Sprouse had an academic background; Moonitz had minimal exposure to public accounting practice, and Sprouse had no practical public accounting experience.

THE RESEARCH DIVISION

The rather disagreeable circumstances that would surround the research studies involving what was to be a conceptual framework of postulates and principles reflected the traditional disagreement among academics and practitioners regarding how accounting principles should be established. Academic were more likely to use the normative approach to identify what principles ought to be and practitioners strongly believed that accounting principles had to be based on practices which had become generally accepted. Practitioners traditionally distrusted efforts of academics regarding research to establish accounting principles and feared attempts to establish uniformity. There were serious disagreements on whether accounting should focus on asset and liability valuation or on revenue and expense allocation models. Of course, there were the strong personalities and political issues that existed. Grady had spent his career supporting the practice based consensus approach to the establishing of accounting principles and very clearly was not supportive of any alternative approach. He had also professionally worked with many of the individuals and actually had attended the University of Illinois with several of the parties involved. [Zimmerman, 1978]

Dr. Maurice Moonitz was appointed as the first Director of the Research Division and Weldon Powell was appointed as the first Chairman of the Accounting Principles Board. The APB decided to wait on output from the Research Division before making any decisions other than those considered most pressing. The Research Division began six projects in its first year. The projects dealt with accounting postulates, broad accounting principles, income taxes, leases, business combinations, and non profit organizations.

Accounting Research Study No. 1, (ARS No. 1) The Basic Postulates of Accounting, was published in 1961. The study was authored by Moonitz and was an attempt to satisfy the recommendation of the special committee to develop basic concepts underlying accounting. It was embarrassing that ARS No. 1 received a rather reserved response, due to the attitude that it did not say much more than was self-evident. ARS No. 1 did not directly impact on income measurement, thus, practitioners were rather reserved in comment. [Previts and Merino, 1998] Accounting historians describe ARS No.1 as “breaking little new ground.” [Davidson and Anderson, 1987] Leonard Spacek responded to the study by stating:

This monograph is a well-written and comprehensive summary of certain concepts that either have had or should have had an influence on accounting practice… Whether or not the fourteen postulates set forth in this monograph are in fact “postulates” (and I do not think they are) depends upon the definition selected for that word. The purpose of the study and the objective established by the special committee (of which I was a member) was to establish the basic postulates as a foundation for the formulation of accounting principles. Most of the so-called postulates set forth in this monograph are self-evident observations that cannot serve as the basic foundation on which sound accounting principles can be established. [Leonard Spacek, 1961]

The first Accounting Research Study did, however, lay the groundwork for Accounting Research Study No.3 (ARS No. 3).

ACCOUNTING RESEARCH STUDY NO.3 “ A TENTATIVE SET

OF BROAD ACCOUNTING PRINCIPLES FOR BUSINESS ENTERPRISES”

Moonitz [December, 1963] recognized that the charge to the Research Division required a new approach that necessarily required more than a survey of existing practice. Experience was to be aided by logic. Experience is by its nature limited because “inferences drawn to extend knowledge cannot extend beyond that of experience to date.” [p. 43] Postulates and principles to be formulated were to provide a “framework of reference” to deal with specific issues and solve detailed problems.



Maurice Moonitz was joined by Robert Sprouse, his colleague at the University of California, Berkeley, for the compilation of ARS No. 3. Sprouse and Moonitz sought to build a broad set of accounting principles on the foundation established in ARS No. 1. As Moonitz states in the preface to ARS No.3 “this is a companion to ARS No.1 and completes the initial assignment of the Research Division of the American Institute of Certified Public Accountants to study the basic postulates and the broad principles of accounting. “ [Sprouse and Moonitz, 1962] Moonitz indicates that Sprouse wrote the first draft of the study and that the study was reworked after the publication of ARS No.1 in order to integrate the two projects. It is worthwhile to note that the profession had been concerned with establishing a set of GAAP for more than 30 years and Moonitz and Sprouse managed to complete both the postulates and the principles in two years. Sprouse and Moonitz identify three guidelines that they attempted to adhere to in the development of the principles: First, to make sure that the principles were compatible with the postulates set forth in ARS No1; second, to carry the analysis, discussion and illustrations far enough to make clear the implications of the principles, but not so far as to convert the study into a handbook or manual of procedure; and third, to formulate recommendations that can actually be reduced to practice in light of the present level of knowledge about business and economic affairs. [Sprouse and Moonitz, May, 1962]

Sprouse and Moonitz identified the emphasis in the postulates study to be on the measurement of wealth in the hands of economic entities. ARS No.3 was designed to build on that emphasis by examining assets, liabilities, and related revenues and expenses, gains and losses, of business enterprises. The study took the position that ideally all assets and liabilities should be recognized as well as all changes that can objectively be determined. The study recommended the recognition of price level changes, and of movements in replacement cost. [Sprouse and Moonitz, May, 1962]

Sprouse and Moonitz begin the ARS No.3 by identifying certain key definitions as follows: Financial Statements-Those which purport to show financial position and results of operations, including supporting schedules. Assets- represent expected future economic benefits, rights to which have been acquired by the enterprise as a result of some current or past transaction. Cost- is a forgoing, a sacrifice made to secure benefits, and is measured by an exchange price. Liabilities-obligations to convey assets or perform services, obligations resulting from past or current transactions and requiring settlement in the future. Owners’ Equity-is represented by the amount of the residual interest in the asset of an enterprise. Net Profit- is the increase in owner’s equity assuming no change sin the amount of invested capital either from price level changes or from additional investments and not distribution to owners. Revenue- is the increase in net assets of an enterprise as a result of the production or delivery of goods or the rendering of services. Expense- is the decrease in net assets as a result of the use of economic services in the creation of revenue or of the imposition of taxes by governmental units. [Sprouse and Moonitz, 1962] Sprouse and Moonitz identified 8 principles in ARS No.3. The principles identified in the study are summarized below in the order in which they appeared.

A. Profit is a result of the whole process of a business enterprise. Therefore, any attempt to assign profit to a portion of the whole process should be constantly monitored to determine the extent to which it introduces bias into the reporting of the amount of profit assigned to specific periods of time. Basically, Moonitz and Sprouse questioned the utilization of the realization principle for recognizing revenue. They stated that to the recognition of profit should be attributable to the whole process of the business activity not just at the point of sale. Also, the use of a concept of realization in accounting implied that there must be unrealized elements of net profit. They believed that the concept of realization conflicted with the basic premise of going concern.

B. Changes in resources should be classified among the amounts attributable to : 1. Changes in the dollar (price level changes) that would lead to restatements of capital but not to revenue or expenses.

2. Changes in replacement cost which would lead to gains or losses. 3. Sale/Transfer or recognition of net realizable value, all of which lead to revenue or gain.

4. Other causes, such as accretion or the discovery of previously unknown natural resources. C. All assets of the business enterprise should be reflected in the records regardless of how it was acquired.

D. Assets should be valued at their future economic services they are capable of rendering to the business enterprise. For the purpose of measurement, it was suggested that all assets might be classified according



to the ease or difficulty with which the relationship to anticipated benefits can be established. For example, the division of assets into (1) assets in the form of money or claims to money and (2) all other assets. Assets in the form of money or claims should be valued at their discounted future exchange price. Specifically, Sprouse and Moonitz recommended that receivables be measured at by the present value of future cash receipts discounted at a market rate of interest (regardless of the interest specified in the contract). This would be applied to long term receivables; short-term receivables would be measured at their expected realizable value. It was recommended that investments in stock be measured at their current market price. Sprouse and Moonitz stated that all other assets must be measured at some objective base that approximates their future value. They indicated that the measurement of other assets would be based on the cost as an approximation of fair market value on the date of acquisition. After acquisition cost should be remeasured to reflect the effect of the changing dollar. Also, property, plant and equipment should be restated to reflect replacement cost; Sprouse and Moonitz recommended that the restatement should take place at periodic intervals, perhaps on a five year basis. They stated that the techniques used for fixed assets should be applied to intangibles. Depreciation and amortization should be based upon the restated numbers.

E. Liabilities should be recorded in the accounts and measured by the present value of the future payments. The market rate of interest at the date of incurrence of the liability is the pertinent rate to use in the discounting process.

F. Liabilities, which call for settlement in something other than cash, should be measured by their agreed upon selling price. The example of subscriptions received in advance is presented with measurement of the obligation being based upon the advance received and recognition of the revenue occurring after the performance has been satisfied.

G. Measurement of Owner’s equity should be classified according to invested capital and earned surplus (retained earnings). Invested capital should be classified according to source. Earned surplus should include the cumulative amount of net profits and net losses, less dividend declarations, and less amounts transferred to invested capital. The earned surplus was also stated to include unrealized components such as the restatement of plant and equipment from acquisition cost to replacement cost.

H. The last principle dealt with reporting the results of operations. At a minimum, data should be classified into revenues, expenses, gains, and losses. Revenue represents a measurement of the exchange value of the products of that enterprise during the period. Expenses measure the costs of the amount of the revenue recognized. Gains/Losses result from the sale of assets, the change in the value of inventories, the settlement of liabilities and the involuntary incurrence of liabilities.

THE PROFESSION’S REACTION TO ARS NO. 3

Accounting Research Study No. 3, A Tentative Set of Board Accounting Principles for Business

Enterprises was published in 1962. The Board politely stated that the studies were “conscientious attempts to resolve major accounting issues but contained inferences and recommendations in part of a speculative and tentative nature . . . . while these studies are a valuable contribution to accounting thinking, they are too radically different from present generally accepted accounting principles for acceptance at this time.” [Accounting Principles Board, April 13, 1962] The APB did note that some of the recommendations might prove acceptable after a period of exposure and consideration.

ARS No.3 did not receive accolades from the profession, but in fact, the study was treated with disdain and in some cases elicited hostile responses from practicing accountants. In reviewing the literature of the period, one can conclude that accountants had great expectations regarding the study and that they were very disappointed with the final product. Every member of the advisory committee commented upon the Study. The comments were overwhelmingly negative; in fact, only one member of the advisory committee supported the principles identified in the study.

Previts and Merino [1998] observe that dissents were widespread due to ARS No. 3’s focus on asset and liability measurement which conflicted with the traditional cost and revenue allocation model. Sprouse and Moonitz [May, 1962] clearly stated that “The concept of profit becomes the focus of attention which leads to an examination of assets and liabilities in order to find the appropriate bases for measuring the results of operations for relatively short periods of time.” [p. 61] The study [Sprouse and Moonitz, May, 1962] took the position that all assets and liabilities and all changes which can be objectively determined should be recognized. In addition to transactions with other entities, changes in price-levels,



replacement costs, and other causes should be recognized when evidence is objectively determinable. Andrew Barr [Spouse and Moonitz, 1962] said ARS No. 3 represented a statement of what the

authors believe generally accepted principles should be rather than what they were. Carmen Blough [Sprouse and Moonitz, 1962] believed that the study was a notable contribution to accounting literature; however, he stated that it did little to address the current need for a guide in the solution of the numerous day to day problems of the profession. Moreover, Blough cites the evolutionary nature of accounting and that the identification of what constitutes accounting principles should be based on the outcome of the evolutionary process. He further stated that accounting principles should not be theoretical hypotheses untried in practice or tried and discarded as impractical. Blough specifically objected to adjusting accounts to reflect price level changes and to reflect current replacement cost. He stated that the ARS No. 3 failed to achieve the stated charge to the research division of developing a logical and cohesive statement of basic principles.

Oscar Gellien stated that the publication of ARS No.3 would serve no useful purpose and likely will delay the development of the broad principles comprehended in generally accepted accounting principles. [Sprouse and Moonitz, 1962] Furthermore, the study failed to base its findings on the basic premise of usefulness within the field of accounting.

Herbert E. Miller’s [Sprouse and Moonitz, 1962] comments on ARS No.3 centered upon the greater subjectivity that would be introduced by application of the principles identified within the study. Miller believed that increase subjectivity and greater reliance on estimates and judgement would result in abuses and a lessening of confidence in published accounting statements.

Leonard Spacek [ Sprouse and Moonitz, 1962] began his comments about the study by identifying the underlying purpose to the authors of the study. He stated that the principal purpose of the study was to provide a foundation for and a general framework of accounting theory so that financial accounting and the resulting financial reporting will meet the current needs of all segments of our society. Spacek further stated that the principles set forth in the study were not supported by any objective research and represented a statement of the authors’ personal opinions. Spacek identified the research in the study as being inadequate, incomplete, superficial, and lacking in logical support.

William Werntz [Sprouse and Moonitz, 1962] stated that it would be a disservice for the study to be published in its present form. He was fearful that the document did not sufficiently make the distinction between practices that were currently accepted and those that might propose changes to current practice. Werntz had concerns about how to implement the changes suggested in the study and also expressed hesitation about some of the so-called principles recommended by the study. His primary concern centered on the idea of adjusting accounts to reflect changes in the price level and changes in the replacement cost. He also identified that changing the revenue realization practice from point of sale to some other basis should be approached very cautiously.

Perhaps the longest response published with the statement came from Paul Grady. [Sprouse and Moonitz, 1962; Grady, May, 1962] The response was summarized in a 1962 article in the Journal of Accountancy. Grady, based on his experience with developing generally accepted auditing standards, and believed that the development of generally accepted accounting principles would be more difficult and require more time than was given to the project. His primary position was that this project should be one of identifying principles for which there is presently general agreement and should not be a “discovery mission.” Grady believed that the profession had the responsibility of establishing an inventory of generally accepted accounting principles before undertaking any substantial changes. Grady served on the Special Committee on Research Programs that recommended that the Postulates and Principles studies be conducted. He believed that the authors had not satisfied the charge of developing a set of principles on which there was general acceptance. Grady also disagreed with the normative or deductive approach adopted by Sprouse and Moonitz in their development of the study. They had explained their deductive approach as identifying problems to be solved and offering a solution by careful attention to what “ought” to be the case, not what “is” the case. [Moonitz, 1961] Grady believed that the use of such an approach at such a critical time in the profession was dangerous. He reiterated the charge of the Special Committee to define accounting principles with general acceptance and accompanied by explanations, reasons, justifications, and logical criticisms.

Sprouse [May, 1964] responded effectively, though perhaps in vain, to the criticism that ARS No. 3 was too radically different from the present generally accepted accounting principles. He said that it should have been no surprise that some of the proposals called for fundamental departure from what was current practice since general dissatisfaction with the present practice led to the new research program. “. .



. It should be equally well understood that a mere description or codification of existing practices could do nothing to alleviate this condition.” [p. 64] He referred to the stated requirement by the Council that advancement of written expression of generally accepted accounting principles required more than a survey of existing practice. He suggested that one wanted to observe currently existing practice, a look at the Accounting Trends and Techniques would prove satisfactory, but would not prove that generally accepted accounting principles exist.

Sprouse [May, 1964] said that perhaps that it was not clear what part of the study was too radical. Since the APB had already taken the position that failure to acknowledge price-level changes was unrealistic, this issue would not appear too radical. The proposed use of net realizable value for inventory was not radical since it would probably not exceed that allowed under ARB No. 43. He noted that the proposed use of replacement costs of most inventories and of plant and equipment, where feasible, was based on need of a fundamental change to eliminate diverse procedures and inconsistencies and provide financial statements that better met the needs of society. The focus on balance sheet values had as its primary goal a more meaningful measurement of income. Sprouse stated that he did not dispute that conservatism is one of the oldest principles of accounting, only that it is desirable or justifiable in present day financial accounting. Sprouse ended the defense by saying by saying “. . . .Financial statements should report the economic facts in as forthright a manner and as accurately as objective measurements permit. Surely it is not the accountant’s role to conceal economic facts on the grounds that businessmen are apt to act foolishly if they know what is really going on.” [p. 68]

ARS No. 3 “probably signaled the demise of any attempts to adopt a normative research orientation for the APB.” [Previts and Merino, 1998, p. 313] A definite shift in the Board’s efforts contributed to the negative reception of the studies. [Jennings, August, 1964] Weldon Powell [January, 1961], chairman of the Board, had signaled the shift in attitude when he said that, although the Institute would try to be bold in thinking, consider new ideas in developing theory, and reach out to new methods, research in accounting was by nature more applied research than pure research. Accounting principles must be practically applicable if they are to be generally accepted. Thus, one of the first steps should be to study prevailing practice to establish what principles are actually being applied and procedures are actually followed. The Board [Jennings, August, 1964] re-appraised its objectives and decided to focus on the solution of particular problems. The Board approved a research project to identify and codify accounting principles which have general acceptance.

ACCOUNTING RESEARCH STUDY NO. 7 “ INVENTORY OF GENERALLY ACCEPTED PRINCIPLES FOR BUSINESS ENTERPRISES”

In 1963 Moonitz resigned as Director of Research and returned to the University of California,

Berkeley. Paul Grady accepted the position of Director of Research. The APB authorized a special research project under the direction of Grady to identify those accounting principles which have achieved general acceptance. Among the advisory board members appointed for the research project were Carman Blough (Chairman), Andrew Barr, Weldon Powell, and Leonard Spacek. [“Project Advisory Committee on Accepted Accounting Principles,” October, 1963] Grady’s appointment as the Director of Research and the authorization of the new principles research project signified a distinct change in the philosophy of the research division and of the APB in promulgating accounting. Grady adopted a more practical inductive approach in promulgating accounting principles. Grady stressed that the negative response that ARS No. 3 received was due to the approach utilized by its authors in the study’s development. He believed that an Inventory of current practice had to be developed before any substantive changes could be recommended.

After accepting the position as Director of Research, Grady immediately began work on the Inventory of Accounting Principles. The basic outline and approach was outlined in Grady’s response to ARS No.3 and published in the Journal of Accountancy in 1962. Grady perceived a need to quickly rectify the damage that ARS No. 3 had done to the profession’s image. He enlisted the aid of several large accounting firms in order to accelerate the research program. Many of the researchers involved in the other studies were practitioners rather than academic researchers.



Grady considered the project to establish GAAP to be largely a process of identifying principles or practices on which there was general agreement and developing a useful classification of these principles. Grady stated that the project mission was to: (1) identify concepts, (2) establish a list of currently accepted accounting principles, (3) present the opinions of all authoritative bodies, and (4) supply definitions and explanations where necessary. The inventory was designed to be easily used by practitioners on a day to day basis to address issues that might arise.

Grady began the Accounting Research Study No.7 (ARS No 7) by setting forth the functions of accounting. He described accounting as a necessary part of any effectively functioning business. Grady asserted that the results of accounting had to be judged from the standpoint of usefulness to society as a whole. His greatest concern was the fair and adequate measurement of income. Grady identified ten concepts in the study. He used the term “concept” instead of “postulate” because the American Accounting Association had indicated that it had greater acceptance. The ten concepts identified were influenced by his personal views. The ten concepts were in general self explanatory: (1) a society and government structure honoring private property rights, (2) business entity, (3) going concern, (4) monetary expression in the accounts, (5) consistency between periods for the same entity, (6) diversity in accounting among business entities, (7) conservatism, (8) dependability of data through internal control, (9) materiality, and (10) timeliness. These concepts were considered to be the general framework for the codification of accounting principles.

Grady established the following sources for determining if an accounting practice had authoritative support: (1) practices commonly found in business enterprises, (2) requirements and view of the stock exchanges, (3) regulatory commissions’ uniform system of accounts and account rulings, (4) regulations and opinions of the securities and exchange commission, (5) opinions of certified public accountants, and (6) published opinions of professional accounting organizations.

The format used in the inventory was designed with the practicing accountant in mind. First, an objective was stated, then principles to obtain the objectives and finally a list of authoritative support for each of the principles identified. There were five objectives identified by Grady in ARS No. 7. The five objectives were (1) income and expenses, (2) equities, (3) assets, (4) liabilities, (5) financial statement presentation. There were thirty-two principles related to the five objectives. In the next sections of ARS No. 7, Grady discussed specific applications and presented the historical origins of the principles. The detailed discussion allowed practitioners to understand the justification for why the principles were considered to be generally accepted and it provided a concise source for citing authoritative support for the principles. Thus, ARS No. 7 provided the only comprehensive discussion of accounting principles for which there existed authoritative support.

Chapter nine of the study deviated from the format following in the earlier chapters. It discussed the issue of price level adjusted financial statements. Because the APB was considering price level accounting at the time Grady was working on the study, he made a definitive statement supporting the publication of financial statements based on historical cost and on a price level adjusted basis. He strongly believed that financial statements presented on both bases were essential to the fair and comprehensive presentation of financial position and the results of operations.

The last three chapters of ARS No.7 summarized the authoritative pronouncements cited in the study. These chapters were included to justify the principles identified in the study. The study was published in 1965; approximately three years after Grady proposed the outline for the study in his response to ARS No. 3. ARS No. 7 “served not only as a convenient reference to analysts of financial statements but as a basis for examination of areas in which diversity of practice existed and which therefore needed the attentions of the APB.” [Carey, 1970]

THE PROFESSION’S REACTION TO ARS NO. 7

The publication of ARS No. 7 concluded Grady’s involvement with the research division. He

believed that the study provided the foundation necessary for the profession to move forward in the establishment of accounting principle which would be accepted by the profession. The publication of the ARS No. 7 calmed the turbulence that had been caused by the publication of ARS No. 3.

ARS No. 7 consolidated accounting thought at a point when the profession’s structure and process for standard setting most needed a positive statement to be contrasted with ARS No. 3. [Previts, September, 1986] Four members of the advisory board commented upon the study. Most of the comments



applauded Grady’s effort in compiling the study. All members of the advisory board recommended that the study be published as Accounting Research Study No.7.

Thomas J. Cogan, [Grady, 1965] member of the advisory board, stated that the Inventory was an important contribution to the existing body of professional literature and its author should be congratulated upon his substantial accomplishment. Cogan was concerned about the concept of diversity that Grady included in chapter two of the study. He believed that uniformity in accounting principles was not desirable under the conditions that existed. He did however suggest that managers should apply discipline in selecting accounting principles and that they should apply consistent and compatible principles.

D. F. MacEachern [Grady, 1965] identified the study as being a truly monumental work. He stated that it would be long regarded as a most significant milestone in accounting. MacEachern also questioned Grady’s definition of “diversity” in accounting principles. He believed that a goal should be established to eliminate alternative methods of accounting which are not justified by differing circumstances.

The only comprehensive review conducted at the time of its publication was in the Journal of Accountancy by Weldon Powell [March, 1965]. Powell served on the advisory board for the study. He proclaimed that the ARS No.7 would be one of the most useful publications of the Institute. Powell cited many benefits of the study. The first significant feature identified by Powell was its practical format. Powell applauded the identification of concepts and the careful attempt to link all principles to the concepts identified. Powell stated that the pragmatic approach used by Grady would be especially helpful to practitioners who needed a guide to address issues. He appreciated the fact that Grady had identified sources of authoritative support for the principles in the study. A second feature cited by Powell was that Grady did not indulge in a lengthy discussion of semantics. Instead, Grady defined key terms and utilized the terms consistently throughout the study. Powell recognized that Grady’s discussion of the basic concepts underlying accounting was the first realistic attempt to provide a conceptual framework for accounting practice.

Powell [March, 1965] also elaborated on the limitations of ARS No. 7. He believed that the level of detail and the discussion of unimportant issues obscured the relevant aspects of the study. Powell stated that industry practices should have received greater attention in the research study. He believed that this would have helped to alleviate some of the criticisms raised about the issue of diversity in accounting principles. Finally, Powell stated that Grady emphasized one side or another of an issue reflecting his own personal viewpoints.

An editorial in The Journal of Accountancy [“Accounting Research Study No. 7”, March, 1965] observed that ARS Nos. 1 and 3 were conceptually based on the argument that an absence of a complete and logically consistent and accepted set of accounting principles required a fresh start to build an ideal framework for accounting. An equally strong argument to begin with current practice, identify principles on which general agreement exists, and engage in an effort to develop consensus on problems not yet resolved represents the approach used for ARS No. 7. Contributions of ARS No. 7 were said to included: placing current problems in perspective, identifying the great progress already made, highlighting controversy, and proving a guide for further deliberations by the APB. ARS No. 7 provided stability at a crucial time in the profession. It was a practical, well-written compendium of accounting principles that were being used. It served to strengthen accounting from the profession's viewpoint and from society’s perspective.

STATEMENT OF ACCOUNTING PRINCIPLES BOARD, NO. 4 By 1965, the Research Division of the American Institute of Certified Public Accountants

(AICPA) had issued three research studies specifically designed to establish a broad statement of accounting principles. The Council approved recommendations of the Special Committee on Opinions of the Accounting Principles Board, referred to as the Seidman Committee, in April, 1965. As part of the first recommendation, which the Board should act on immediately, were: (1) list and describe the basic concepts on which accounting principles should be oriented, (2) state the accounting principles on which practices and procedures should conform, and (3) define a number of terms and phrases, including generally accepted accounting principles, concepts, principles, practices, procedures, assets, liabilities, and income. [Moonitz, Winter, 1970] The three research studies had addressed these issues, and most of these and the other terms had been defined in one or all of the three research studies. However, content of research studies did not represent official positions of the AICPA The special committee observed that ARS No. 7 provided a comprehensive statement of



accounting principles that appeared to be generally accepted, a discussion of the functions of accounting, and basic concepts on which accounting is oriented. ARS No. 7 was considered to provide most of the raw materials needed to prepare the document or documents the special committee recommended. The Committee on the Fundamentals of Financial Accounting completed its task with the publication of Basic Concepts and Accounting Principles Underlying Financial Statements of Business Enterprises as Statement of the Accounting Principles Board, No. 4. [APB, October, 1970] Statement No. 4 specifically identified ARS No. 1, 3, and 7 as among the sources used. The project [Moonitz, May, 1971] began as an effort to codify currently accepted accounting principles and was to be issued as an Opinion of the Board. However, before its final issuance, all controversial language was removed and its was changed to a Statement. It covers much the same ground that ARS No. 7 did, and issued as a statement, is binding on no one. Statements do not represent Opinions and thus accounting practitioners did not have to disclose any departures from its content. The Board clearly stated that the accounting principles described represent what the Board believes to be generally accepted, but the Statement does not change, supersede, or interpret any of the ARBs or Opinions currently in effect. Thus, Moonitz [Winter, 1970] points out that, although Statement No. 4 and ARS No. 7 were based on highly practical and relatively noncontroversial levels, the accounting profession had not authoritatively adopted a set of generally accepted accounting principles.

THE IMPACT OF ARS NO. 3 AND ARS NO. 7 This paper has identified the profession’s reaction to ARS Nos. 3 and 7 at the time of their publication. Both of these studies had the same basic purpose: to provide a foundation that could be used to promulgate generally accepted accounting principles. However, by 1970, ARS Nos. 3 and 7 had not resulted in a single Opinion of the APB. Additionally, few of the Accounting Research Studies were used as a basis for an Opinion, [Moonitz, Winter, 1970] and the research program was a disappointment. [Flegm, 1984]

Grady (August, 1964) clearly stated that ARS No. 7 was not intended to discover new or improved accounting principles. It discussed the basic concepts on which accounting principles were oriented, listed accounting principles regarded as essential to fiduciary accountabilities, and presented Opinions of the APB, CAP, and other authoritative accounting pronouncements then in effect. It supplied explanatory and connecting language needed to create a practical accounting codification for use by business and accountants. The Inventory helped practitioners to understand why these practices were considered acceptable and provided concise sources for citing authorities in support of the practice. Thus, the study provided the only comprehensive discussion of accounting principles for which authoritative support existed. Carey [1970] stated that it “served not only as a convenient reference to analysts of financial statements but as a basis for examination of areas in which diversity of practice existed and which therefore needed the attentions of the APB.” [p. 142] Grady reflected the attitude of much of the accounting profession who were more comfortable with “principles” or rules based on practical experiences and “general acceptance” or consensus. However, as a research study, the inventory was not officially accepted as a written expression of generally accepted accounting principles. [Carey, 1970]

ARS No. 3 and its authors were largely criticized for advocating principles that did not have general acceptance at the time of the study’s publication. Sprouse and Moonitz had focused on an asset and liability valuation approach which conflicted with the traditional revenue and expense allocation model [Previts and Merino, 1998] and practitioners could not accept the changes this would bring to accounting measurement. Moonitz [Winter, 1970] reports that Opinions of the Board bearing on valuation of assets and liabilities and the resulting recognition of revenues and expenses and operating results were not successful and were in many cases not followed in practice. However, a careful analysis of current GAAP suggests that some of the “principles” recommended by Sprouse and Moonitz eventually attained general acceptance. Specifically, the historical cost assumption, while still part of our current conceptual framework, has been adapted to address special situations in which the utilization of historical cost would greatly mislead users of financial information. Sprouse and Moonitz also question realization of revenue at point of sale. Practitioners today recognize that there are some conditions in which revenue recognition is justified at some point other than point of sale. However, revenue recognition still relies heavily upon recognizing revenue at the culmination of the sale transaction.



ARS No. 3 received the most vehement criticism for its recommendation of price level adjusted figures in the financial statements. Ultimately, price level adjusted statements were required as supplemental disclosure information for many large companies. The standards did not go the extent of revaluing assets and basing depreciation on the revalued amounts as recommended in ARS No. 3. Also, when the APB eventually issued a statement on restating financial statements for the affect of changes in the price level, they narrowed the method to utilize in providing the supplementary information by stating that companies should employ the GNP deflator. The APB did not, however, require companies to produce this information. Sprouse and Moonitz were somewhat ambiguous in providing a method for restating financial information. They suggested using either an index number designed to measure movements in the prices of items or an appraisal. Sprouse and Moonitz also believed that the adjusting of the financial statements to reflect price level changes need not be confined to supplemental information. They disavowed the historical cost concept and believed that the financial records should reflect changes in price levels. Current GAAP encourages but does not require the presentation of the effects of changing prices on the financial statements.

ARS No. 3 specifically identified the need to restate marketable securities at their current market price. Sprouse and Moonitz believed that the current market price represented objective information with respect to the amount of cash into which the securities could be converted. It would also allow the user of financial information to assess the decisions of the company to buy, hold, or sell securities. Current GAAP requires presentation of temporary securities at their current market price.

ARS No. 3 was a normative or deductive research study identifying what the author’s believed to be a sound set of accounting principles. The profession never adopted the normative approach used in compiling ARS No. 3. It was considered too radical at its time of publication A few of the ideas suggested by Sprouse and Moonitz have came to fruition as an accounting principle. The asset and liability valuation approach has gained greater acceptability as evidence by the Financial Accounting Standards issued by the Financial Accounting Standards Board. The recognition of price level adjusted financial information is not currently required by GAAP, but it was considered during the 1970s when inflation was high. Measurement of income is still heavily linked to the culmination of the selling process rather than to the production process as identified in ARS No. 3, however, consideration of other points or recognition are considered.

The words of Alvin R. Jennings [August, 1964], perhaps are prophetic. He observed that ARS No. 1 and 3 were scholarly documents that added greatly to accounting literature, but were not received as realistic proposals for more or less immediate acceptance. “Nonetheless it would be a mistake to underestimate their importance as indicators of the direction in which accounting may very well develop in the future.” [p. 31] As this study continues with additional analysis of the Financial Accounting Standards, it is likely that additional elements of ARS No. 3 may no longer be considered speculative and may be found at least partially in current standard setting.



REFERENCES Accounting Principles Board (April 13, 1962). “Statement by the Accounting Principles Board” (New

York: American Institute of Certified Public Accountants). Accounting Principles Board (October, 1970). Basic Concepts and Accounting Principles Underlying

Financial Statements of Business Enterprises, Statement of the Accounting Principles Board, No. 4 (New York: American Institute of Certified Public Accountants).

“Accounting Research and Accounting Principles” (December, 1958). The Journal of Accountancy, 27-28. “Accounting Research Study No. 7” (March, 1965). The Journal of Accountancy, 27-28. American Institute of Accountants (1939). 1938 Yearbook (New York: American Institute of

Accountants). American Institute of Certified Public Accountants (1961). Accounting Research and Terminology

Bulletins, Final Edition (New York: American Institute of Certified Public Accountants). “A Tentative Statement of Accounting Principles Affecting Corporate Reports” (June, 1936). The

Accounting Review, 187-191. "A Statement of Objectives of the American Accounting Association" (March, 1936). The Accounting

Review, 1-4. Carey, John L. (1969). The Rise of the Accounting Profession: From Technician to Profession, 1896-

1936 (New York: American Institute of Certified Public Accountants). Carey, John L. (1970). The Rise of the Accounting Profession: To Responsibility and Authority, 1937-

1969 (New York: American Institute of Certified Public Accountants). Davidson, Sidney and Anderson, George D. (May, 1987). “The Development of Accounting and Auditing

Standards,” The Journal of Accountancy, 110-127. DeMond, C. W. (1951). Price Waterhouse & Co. In American: A History of a Public Accounting Firm

(New York: Price Waterhouse & Co.). Dykxhoorn, (1989). “Maurice Moonitz.” Biographies of Notable Accountants, Academy of Accounting

Historians (New York: 1989). Flegm, Eugene H. (1984). Accounting: How to Meet the Challenges of Relevance and Regulation (New

York: John Wiley & Sons, Inc.). Grady, Paul (May, 1962). “The Quest for Accounting Principles,” The Journal of Accountancy, 45-50. Grady, Paul (August, 1964). “AICPA Accounting Research Program,” The Journal of Accountancy, 57-59.



Grady, Paul (1965). Inventory of Generally Accepted Accounting Principles for Business Enterprises: Accounting Research Study No. 7 (New York: American Institute of Certified Public Accountants, Inc.).

“History of the Accounting Procedure Committee—from the Final Report” (November, 1959). The Journal

of Accountancy, 70-71. Horngren, (1994). “Robert Sprouse: An Introduction.” Accounting Historians Journal, December 1994. Jennings, Alvin R. (January, 1958). “Present-Day Challenges in Financial Reporting.” The Journal of

Accountancy, 28-34. Jennings, Alvin R. (August, 1964). “Opinions of the Accounting Principles Board,” The Journal of

Accountancy, 27-33. King, Teresa Tyson (1989). An Analytic Study of Selected Contributions of Paul F. Grady to the

Development of Accountancy (Dissertation: Georgia State University). Moonitz, Maurice (1961)..The Basic Postulates of Accounting. Accounting Research Study No. 1 (New

York: American Institute of Certified Public Accountants). Moonitz, Maurice (December, 1963). “Why Do We Need ‘Postulates’ and ‘Principles,’” The Journal of

Accountancy, 42-46. Moonitz, Maurice (Winter, 1970). "Accounting Principles—Some Lessons from the American Experience,” Journal of Business Finance, 51-64. Moonitz, Maurice (May, 1971). "The Accounting Principles Board Revisited," New York Certified Public Accountant, May 1971, 341-345. Powell, Weldon (January, 1961). “Report on the Accounting Research Activities of the American Institute

of Certified Public Accountants,” The Accounting Review, 26-31. Powell, Weldon (September, 1964). “The Development of Accounting Principles.” The Journal of

Accountancy, 37-43. Powell, Weldon (March, 1965). “’Inventory of Generally Accepted Accounting Principles,’” The Journal

of Accountancy, 29-35. Previts, Gary John (September, 1986). Remembering Paul F. Grady, Accountancy’s Statesman, 1900-1984

(Working Paper No. 68, The Academy of Accounting Historians). Previts, Gary John and Barbara Dubis Merino (1998). A History of Accountancy in the United States: The

Cultural Significance of Accounting (Columbus: Ohio State University Press). “Project Advisory Committee on Accepted Accounting Principles” (October, 1963). The Journal of

Accountancy, 11. “Report to Council of the Special Committee on Research Program” (December, 1958). The Journal of

Accountancy, 62-68. Sanders, Thomas Henry, Henry Rand Hatfield, and Underhill Moore (1939). A Statement of Accounting

Principles (New York: American Institute of Accountants, Haskins & Sells Foundation, Inc.). “SEC Commissioner Seeks More Uniformity in Accounting Practice” (March, 1963). The Journal of

Accountancy, 9.



Spacek, Leonard (December, 1958). “Can We Define Generally Accepted Accounting Principles?” The Journal of Accountancy, 40-47.

Spacek, (1961). A Tentative Set of Broad Accounting Principles for Business Enterprises. Accounting

Research Study No. 3 (New York, American Institute of Certified Public Accountants, 77-79. “Special Committee on Accounting Research Program” (August, 1958). The Journal of Accountancy, 77. Sprouse, Robert T. (May, 1964). “The ‘Radically Different’ Principles of Accounting Research Study No.

3,” The Journal of Accountancy, 63-69. Sprouse, (1994). “Response.” Accounting Historians Journal, 155-159. Sprouse, Robert T. and Moonitz, Maurice (May, 1962). “Summary from ‘A Tentative Set of Broad

Accounting Principles for Business Enterprises,’” The Journal of Accountancy, 61-63. Sprouse, Robert T. and Moonitz, Maurice (1962). A Tentative Set of Broad Accounting Principles for

Business Enterprises. Accounting Research Study No. 3 (New York: American Institute of Certified Public Accountants).

Storey, Reed K (1964). The Search for Accounting Principles: Today's Problems In Perspective (New

York: American Institute of Certified Public Accountants, Inc.). Storey, Reed K. (June, 1964). "Accounting Principles: AAA and AICPA," The Journal of Accountancy,

47-55. “The Accounting Procedure Committee” (September, 1959). The Journal of Accountancy, 29-30. Tomassini, (1997). “Maurice Moonitz.” and “Robert T. Sprouse.” Accounting Hall of Fame. Van Riper, Robert (1994). Setting Standards for Financial Reporting, (Westport, Connecticut: Quorom Books). Zeff, (1987). “Leaders of the Accounting Profession: fourteen who made a difference.” Journal of

Accountancy, 46-71. Zimmerman, Vernon K. (1978). Editor, Written Contributions of Selected Accounting Practitioners,

Volume 2: Paul Grady (Urbana-Champaign: University of Illinois, Center for International Education and Research in Accounting).



A CUSTOMER-DESIGNED ACCOUNTING INFORMATION SYSTEMS CURRICULUM

Alan B. Deck Bellarmine College

[email protected]

Michael D. Mattei Bellarmine College

[email protected]

ABSTRACT

The fastest growing revenue base of the Big 5 accounting firms deals with consulting and systems expertise. This trend is expected to continue and magnify in the twenty-first century. In order to meet the future needs this trend is creating, a new four year curriculum in Accounting Information Systems was developed at a small mid-western liberal arts college. To ensure the new degree would be viable when the freshmen of the 2003 class graduate, it was critical that the skills needed at that time would be included in the curriculum. To determine these skills, professionals from Big-5 accounting firms and local industry were consulted and those of various accounting education committees were reviewed. This paper discusses the skills suggested by these professionals and presents the newly developed curriculum.

PROFESSIONAL ACCOUNTING ORGANIZATIONS

A taskforce of the Information Systems and Control Foundation states "The need for well-

educated Information systems (IS) auditors and control professionals is increasing, thanks to technology's potential to dramatically change organizations and business practices, reduce costs, and create new opportunities." The Education Committee of the International Federation of accountants state that: "The knowledge that individuals must gain prior to qualification falls into four categories:

• general knowledge • organizational and business knowledge • information technology knowledge • accounting and accounting related knowledge"

Other professional organizations, such as the American Institute of Certified Public Accountants and the Institute of Management Accountants are also making efforts to ensure that future accounting need to be proficient with information systems and technology.

MEMBERS OF THE ACCOUNTING PROFESSION

Preliminary informal discussions have been held with three members of the professional accounting community. Each individual is a member of a public accounting firm or a business which currently recruits heavily at the academic institution and were interested in assisting the institution in the development of an Accounting Information Systems degree.

A brief review of each individual's discussion follows:

Director, Operational & Systems Risk Management Services (Big 5 accounting firm) "I was excited to hear that you are working on this type of program. We have had limited success finding



candidates in our local area with these skills and often have hired staff from out of state as a result. We are seeking individuals who are familiar with various operating platforms and understand the controls associated with each. I would also like to offer to meet with you to discuss your plans for the new degree if that would be of help. Please call me if you have any questions or if you would like our firm help you in implementing the program.”

Senior Manager of Assurance Services (Big 5 accounting firm) "I applaud your efforts to establishing an Accounting Information Systems degree at your institution. I believe that the program that is being developed is the wave of the future." Director of Accounting Information Systems (Fortune 500 company located in the same city)

"The accounting people at our company must be skilled in the following areas:

Focus Skills Able to Manipulate spreadsheets

Knowledge of Databases such as Access, Paradox, Approach Financial applications of Database This corporation’s computer technology is currently mainframe and the Director expects that to continue and expand. Their accounting systems employees must have "Focus" skills and be knowledgeable of client-server based systems. Currently, the company is hiring accounting majors from colleges and universities in the region and having to teach them these skills. “Students who come in with these basic skills would be hired over those without. Also, since not all of their accountants sit for the CPA examination, a four year degree would be excellent.”

SUMMARY From the information above, it appears that a degree program for Accounting Information Systems would provide the area with a major that would attract the support of both students and members of the accounting and accounting information systems profession. It should also meet the needs of the professional accounting bodies which perceive a need for change in accounting education. Further, it would be one of the first academic institutions in this general area to develop such a degree The current accounting major at this academic institution, combined with the MBA curriculum, both meets the current national requirements for licensing by all State Boards of Accountancy and provides access into the accounting profession. However, it does not meet the needs of the profession in one of the major areas of accounting that is expected to have rapid growth in the future; the audit and advisory services associated with computers and computer systems. Indeed, this area of education has received growing attention by many professional accounting bodies as well as individual members of the accounting profession. The intent of establishing the major in Accounting Information Systems is to prepare accountants of the 21st century for a professional career that departs significantly from that of the traditional major. (A copy of the new curriculum will be available at the meeting.)



REFERENCES Accounting Education Change Commission. 1990 Position Statement No. 1: Objectives of Education for

Accountants. Torrance, CA: Accounting Education Change Commission. International Federation of Accountants. Revised June 1998 International Education Guidelines, IEG 11, Information Technology in the Accounting Curribulum. Education Committee of the International Federaton of Accountants. www.ifac.org/StandardsAndGuidance/Education.html.



A DIFFERENT VIEW ON TEACHING THE STATEMENT OF CASH FLOWS

Alworth, Charles

Texas A&M University-Kingsville [email protected]

Shorter, Jack


VanZante, Neal


ABSTRACT

This paper proposes that the statement of cash flows be introduced at the same time as the balance

sheet and the income statement. It should be presented in a simplified format, just as the balance sheet and income statement are. In simple form, it is as easy to understand as the other statements. Not discussing it along with the balance sheet and income statement seems to leave a lasting confusion with students. They are used to thinking on a cash basis, not an accrual basis. If the statement of cash flows is omitted, they seem to adopt the income statement as a surrogate. We use the traditional accounting equation worksheet which is presented in the first chapter of many accounting principles texts as a basis for teaching all three of the financial statements at the same time. This approach seems to help students understand the income statement better as well as the cash flow statement.

INTRODUCTION

The purpose of this paper is to suggest that instructors introduce the statement of cash flows (SCF)

in the first chapter of accounting principles along with the balance sheet and the income statement. Introduction of the SCF has traditionally been deferred until the following semester. Such an approach is confusing for students, who tend to think of financial matters on a cash basis. They intuitively look for a report on cash flow among the accounting statements and seem to assume that the income statement has something to do with cash. With this erroneous concept in mind, the student may be confused about the income statement for the rest of the course. This confusion can be prevented by introducing the SCF in chapter one.

An apparent reason for omitting a full discussion of the SCF in chapter one is that it is too complex for the student at this stage of the course. But the statement itself is simpler than the balance sheet or the income statement. It is just a summary of cash increases and decreases. If introduced on this basis in chapter one, it will help the student understand the accounting process better.

The process of classifying cash flows as operating, investing, and financing activities is not necessary at the beginning. At this level, the instructor should simply ignore these classifications and present the statement in the form of cash receipts and disbursements. The instructor thus introduces the students to the essence of the statement without undue complexity. For an introduction to the statement, this is sufficient. After all, that is all instructors do with the income statement at this level. They do not include cost of goods sold, extraordinary items, or the multi-step format. They are only interested in the students’ general understanding of a simple version of the statement. The same should be true of the SCF.

Another source of complexity is the process instructors have traditionally used to prepare the



statement, namely an elaborate work sheet or T-account approach. Non-cash accounts are analyzed to determine cash flows. To understand this process, students must have a good understanding of double entry accounting. At the beginning stage, students are not prepared for such a process. We propose using a simple method of analyzing the cash account to determine the cash flows.

As a result of an early introduction of a basic, unclassified SCF, students are made aware of the existence and approximate format of the statement from the beginning. This helps them understand that the income statement does not purport to show cash flows, a common misconception among accounting students. Accountants have a special statement to show cash flows and students learn how the statement relates to the accounting equation. Later in the course when the SCF is discussed in more detail, it is relatively simple to show students how to classify the cash flows into operating, investing, and financing activities. This approach also shows students that the SCF is the same as the statement of cash receipts and disbursements (whether historical or budgeted), but formatted differently. Students are also ready for a detailed discussion of the traditional approach to preparing the cash flow statement.

INTRODUCING CASH FLOWS

The first chapter of many accounting principles texts affords instructors an excellent opportunity to introduce students to the SCF as well as demonstrate the difference between accrual and cash basis accounting. The text usually presents a problem similar to Exhibit 1 to introduce students to the accounting equation and how the accountant records business transactions. The process is demonstrated on a spreadsheet similar to Exhibit 2. Because the concept of debits and credits has not yet been introduced, the text relies on showing the effects of various simple transactions on the accounting equation using this worksheet. The text then shows that the balance sheet is prepared from the ending totals of the accounting equation at the bottom of the spreadsheet. The income statement is a summary of the transactions in the owner’s equity column, ignoring any owner investments or withdrawals. The opportunity often missed is to show that the cash column contains the information necessary to prepare the SCF.

Exhibit 1 Bob Jones Cleaners

Details of Transactions Month of September, 2000

Trans No. Transactions (1) Bob Jones invested $100 in his business, Bob Jones Cleaners. (2) Paid $30 cash for land for a future business location. (3) Bought $6 of cleaning supplies on account. (4) Received $40 cash from clients for accounting service revenue earned. (5) Performed cleaning services for a client on account, $50. (6) Paid $17 cash for rent expense. (7) Paid $15 cash for wages expense. (8) Paid $4 on the account payable from Transaction No. 3. (9) Received $27 on the account receivable from Transaction No. 5.

(10) Withdrew $3 cash for personal expenses.



Exhibit 2

Bob Jones Cleaners Accounting Equation Analysis of Transactions

Month of September, 2000 Assets Liabilities Equity

Trans Cash A\C Rec Supplies Land A\C Pay Capital Type of Equity

(1) 100 100 Invest (2) -30 30 (3) 6 6 (4) 40 40 Revenue (5) 50 50 Revenue (6) -17 -17 Rent Exp (7) -15 -15 Wage

Exp (8) -4 -4 (9) 27 -27 (10) -3 -3 Drawing Totals 98 23 6 30 2 155

UNCLASSIFIED CASH FLOWS

Once the instructor explains how the income statement (Exhibit 3), the statement of owner’s equity (Exhibit 4), and the balance sheet (Exhibit 5) are prepared from the worksheet (Exhibit 2), he can then include a discussion of how the SCF (Exhibit 6) is prepared from the cash column of that same worksheet. Because students are already familiar with the details of the problem, it should require little additional time to discuss the SCF.

Exhibit 3 Bob Jones Cleaners Income Statement

Month Ended September 30, 2000 Service Revenue 90 Expenses Rent Expense 17 Wages Expense 15 32 Net Income 58




Statement of Owner’s Equity Month Ended September 30, 2000

Bob Jones, Equity, Sept 1 0 Investment 100 Net Income 58 158

Less: Withdrawals 3 Bob Jones, Equity, Sept 30 155

Exhibit 5

Bob Jones Cleaners Balance Sheet

September 30, 2000 Cash 98

Accounts Receivable 23 Office Supplies 6

Land 30 Total Assets 157

Accounts Payable 2 Bob Jones, Equity 155

Total Liabilities & Equity 157

Exhibit 6 Bob Jones Cleaners SCF (Unclassified)

Month Ended September 30, 2000 Cash Balance Sept 1 0

Cash Receipts: Investment (T1)* 100

Service revenue in cash (T4) 40 Collection of Receivables (T9) 27 167

167 Cash Payments:

Purchased Land (T2) 30 Paid Rent Expense (T6) 17

Paid Wages Expense (T7) 15 Paid Accounts Payable (T8) 4

Withdrawals (T10) 3 69 Cash Balance Sept 30 98

*T1 = Transaction 1

For the cash receipts portion of the cash flow statement, students need only select the positive items in the cash column and describe them as in the descriptions of the transactions (Exhibit 1). There are three positive amounts in this problem. Transaction 1 is a $100 investment by the owner. Transaction 2 is $40 in cash revenues. Transaction 9 is a collection of accounts receivable. Students readily see that these are all increases in cash and how they occurred. The cash payments section is equally easy. Students select



the negative items and describe them similarly to the cash receipts. They learn that some cash payments are expenses while others are not.

They see that some items of cash flow appear on the income statement and others do not. The worksheet helps students to see why. Instructors have excellent opportunities to elaborate. The worksheet helps students use their spatial sense to reinforce their ability to discriminate between cash flow and income. Students see that cash and income have separate columns at far ends of the worksheet. Cash and income are separate parts of the accounting equation. They are not the same.

CLASSIFIED CASH FLOWS Later in the first principles course, instructors can use the same problem (as we do here) to explain how to prepare the classified SCF. In some texts, this subject is placed in the second course, so instructors might not want to use the same problem. But they can use the same worksheet to introduce the idea, and then use the standard cash flow worksheet later.

Once students understand the three classes of cash flows, it is a simple matter to prepare the classified statement (Exhibit 7) directly from the worksheet. The operating activities are any changes in the cash column that are also a change in a current asset or liability account or a revenue or expense on the income statement. Investing activities are any change in the cash column that is also a change in a long-lived asset. Financing activities are any change in the cash column that is also a change in a long-term liability or equity item.


Statement of Cash Flows-Direct (Classified) Month Ended September 30, 2000

Cash Balance Sept 1 0 Operating Activities: Service Revenues (40+27) 67 Rent Expense -17 Wages Expense -15 Paid Accounts Payable -4 31 Investing Activities: Purchased Land -30 Financing Activities: Investment by Bob Jones 100 Withdrawals -3 97 Increase in Cash 98 Cash Balance Sept 30 98



INDIRECT METHOD

The indirect method (Exhibit 8) may be prepared using the same work sheet. The net income

figure, of course, comes from the income statement (Exhibit 3). Then students simply net the amounts in each current-asset or current-liability column to get the adjustments to net income to derive the cash flow from operating activities. For example, accounts receivable increased by $23 during the period, from a balance of zero to $23. Or students may simply net the changes in the account during the period: $50 - 27 = 23.


Statement of Cash Flows-Indirect (Classified) Month Ended September 30, 2000

Operating Activities: Net Income 58 Increase in Accounts Receivable -23 Increase in Office Supplies -6 Increase in Accounts Payable 2 Cash Flow from Operating Activities 31

CONCLUSION

Introducing the SCF in chapter one should help students understand the statement better. It also should help them understand relationships between all the elements of the accounting equation. Early introduction of the SCF also offers the following:

• Requires no debits or credits. • Uses the same accounting equation approach most texts use to introduce accounting. Thus it

should be easy for students to understand. • Clearly shows students that the cash flow statement is simply an analysis of the cash account

classified into operating, investing, and financing activities. • Clearly shows students the difference between accrual and cash accounting. • Sets up easily using an electronic spread sheet program. • Shows the relationship between the balance sheet, income statement, and cash flow statement. • Works well for the indirect method of presenting cash flows. It is relatively simple to net the

amounts in each current-asset or current-liability column to derive cash flow from operating activities.



“A PATH ANALYTIC MODEL OF MUNICIPAL BUDGETARY

SLACK BEHAVIOR”

Walter B. Moore Nova Southeastern University

[email protected]

Peter J. Poznanski Cleveland State University [email protected]

Richard Kelsey

Nova Southeastern University [email protected]

This is an exploratory study seeking to understand what factors induce municipal managers to ask for excess funding in their budget requests. A survey was taken of nine hundred and twenty-eight municipal managers regarding their perceptions about: budgetary slack, budget attainability, budgetary use, slack detection, and their general attitude toward the budget. Hypotheses were testing using correlation analyses. Using path analysis, the correlations were decomposed into direct, indirect and spurious effects. It was found that managers' propensity to create slack was directly effected by slack detection, budgetary use, and their attitudes toward the budget. While budget attainability was significantly associated with slack, path analysis revealed that attainability had very little direct effect on a manager's propensity to create slack. The results of the study indicated that municipal budgetary slack behavior was similar to that found in the private sector.

INTRODUCTION

Budgets serve three decision-making functions: planning, controlling, and motivating (Ronen and Livingstone, 1975) and should be designed such that managers take actions that are in the best interest of both the organization and themselves. In their article on participative budgeting, Becker and Green Jr. (1962, p. 399) pointed out that, ". . . the budget can act as a motivating force and can induce better performance from the members of the organization." Unfortunately, Becker and Green Jr. conceded that under certain conditions budgets may also act as disincentives, adversely affecting goal congruence and performance. Schiff and Lewin (1970, p. 259) stated that, "Moreover, it is their (budgets) use as control devices that has made budgets the focus of much criticism by behavioral scientists who view them as a coercive instrument used by top management to "enforce" its objectives on the participants of the organization." Given their coercive nature, budgets may lead to undesirable behavior that can manifest itself in several ways, including the creation of excessive budgetary slack. In the municipal sector, budgets are legal documents that establish limits on spending, and therefore are used to monitor compliance with mandates established by the executive and legislative branches of government. In addition, the budget is a resource allocation scheme. Most governmental revenues, unlike revenues from profit-seeking entities, are derived from compulsory payments. Governmental revenues are generally seen as relatively fixed. Private firms may attempt to increase revenues by advertising, changing their product mix, or by altering their price structure. None of these options is readily available in the public sector. Taxes, the primary source of revenues for governmental entities, are based on rates set by legal process. It is often difficult to increase tax rates, therefore, increases in revenues must come from an increase in the tax base, which occurs slowly as a result of economic



activity. Once the budget has been approved, spending limits for each agency have been imposed and may not be exceeded without due legal process. While considerable effort has been devoted to explaining budgetary behavior at an organizational level, relatively few studies have focused on the individual manager, particularly within the context of nonprofit organizations. To date, most budgetary research at the individual level has been conducted in a profit-seeking environment. An explanatory model of budgetary slack at the individual manager level involves two questions (Lukka, 1988): (1) what are the intentions that precipitate slack creation, and (2) what are the attitudinal factors underlying these intentions? This exploratory study seeks to provide evidence addressing these two questions, as they apply to governmental entities. The nonprofit environment is substantially different from that found in profit-seeking firms, in part, due to differences in principal-agent relationships, and purposes of budgetary reporting. The following section discusses these differences.

PRINCIPAL-AGENT RELAITONSHIPS

An agency relationship is defined as, "a contract under which one or more persons (the principal(s)) engage another person (the agent) to perform some service on their behalf which involves delegating some decision making authority to the agent (Jensen and Meckling 1976, p. 308)." Assuming all parties to the agency relationship are rational, evaluative agents, maximizing individuals will not always act in the best interests of their principals. Consequently, principals provide incentives and monitor agents to reduce the divergences between the best interest of themselves and the agent. In addition, an agent will incur bonding costs as assurance to the principal that s/he will not take actions harmful to the principal. Monitoring and bonding will not totally eliminate the divergences. The reduction in the principal's interest due to these divergences are costs of the agency relationship (residual loss). Total agency costs include monitoring costs, bonding expenditures, and the residual loss. An agency relationship exists in all organizations, including governments. In municipalities the relationship exits among agency managers, elected and appointed officials, and constituencies. To the agency manager two general sets of principals exist, upper-management and voters. Agency managers make decisions that may not be in the best interest of upper-management (including mayors or city managers) or voters. In municipal governments budgets act as monitoring devices. Therefore, the additional costs of implementing budgets become part of agency costs. Zimmerman (1977) offers some insight into agency theory as it applies to municipal governments. Upper-management and departmental managers are agents of the electorate, therefore an agency problem exists. These agents will exhibit behavior incongruent with interests of the voters. This behavior may manifest itself in shirking, consuming perquisites, or performing illegal acts. Some agents (departmental managers) may pursue actions that are intended to increase the size and influence of their individual departments. One method of increasing size and influence is to increase appropriations by including slack in budget requests. Hence, conflicts occur between the departmental manager and upper-management, and the departmental manager and voters. Whenever the departmental manager engages in actions that his/her constituency or upper-management opposes, agency costs are generated. Likewise, those agents who are in upper-management (mayors and city managers) pursue their own self-interests. Upper-management are agents of the voters and will use the resources of their offices for self-serving purposes.

BUDGETARY REPORTING "Monitoring the behavior of municipal government is relatively more difficult than monitoring the behavior of corporate management since there is no invisible hand of a competitive market to impose an external discipline and there is no handy "bottom line" measure of performance (Raman, 1981, p. 352)." This lack of a competitive market requires the substitution of statutory, fund, and budgetary controls, all of which have a primary purpose of monitoring compliance with mandated fiscal constraints. Unique to the nonprofit sector is the idea of "budgetary accountability," that is, whether appropriated funds are spent as designated and within expenditure limits. In the public sector, budgets have the force of law; it both authorizes and limits the amounts expended for specific purposes. Generally, budgets cannot be modified without due process. Therefore, the budget, and the subsequent reporting of



the budget, play a more significant role in the public sector. Daniels and Daniels (1991) reported that different user groups desire different information from municipal reports. In particular, it was found that legislative/oversight officials rated compliance information the most important focus of municipal financial statements. "For example, legislative/oversight officials rely more heavily than members of other user groups on the comparison of budget to actual, particularly for judging performance and cost of services (Daniels and Daniels, 1991: p. 31)." This increased importance of the budgetary role in municipalities will manifest itself in techniques ensuring budgetary compliance, such as the inclusion of slack in budget requests. According to expectancy theory, slack facilitates the attainment of budgetary goals.

HYPOTHESES DEVELOPMENT

This exploratory study examines how four variables: (1) budget attitude, (2) budget attainability, (3) budgetary use, and, (4) information asymmetry affect an agency manager's propensity to create slack when submitting budget requests. The independent variables examined may exhibit behaviors unique to the public sector due to differences in principal- agent relationships and reporting purposes. The information flow in public sector organizations is both internal and external. Internally, information flows occur between agency managers and their superiors, such as budget departments and city managers. Externally, information flows from agency managers to the general constituency. These diverse information flows stem from the existence of multiple agency- principal relationships unique to governmental organizations. Attainability of meeting the budget becomes more important for the agency manager due to the legal status of the budget and its relatively fixed nature. Unlike the private sector budget, the consequences of a budget overrun in the public sector are far more severe, creating greater pressure on the agency manager. This increased pressure may elicit behaviors that differ from private sector managers. The political environment within which governmental entities must operate may cause agency managers to perceive the functions of budgets differently from their private sector counterparts. While it is recognized that "politics" exists, to some degree in all organizations, it is certainly more pronounced in government. In addition, since members of the city council and mayors are elected, agency managers may perceive that the budget is a "tool of reelection" and not be responsive to their needs.

Lastly, agency manager budget attitudes are likely to differ from those of private sector managers due to the reasons mentioned above. Clearly, how mangers react to (1) possessing information not shared with external parties, (2) the difficulty of operating under budget constraints, and (3) how the budget is perceived to be used will impact their overall attitudes toward the budget. This study is intended to be exploratory; in most instances it builds upon evidence provided by private sector studies. Unfortunately, few studies provide empirical evidence of budgetary behavior in public sector organizations. Consequently, many of the hypotheses are presented in the form suggesting that public sector and private sector budgetary behaviors coincide.

BUDGETARY SLACK

Crecine (1969) viewed the governmental budgetary process as being comprised of three frameworks: (1) an optimizing process, (2) an externally determined event, and (3) an internal bureaucratic process. Budgeting is expected to be an optimizing process. While governments should attempt to maximize community utility, Crecine (1969) argued that governments lack sufficient information to maximize their utility and, therefore, allocations are made based on criteria other than utility maximization. These other criteria may be seen by agency managers as arbitrary or self-serving and not "fair." The budgeting process also attempts to link community demands to expenditures. Usually community demands are interpreted by representatives. City council-members, mayors, and other local politicians adjust or mold agency requests to meet community priorities. Unfortunately, a lack of congruence between the interests of the representatives and their constituents can exist. Agency managers will believe that, although their budget requests are in the best interest of both the city and themselves, the budget has become a self-serving instrument of others. Lastly, the budget process is an internal bureaucratic process. Bureaucratic dynamics are present in both private and public organizations. Departmental or agency managers interact with other agency heads, budget departments, upper- management, and constituencies in an effort to increase resources or, in times of financial distress, to maintain current levels



of funding. The study on bureaucratic dynamics by Cyert and March (1963) provides insight into the politics of the allocation process. Often resource allocation (budgeting) may appear to be irrational, resulting in financial maneuvering, including the realignment of priorities, and the reevaluation of estimates. Cyert and March (1963, p. 270) stated that: “In budgeting . . . we expect to find that goals tend to enter as more or less independent constraints . . . Where an allocation plan apparently meets the constraints, we expect rather loose evaluations of the accuracy of the estimates and other assumptions on which it is based. Where resource rationing is necessary, we expect two general kinds of reactions: first, a tendency to use arbitrary allocation rules that maintain the relative positions of the members of the coalition; second, a tendency to reevaluate those estimates that are relatively difficult to defend in terms of traditional organizational practice.”

In prosperous times, agency managers are primarily concerned with receiving their fair share of increased funding. When revenues are declining, their efforts are directed at protecting their base. The techniques used to allocate increases and decreases in funding must be perceived by agency heads as equitable, otherwise behavior will be adversely effected, resulting in "financial maneuvering." In organization theory, the organization is viewed as a coalition of individuals. In a private enterprise these individuals include: managers, workers, stockholders, suppliers, customers, attorneys, and regulatory agencies. In the governmental sector the coalitions are made up of administrators, workers, appointed officials, elective officials, legislators, judges, clientele, and interest group leaders (Cyert and March, 1963). Payments to these individuals in excess of that needed to maintain the various coalitions are defined as organizational slack. The excess payments may be made to either external or internal parties. Internal payments are referred to as budgetary slack. Downs (1978) suggested three reasons why managers may include slack in budget requests. First, bureaus seek to expand for the following reasons: (1) rapidly growing bureaus attract better personnel, (2) an expanding bureau bestows greater power, income, and prestige to its members, (3) growth reduces conflict among bureau members, and, (4) bureau expansion increases the chance for survival. Second, some types of managers are motivated by the power and prestige provided by larger bureaucratic domains. Lastly, there is a propensity for bureau members, when faced with uncertainty, to increase their overall appropriations rather than by rearranging their existing allocations. Certainly one method of increasing appropriations, and therefore the size of the bureau, is to ask for excess resources when submitting budget requests.

BUDGET ATTITUDE AND SLACK

"Budgets are accounting techniques designed to control costs through people (Argyris, 1952; p. 97)." Given their nature, it is not surprising that attitudes toward budgets are generally negative (Samuelson, 1986). The mere mention of control has negative connotations. It is recognized that budgets serve multiple functions including planning and coordinating, and it may be that how one views the budget depends on its perceived function. As mentioned earlier, budgets are predominantly legal devices that measure compliance and, therefore, may be viewed as primarily control devices by governmental managers. Onsi (1973) sought to identify factors that induce managers to include slack in budget requests. He found that those who had a negative attitude toward the budget created slack. Ancillary evidence supporting Onsi's findings was provided by Cammann (1976) and Merchant (1985). Cammann found that a defensive posture (including creating slack) was taken by managers who viewed budgets negatively. Specifically, Cammann's result showed that when the budget was used as a rewarding mechanism, managers used "defensive subordinate responses," which included slack creation. Merchant (1985) found that certain attitudes toward the budget were negatively associated with the propensity to create slack. It should be pointed out that there are a myriad of "attitudes" about the budget. The attitudes tested by Cammann and Merchant are not identical with those tested in this study, but do indicate that the way managers view the budget affects their propensity to create slack. Onsi, Cammann, and Merchant conducted their studies within the context of profit-seeking firms. To date, there exists a paucity of evidence identifying how budget attitudes affect slack creation in nonprofit environments. The first hypothesis, in alternate form, follows:



H1: A negative association exists between the propensity to build slack into the budget and attitudes toward the budget.

BUDGET ATTAINABILITY AND SLACK

“It is often stated in the budgeting literature that the mere existence of a reward system leads to the creation of budgetary slack. The motivational impact of budgets can be reinforced by linking the reward system to budgetary control. Such a motivational impact of this link needs to be understood in terms of a larger framework such as the expectancy theory of managerial motivation (Lukka, 1988: p. 288)." The inclusion of slack reduces the uncertainty of meeting organizational goals, thus enhancing the opportunity of attaining rewards. Vroom's (1963) expectancy model suggests that as budget goals become increasingly difficult to achieve, higher levels of ability are required to perform at a level sufficient to obtain rewards. Conversely, as budget goals become easier to attain, lower levels of ability are needed to achieve budget goals. Ronen and Livingstone (1975) refined Vroom's model of expectancy theory by integrating subsequent research findings into existing theory. They contended that standards should be set such that goals are realistic and attainable. Ability interacts with how a manager perceives the likelihood of being able to achieve the budget goals. The more difficult it is to achieve budget goals, the greater the propensity to build in slack. By introducing slack, the manager lessens the degree of difficulty and, therefore, less ability is needed to successfully achieve budget goals. Since managers are often evaluated based on meeting budget goals, creating slack will increase the likelihood of successfully meeting goals and receiving rewards. In addition to its role in expectancy theory, budget attainability plays an indirect part in the principal-agent model. It is usually assumed that in agency relationships, the agent is work-averse. The inclusion of slack makes attaining budget goals easier; as budget attainability becomes easier less effort is needed. Otley (1978, p. 126) noted that "When a manager perceives that he is evaluated primarily on his ability to meet his budget . . . His response to such feelings will be such that he is more likely to bias his budget estimates by building in slack so that the budget becomes easier to attain." This appears to be consistent with both expectancy and agency theories. This study hypothesizes, in alternate form, that: H2: A negative association exists between the propensity to build slack into the budget and perceived attainability of achieving budget goals.

BUDGETARY USE AND SLACK

Budgetary use of the budget is defined, for this study, as the manager's perception of how the budget is being used. Administrators may view budgeting tasks as mere exercises in arithmetic. Many people working in the governmental sector believe that substantive decisions are political, based on influence, connections, and behind the scene maneuvers (Vinter and Kish, 1984). Wildavsky (1975, p. xii) stated: The bonds between budgeting and "politicking" are intimate. Realistic budgets are an expression of practical politics. The allocation of resources necessarily reflects the distribution of power. “Budgeting is so basic it must reveal the norms by which men live in a particular political culture for it is through the choices inherent in limited resources that consensus is established and conflict is generated.” Wildavsky's (1975) contention is supported by Hofstede (1981), and suggests that managers and their superiors will view the role played by the budget differently. "Senior management often articulate one role for the budget but budgetees then perceive that another very different role may be intended . . . such conflicting expressions of the roles of budgeting are here seen to be a major factor underlying both attitudes and behaviors orientated towards budgetary control systems (Samuelson, 1986: p. 35)." These perceived differences in budgetary roles will contribute to budgetary conflicts and uncertainty, leading to the inclusion of slack in budget requests submitted by agency managers to upper- management. This study hypothesizes, in alternate form, that:

H3: A negative association exists between the propensity to build slack into the budget and



perceived budgetary use of the budget.

INFORMATION ASSYMETRY AND SLACK

Miller and Moe (1983, p. 297) stated that, "Bureaucrats seek to maximize budgets rather than profits; their resources typically derive from lump-sum legislative appropriations rather than from selling goods in the marketplace; and in dealing with the legislature, they have an effective monopoly over information about the true costs of supply." They demonstrated that bureaucrats will put their monopoly powers to use in securing budgets higher than socially optimal. Jaworski and Young (1992) suggested that subordinates use private information to affect results, particularly when performance evaluations are based on the results. The results of their research, while not examining direct associations between informational asymmetry and slack, do provide evidence that the existence of informational asymmetry does lessen dysfunctional behavior. Specifically, it was found that information asymmetry lessened job tension, which in turn lessened the degree of dysfunctional behavior. Dysfunctional behavior was defined for their study as actions in which a subordinate attempts to manipulate elements of a control system for his/her own purposes. Since budgets are part of an organization's control system, and slack creation may be identified as dysfunctional behavior, Jaworski and Young's (1992) findings provide evidence of an association between informational asymmetry and slack. More direct evidence for an informational asymmetry/slack relationship is provided by Merchant (1985) andKmetz (1980). Merchant (1985) found that a superior's ability to detect slack was negatively associated with a manager's propensity to create slack. Merchant (1985, p. 203)pointed out that, "any of the attitude/behavior consistency theories (e.g. cognitive dissonance theory, balance theory, and congruity theory) would predict a negative relationship between superiors' abilities to detect slack and a manager's propensity to create it." His findings strongly support the predicted association between slack and information asymmetry. Kmetz (1980) administered a questionnaire to 33 governmental managers. Kmetz sought to determine whether an association existed between slack and information flow in a nonprofit context. The results showed a negative association existed between slack resources and information flow. The results from both studies support earlier findings by Onsi (1973). In this study, the fourth hypothesis in alternate form is

H4:A negative association exists between the propensity to create slack and information asymmetry.

BUDGET ATTITUDE AS AN INTERVENING VARIABLE

This study also explores the possibility that budgetary attitude acts as an intervening variable between the information asymmetry, budgetary use and attainability variables and the budgetary slack variable. Specifically, the relationship between the three remaining exogenous variables (information asymmetry, attainability, and budgetary use) and slack is modified by their effect on managers' attitudes toward the budget. The total effect of the information asymmetry variable on slack is partially attributed to the effect it has on a manager's attitude toward the budget. Onsi (1973) found some evidence that budget attitude and information asymmetry were negatively associated. The less information shared with superiors the better the manager's attitude toward the budget. Searfoss (1976) found a moderately positive association between motivation to achieve the budget and budget attainability. The more attainable the budget the more improved was a manager's attitude toward the budget. Finally, Kenis (1979) and Onsi (1973) found some support for an association between attitudes toward the budget and how the budget was used. The more meaningful the budget was perceived to be the more likely was a manager's attitude toward the budget to be positive. Given the associations among the exogenous variables and between the attitude and slack variables it would appear that attitude is acting as an intervening variable. Using path analysis the correlations among the independent variables and slack can be decomposed into direct, indirect, spurious and unanalyzed effects.

SURVEY IMPLEMENATION

The cities chosen for this study were selected from a list provided by the Government Finance



Officers Association. The sample was limited to cities having a population ranging from 25,000 to 200,000. The finance officer of each sample city was sent a letter. The letter requested: (1) their city's cooperation, (2) names and working addresses of each person participating in the budget process, and (3) a statement typed on their city's letterhead regarding the appropriateness of the study and asking employees to respond to the questionnaire. After receiving lists of budget participants, a questionnaire, a copy of the finance officer's memo, and a self-addressed stamped envelope were mailed. Due to the sensitive nature of the study, no demographic or personal questions were included in the survey. Seventy-seven cities, from twenty-seven states, agreed to participate in the survey. There were 1102 questionnaires sent out and 928 returned, representing an 84.2 percent response rate.

VARIABLE MEASUREMENT The budgetary slack variable (SLACK) addressed how managers viewed the inclusion of excess resource requests in their budget estimates. The more positive they viewed budgetary slack, the greater the propensity to include slack in their budget requests submitted to upper-management. The items chosen to measure budgetary slack were based on: (1) their use in a previous study (Onsi, 1973), (2) results of the pilot study, and (3) the results of factor analysis. A pilot study was used to test the questionnaire. The questionnaire was then revised and used for this study. The budget general attitude variable (ATTS) measured how the managers "felt" toward the budget system. This variable sought to measure if the manager had a positive or negative attitude toward the budget. The items selected were based on: (1) their use in previous studies (Collins, 1978; Collins, Seiler, and Clancy, 1984), (2) results of the pilot study, and, (3) the results of factor analysis. Perceived budget attainability (ATTAIN) reflected how managers perceived the likelihood of being able to achieve the goals specified in the budget. The items chosen to measure this variable were based on: (1) their use in previous studies (Raia, 1966; Searfoss, 1976), (2) results of the pilot study, and (3) the results of factor analysis. The questions measuring budgetary use (BU) were originally developed by the author and refined based on results of a pilot study. This variable measured the manager's attitude regarding budgetary use. Items chosen to measure the budgetary use variable were selected based on: (1) face validity, (2) results of the pilot study, and (3) the results of factor analysis. Information asymmetry (IA) was measured with items used in previous studies (Onsi, 1973; Merchant, 1985). The items were also selected based on factor analysis and usage in the pilot study. The information asymmetry variable measured the perception of managers regarding slack detection by political representatives and their constituencies.

DATA ANALYSES

Factor analysis was applied to the questionnaire items. Each item was measured using a six point Likert-type scale. Using oblique rotation, five factors were extracted and used in the study. One major advantage of oblique rotation is that the factors are allowed to be correlated. It is unlikely that behavior found in nature is uncorrelated (Kim and Mueller, 1978). These factors were retained after final rotation based on a minimum eigenvalue greater than one, observation of the scree plot, and factor interpretation relative to theory. Variable scales were formed based on factor loadings and theory interpretation (see Appendix A). The respondent scores for all questions (items) used in the scale were summed and used as the scale score for that subject. The scale scores were then used in further analyses. Two items had factor loadings below .40. These items were retained in the scale based on: (1) theory, (2) use in similar studies, and (3) face validity. Reliability tests (Coefficient Alpha) for each scale were computed. The results are presented in Table 1.

TABLE 1 COEFFICIENT ALPHA FOR VARIABLES OF INTEREST

Variable* Coefficient Alpha



SLACK .63 ATTS .49 ATTAIN .61 BU .66 IA .53 *SLACK = budgetary slack variable ATTS = attitude toward the budget variable ATTAIN = budgetary attainability variable BU = budgetary use variable IA = budgetary information asymmetry variable The results of the factor analysis confirmed each of the variables selected a priori. The hypotheses were first tested using correlation analysis. Path analysis, an extension of regression analysis, was then used to analyze the relationship among the variables. The primary advantage of path analysis is that the linear relationship (observed correlation) among variables can be decomposed into direct, indirect, spurious, and unanalyzed effects. Path analysis is a regression based technique that estimates the magnitude of linkages among variables. The estimates (path coefficients) are obtained by regressing endogenous variables on variables that directly affect it. The solution for path coefficients are simply the standardized beta coefficients obtained from the regressions. This is true only when the residual terms of the equations are assumed to be uncorrelated. Since it is virtually impossible to include all possible confounding variables, this study assumes uncorrelated residuals. The path model (Figure 1) includes three exogenous (independent) and two endogenous (dependent) variables. The three exogenous variables budgetary use, attainability, and information asymmetry are determined by factors outside the model. The arrows represent the effects among the variables. The absence of arrows between exogenous variables indicates a lack of analyzed correlation; no statement is made regarding cause and effect among these variables. Each endogenous variable was regressed on those variables directly affecting it. The following two regression models were estimated: SLACK = B1(ATTS) + B2(BU) + B3(ATTAIN) + B4(IA) +e (1) ATTS = B1(ATTAIN) + B2(BU) + B3(IA) + e (2) The relationships among the variables are represented by a series of path coefficients that are standardized beta coefficients. In each of the above equations, e represents the unexplained variance.

RESULTS The variable means and standard deviations are presented in Table 2. The following attitudes are indicated by the variable means: 1. Managers had a moderate propensity for including slack in their budgets.

2. Managers had an almost neutral feeling toward the budget. 3. Managers believed the budget to be fairly difficult to attain. 4.Managers perceived the budget to be a political device. 5. Managers believed that there exist some budget information asymmetry with the public and elected

officials. TABLE 2 VARIABLE MEANS AND STANDARD DEVIATIONS Variable* Means STandard Deviation



SLACK 3.44 .89 ATTS 1.60 .59 ATTAIN 3.87 1.07 BU 3.57 1.40 IA 2.75 1.02 *SLACK = budgetary slack variable ATTS = attitude toward the budget variable ATTAIN= budgetary attainability variable BU = budgetary use variable IA = budgetary information asymmetry variable Table 3 presents the correlations among the five variables. Slack was found to be significantly correlated with the remaining four variables. The regression results are presented in Table 5. An R2 of .242 was produced when slack was regressed on the budgetary use, attainability, information asymmetry, and attitude variables. Equation 2 produced an R2 of .261.

TABLE 3 ZERO ORDER CORRELATIONS

Variable* SLACK ATTS ATTAIN BU IA SLACK ATTS -.4242 ATTAIN -.2264 .3961 BU -.2998 .3257 .4598 IA -.4054 .5188 .3871 .3724 ___________________________________________________________________ *SLACK = budgetary slack variable ATTS = attitude toward the budget variable ATTAIN = budgetary attainability variable BU = budgetary use variable IA = budgetary information asymmetry variable

TABLE 5

REGRESSION RESULTS AND DERIVATION OF PATH COEFFICIENTS

Coefficient* Value Standard Error T Value P51 -.1419 .0242 -3.730

P52 -.2163 .0349 -5.424 P53 .0314 .0325 .809

P54 -.2791 .0416 -.7056 *P51 is the path coefficient linking slack and budgetary use P52 is the path coefficient linking slack and information asymmetry P53 is the path coefficient linking slack and attainability



P54 is the path coefficient linking slack and attitude Regression (1) R2 = .242 Regression (2) R2 = .261 The correlation between budget attitude and slack was found to be -.4242 (Table 3). This supports hypothesis 1 and earlier findings of Onsi (1973). The attitude variable also acted as an intervening variable between the budgetary use, attainability, and information asymmetry variables and the budgetary slack variable. In addition to the direct effect of attitude on slack (-.2791), information asymmetry, attainability, and perceived budgetary use affected how a manager "felt" about the budget (Table 4). How managers felt toward the budget, in turn, effected their propensity to create slack. An R2 of .2610 was produced when attitude was regressed on the information asymmetry, budgetary use, and attainability variables. A positive effect on budgetary attitude was found to exist when the manager believed that the budget was being used as a useful financial tool, when the budget was attainable, and when the manager did not share private information about slack.

TABLE 4 DECOMPOSITION OF EFFECTS

Linkage* Direct Indirect Total Effect Effect Effect BU/SLACK -.1419 -.0272 -.1691 IA/SLACK -.2163 -.1118 -.3281 ATTAIN/SLACK .0314 -.0566 -.0252 ATTS/SLACK -.2791 0 -.2791 *SLACK = budgetary slack variable BU = budgetary use variable IA = information asymmetry variable ATTAI = attainability variable ATTS = budgetary attitude variable A significant negative relationship existed between perceived attainability of the budget and the propensity to create slack (-.2264), and therefore appeared to support hypothesis 2 (Table 3). This suggested that as a manager perceives the budget to be difficult to attain, s/he will be more inclined to create slack. However, when the correlation was decomposed, only a .0314 direct effect and a -.0566 negative indirect effect through the attitude variable were found (Table 4). While a significant correlation was found, most of the effect was due to an unidentified variable(s) not included in the model, therefore hypothesis 2 was not supported. The lack of total effect between attainability and slack cast doubt on the applicability of expectancy theory in governmental contexts. This would suggest that the reward structure is not based on budget performance. Managers view the budget not only as an upper spending limit but also as the minimum. There is an apparent lack of incentive for managers to reduce spending, particularly since this may lead to reduced budgets in subsequent years. A reward system tied to budget performance would provide inducement for doing more with less. This is particularly important in a tight economy when budget-cutting can be detrimental to morale. Hypothesis 3 was supported. A correlation of -.2998 was found to exist between the budgetary use variable and slack variable (Table 3). When the correlation was decomposed, the direct effect of perceived budgetary use on slack was -.1419 and the indirect path through the attitude variables was - .0272 (Table 4). Therefore, the total effect of budgetary use on slack was -.1691. The remaining (-.1307) effect is due to spurious relationships. The results indicate that as managers perceive the budget to be something other than a meaningful financial tool, their propensity to create slack increases. Managers use slack to protect themselves against the uncertainty created by upper-management manipulating the budget.



Hypothesis 4 was also supported. Information asymmetry and slack was found to be significantly correlated (-.4054) (Table 3). When the correlation was decomposed, the direct effect was found to be -.2163, the indirect path through the attitude variables was -.1118, and the remaining effect (- .0773) was found to be spurious (Table 4). When a manager believes that slack can not be detected by superiors he/she will be more inclined to include slack in budget requests. The opportunity to create slack is more likely to exist when superiors are unable to detect its existence. The results support earlier findings by Onsi (1973) and Merchant (1985).

SUMMARY AND CONCLUSIONS

The results of this study indicated that managers have a moderate propensity to build slack in their budgets, and the propensity is affected by: (1) their general attitude toward the budget, (2) the degree of slack detection, and (3) the perceived use of the budget. The perception about budget attainability did not directly affect slack propensity. It was found that in addition to the direct effect, budget attitude acted as an intervening variable. The perceived use of the budget, level of information asymmetry and perceived budget attainability affected how a manager viewed the budget, and how they perceived the budget affected their propensity to create slack. The more negative managers viewed the budget, the greater the propensity to create slack. Adding slack reduces the uncertainty associated with meeting the budget and anxieties about how the budget will ultimately be used.

The most influential variable affecting slack was information asymmetry. The propensity to create slack was effected by the manager's belief about slack detection. The greater the information asymmetry the greater the propensity to created slack. A lack of detection provides a window of opportunity for creating slack. The perception about how the budget is used only moderately affected slack creation. When managers believed that the budget was used as a financial tool, they were less inclined to include slack in budget requests. Slack propensity was indirectly affected by perceived budget use due to its affect on a manager's attitude toward the budget in general. Intuitively, it is not surprising to find that how a manager perceived budgetary use was reflected in his/her general feeling toward the budget. The results of this study support earlier findings by Onsi (1973) and Merchant (1985). These earlier studies were conducted in private sector environments. The findings regarding budget use, information asymmetry, and budget attitudes indicated that public sector slack behavior is similar to that found in the private sector. Expectancy theory suggests that budget attainability should be negatively associated with budgetary slack behavior. The results of this study do not support this premise. While expectancy theory has found some support in private sector studies, its use in the public sector is questionable. This study is intended as exploratory. Its purpose was to provide evidence determining if slack behavior in the public sector is similar to that found in the private sector. It is recognized that different factors influence the public sector. More effort should focus on theory building and confirmatory research explaining slack behavior in nonprofit environments, including governmental entities. A relatively new approach, the Safety-First Model, may offer additional insight into the causes of increasing budgets. Hagigi, Kluger and Shields (1990) suggest that managers' propensity to overspend is due to their risk- avoidance nature, particularly when subsequent budgets are based on historical spending patterns. Future research should examine the possibility of integrating the Safety- First Model with more traditional behavioral models. Certain limitations should be considered when analyzing the findings of this study. The cities included in the sample were limited to populations of 200,000. Larger municipalities with more complex bureaucracies may possibly influence budgetary behavior differently from their smaller counterparts. Also, the findings should not be extended beyond municipalities. Budgetary behavior of governmental managers may not coincide with that of other nonprofit sector managers. Finally, two of the five variables had Coefficient Alphas below .60. The IA and ATTS variables had Alphas of .53, and .49 respectively. Therefore, while some measurement error exists, the error does not appear to be excessive.

APPENDIX A BUDGETARY SLACK _____________________________________________________________ Questionnaire Item



Factor Loading _____________________________________________________________ 13. When the opportunity arises, do you attempt to induce slack in your budget? (slack is the addition of extra funds in budget requests) .71 20. Including additional amounts in budget requests for contingencies is a good idea. .68* 22. Extra funds in the budget is good to do things that cannot be officially approved. .41* 26. Other managers routinely add amounts for contingencies in their budget request. .42* 30. My supervisors are seldom opposed to my adding extra amounts in my budget requests. .31* 50. Reducing my budget in one year will prevent me from acquiring adequate funding in a subsequent year. .26* 56.Slack should never be included in budget requests. .77 _____________________________________________________________

BUDGET ATTITUDE

_____________________________________________________________ Questionnaire Item Factor Loading _____________________________________________________________ 12. Special problems I have mentioned to budget people have been ignored when setting the new budget. .45* 25. My budget is predetermined based on last year's budget. .59 31. To protect himself, a manager submits budget requests that can safely be attained. .41 40. The city does not receive adequate funding. .41 50. Reducing my budget in one year will prevent me from acquiring adequate funding in a subsequent year. .57 _____________________________________________________________



BUDGET ATTAINABILTIY _____________________________________________________________ Questionnaire Item Factor Loading _____________________________________________________________ 21. The budget is usually set too tight. .47 28. The budget is usually difficult to achieve. .73 29. I have no control over my department budget. .46 39. Budget goals set by the city council and/or upper-management is usually unrealistic. .45 _____________________________________________________________

BUDGETARY USE _____________________________________________________________ Questionnaire Item Factor Loading _____________________________________________________________ 19. Budget preparation is a political rather than financial exercise. .81 35. Budget preparation is more political than financial. .80 52. Politicians have more control over budgets than department managers. .49 _____________________________________________________________ INFORMATION ASSYMETRY _____________________________________________________________ Questionnaire Item Factor Loading _____________________________________________________________ 48. The general public is not aware of how budgets are prepared. .77 49. Politicians are not aware of slack in municipal budgets. .53 50. Reducing my budget in one year will prevent me from acquiring adequate funding in a subsequent year. .40 51. Taxpayers and politicians do not appreciate managers making sincere efforts to reduce their department's expenditures. .52 _____________________________________________________________ Note: *Item was reverse coded to aid interpretation



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to Achieve the Budget," Academy of Management Journal, December, 1973, 541-553. Vinter, R.D., and R.K. Kish, (1984) Budgeting for Not-For-Profit Organizations (New York: Free Press,

1984). Vroom, V.H., (1964) Work and Motivation (New York: Wiley, 1964).

Wildavsky, A., (1975) Budgeting - A Comparative Theory of Budgetary Processes (Boston: Little, Brown, 1975).

Zimmerman, J.L., (1977) "The Municipal Accounting Maze: An Analysis of Political Incentives," Journal of Accounting Research, 1977, 107-144.



A VISUAL APPROACH TO TEACHING THE REA ACCOUNTING MODEL

Rupp, Galen L.

Pittsburg State University [email protected]

Hardin, J. Russell


ABSTRACT

The traditional, view-driven accounting system architecture based on debits and credits, journals,

and ledgers is often not capable of providing the information that management and other users need in today’s rapidly changing business environment. Based solely on providing a financial view of operations, it ignores critical nonfinancial information such as quality, customer service, and other essential information about business processes. An event-driven architecture using a relational database approach has been suggested as a possible alternative to the traditional accounting system architecture. This paper discusses the use of the REA (resources, events, and agents) model for designing the database structure (tables) for an event-driven architecture. A visual approach to teaching the REA model is presented along with illustrations. This approach makes it easier for students to understand and apply the various steps in the REA modeling process. While the visual approach is useful in almost all of the steps, its greatest contribution is simplifying the task of defining cardinalities. This difficult step is made relatively easy by using sequential or animated multimedia slide presentations.



ACCOUNTING FOR DECISION MAKERS: A NEW STRATEGY TO EMBRACE NON-BUSINESS AND

BUSINESS RELATED MAJORS

Conway, Susan Slippery Rock University [email protected]

Zulauf, Lori

Slippery Rock University [email protected]

The Challenge: How does the Accounting curriculum provide both the financial and managerial skills

that non-business and business related majors need in a one-semester survey course? The Solution: Accounting for Decision Makers, a new, user-friendly survey course developed to

introduce both financial accounting and budgeting to service and retail majors, such as tourism, sports management and communication.

Following is the detail explaining the development of this course, along with a comprehensive case study on budgeting for the service sector. Slippery Rock University's accounting department has developed a unique financial and managerial survey course tailored to the needs of business-related and non-business majors. Previously these majors did not require accounting due to the level of difficulty and excessive detail. The survey course is now required of many Communication, Sports Management, and Park & Recreation majors. The course was developed in response to a survey of non-business alumni and their employers, which indicated that their strongest accounting need is for understanding financial statements and budgeting. Most accounting survey courses do not meet this need because budgeting is not a part of the course content. In addition, textbooks are difficult to find because most textbooks' budgeting coverage is focused on manufacturing organizations. Slippery Rock's course is designed to provide an overview of basic accounting principles, standards and practices. The students then classify, analyze and interpret accounting information in order to prepare budgets and make business decisions.

The first half of the course, Accounting for Decision Makers, emphasizes financial terminology, interpreting and using information provided by the accounting cycle, understanding the uses and purposes of financial statements, and identifying accounting control procedures. The second half of the course focuses on using accounting information to prepare budgets, analyze variances, and implement internal controls so that the business achieves its financial and non-financial goals. A comprehensive budgeting case study is assigned in the second half of the semester, enabling the student to develop and analyze the various components of a budget.

THIS PAPER WILL INCLUDE

Survey Results from Alumni and Employers Catalog Description and Abbreviated Syllabus Book Selection Criteria Enrollment Data Feedback from Faculty and Students Comprehensive Case Study: Bloom Music Center



SURVEY RESULTS FROM ALUMNI AND EMPLOYERS

Below are the results of a survey of employers of our Parks & Recreation majors and Parks & Recreation alumni who graduated 3-7 years ago. They were asked to evaluate the following topics by the level of understanding needed. Response: 1. Students will require detailed, technical understanding of this concept. 2. Students will require a conceptual understanding of this topic. 3. Students do not need this topic. The responses are listed in order of importance.

NUMBER OF RESPONSES

#1 #2 #3 Mode Mean Expense Budget 20 2 0 1 1.09 Variance Analysis 19 3 0 1 1.14 Cash Budget 14 6 3 1 1.38 Sales Budget 14 6 1 1 1.38 Inventory 14 7 1 1 1.41 Income Statements 12 9 1 1 1.50 Statement of Cash Flows 12 9 1 1 1.50 Production Budget 11 9 1 1 1.52 Balance Sheet 10 12 0 2 1.55 Accounts Payable 10 9 1 1 1.55 Accounting Cycle 9 11 2 2 1.68 Accounts Receivable 9 10 3 2 1.73 Double Entry Accounting 8 11 3 2 1.77 Internal Control 9 9 4 1 & 2 1.77 Accrual vs. Cash Basis Acct. 5 13 4 2 1.95 Computerized Accounting Systems 6 11 5 2 1.95 Leasing Rules 3 11 7 2 2.19 Accounting Information Systems 1 14 7 2 2.27 Present Value 1 12 7 2 2.30 Ratio Analysis Financial Statements 0 15 7 2 2.32 Depreciation 0 15 7 2 2.32 Accounting Standards 0 14 7 2 2.33 Bad Debt 1 12 9 2 2.36 Plant Assets 0 12 9 2 2.43 Investments 2 8 12 3 2.45 Notes Payable 2 7 12 3 2.48 Int'l Acct. and Global Economy 0 8 13 3 2.62 Mortgages Payable 2 2 17 3 2.71 Bonds Payable 1 4 16 3 2.71 Stockholders' Equity 0 6 15 3 2.71

ALUMNI AND EMPLOYER SURVEY COMMENTS

“Rating based on a position in recreation. Resort managers would need understanding of all concepts.” “I would have loved to have some accounting classes in my background. I often struggle following basic accounting procedures. I believe it has cost me jobs when I have interviewed and not had the skills required.”



“Basically, you have to know your debits and credits. Inventory is very important.” “Types and levels of accounting knowledge is going to depend on the size and type of the facility the student is employed with. Also, as they move up in the company they will need to know different aspects. Budgeting is definitely an area I would concentrate on.” “Offer information that aids the computer aspects.” “Simple ideas rather than complex problems: payroll, insurance, workman’s comp, and OSHA.” “Address padding a budget for problems.” “At my current position, I’m not involved in the budget process. I’m told what I have to spend and that is the last I hear from them.” “Explain job costing.” “In past experience, students in general need a better understanding/knowledge of how to determine program costs and set fees for programs. I have had staff that thought we simply took a price from thin air, etc.” “Other suggestions I have are preparation of profit and loss statement, profit and loss projection, difference between profit and loss projection and cash flow projection, and understanding of terms such as ROI, EBIT, EBIDT, etc.” “Cash flow, profit loss statements, and a basic budget design are very important.” “Understanding financial statements (YTD/monthly), cash flow budgets, and capital/restricted budgets vs. operating” “Our interns receive an opportunity to create, track, and utilize a working budget as part of their special project. They will also have a general understanding of our department, as well as, the resorts overall budget. Being very hands on internship experience, exposure to the accounting/financial side of the resort is limited. We do offer special training sessions during our weekly staff meetings in order to provide the interns with as much exposure to this area as possible.” “Good understanding of cost of goods sold, retailing and its impacts on inventory, and cash flow.”

ALUMNI AND EMPLOYER SUGGESTIONS FOR CASES OR PROJECTS “Bring in local business person(s) (corporate and self employed entrepreneur) to review their respective financial procedures.” “Have someone come in from a Recreation Department and show the students an example of everything the recreation personnel has to do relating to Accounting.” “Plan an event, project costs, develop budget (Revenues, costs, overhead) operate, evaluate fiscal goals vs. actual.” “Develop month long calendar of events, do budget and projections based on estimated attendance, then analyze based on actual costs and attendance revenues.” “Plan a line item budget or provide the budget and give a list of problems (pitfalls) for students to figure out.” “Have students prepare a budget report based off of quarterly activity within their budget. Present the



report to the class. (A.k.a.-managers, owners, board of supervisors)” “Present students with a cash flow problem. Ask students to design a form(s) that would track revenues and expenses daily, weekly, and monthly. Have them explain their line of thinking and explain how the forms would be used within the organization.” “Have the students do a profit, loss analysis of a resort per month and let them analyze for practice.” “Determine price from budgeted cost of goods sold and cost of item. Determine cost of goods sold based on cost of item and retail price. Use this information to forecast sales budget and open to buy. Develop a purchasing plan for 12 months.”

ACCOUNTING FOR DECISION MAKERS CATALOGUE DESCRIPTION The course is designed to provide an overview of basic accounting principles, standards and practices to enable managers in service industries to classify, analyze and interpret accounting information and to use accounting information to prepare budgets and make business decisions. The first half of the semester emphasizes financial terminology, interpreting and using information provided by the accounting cycle, understanding the uses and purposes of financial statements, and identifying accounting control procedures. The second half of the semester emphasizes the use of accounting information to prepare budgets, analyze variances, and implement internal controls so that the business achieves its financial and non-financial goals.

ABBREVIATED COURSE SYLLABUS Part One: Financial Accounting A. Accounting and Organizations B. Accounting Process

1. Purpose of Organizations 2. Decisions in Organizations 3. Transformation Process

C. Information in Organizations 1. Information for Decision Makers 2. Information Systems 3. Processing Accounting Information

D. Accounting Measurement E. Accounting for the Transformation Process

1. Accounting for Incomplete Transformations 2. Time and Accounting Measurement 3. Accrual vs. Cash Measurement 4. Measuring the Transformation Process

F. Processing Accounting Information G. Processing Transactions

1. Accounting Cycle 2. Accounting Systems 3. Control of Accounting Systems

H. Reporting Accounting Information I. Purpose of Financial Statements

1. Financial Statement Content and Presentation 2. Use of Financial Statements 3. Financial Statements and the Transformation Process

J. Annual Report: Walt Disney



Part Two: Managerial Accounting

A. Introduction to Budgeting 1. Where Do We Obtain Budget Information 2. Generating the Budget Numbers

B. Sales Budgets C. Expense Budgets

1. Seven Methods to Budget for Expenses 2. Payroll Budgeting

D. Costs E. Calculating FC, VC, Per Unit Cost, Job Order Costing and Allocation of Costs in a Service

Industry F. Cash Flow Budgets G. Static vs. Flexible Budgeting H. Variances I. Management Control and Budget Preparation Process J. Getting the Budget Approved

MAJOR POINTS TO CONSIDER WHEN SELECTING A BOOK Financial Perspective:

♦ Accounting equation ♦ Emphasizes financing, operating and investing activities ♦ Covers major business forms ♦ Cash versus accrual concepts clearly explained ♦ Process accounting information is in equation format Managerial Perspective ♦ Budgeting from a service/retail sector viewpoint ♦ Detailed emphasis on the preparation of sales budgets, expense budgets, payroll budgets and cash flow

budgets ♦ Calculating break even points ♦ Fixed costs, variable costs and per unit cost concepts ♦ Calculating variances ♦ Analyzing variances and emphasizing the corrective action needed to improve performance

The textbook we currently use is Accounting Information for Business Decisions, Volumes 1 and 2 by Cunningham, Nikolai and Bazley, Harcourt Brace College Publishers, ISBNs 0-03-022438-1 and 0-03-022439-X. Other possible choices include Financial Accounting: Information for Decisions, 3e by Ingram and Baldwin, South-Western College Publishing, ISBN 0-538-87062-1 coupled with over the counter books such as Budgeting A La Carte, by John A. Tracy, John Wiley & Sons, Inc. ISBN 0-471-10928-2 and Essentials of Business budgeting, by Robert G. Finney, American Management Association, ISBN 0-8144-7836-0. Additional information on text selection as well as comprehensive case studies are available from the authors.

ENROLLMENT DATA

Semester Number of Students Number of Sections

09/97 15 1 01/98 27 1 09/98 40 2 01/99 31 1



09/99 72 2

FEEDBACK FROM FACULTY AND STUDENTS

Experience revealed that the non-business majors were a receptive audience, eager to understand what would be expected of them in the workforce, and how this type of knowledge would be critical in their career. Furthermore, the tensions and fears about accounting and the intimidation of debits and credits were minimized. The course increased a large majority of the students’ confidence in their abilities, and with encouragement, some went on and enrolled in Principles of Accounting I. Slippery Rock University’s accounting department has received favorable feedback from the chairs of the

Parks & Recreation Department and the Sports Management Department. As part of the Parks and Recreation/Environmental Resort Recreation Management/Tourism major each student must intern in a company related to their specific major. A requirement of the internship program is that weekly reports must be submitted back to the instructor. Two students who had taken Accounting for Decision Makers prior to their internships had the following to say about this particular course:

During the week I have gained a lot of knowledge about the management responsibilities in this sector of the Recreation Department. Rather than spend my rotation cleaning bikes, the Wheels N’ Keels manager spent almost all of his time going over his daily duties with me. We worked on the budget, inventory, the tracking system, and some end of the month reports. He gave me some responsibilities during my rotation like completing reports on my own following his examples. I also did some work on the budget and the budget variances. This work was heavily related to the Accounting for Decision Makers course I took my last semester. The course talked a lot about determining budget variances. I was amazed to see how it actually does relate to many operations. The accounting classes that I have taken throughout my education have been very helpful. “Accounting for Decision Makers” is one of the most needed courses for future managers. So much of the information that I received in the course has been related to my internship. Although every budget is different in its own way, there is a lot of important information in each one. A good manager needs to know how to read a budget and make decisions accordingly based on the numbers. (Kim Byrns, Weekly Report Number 3.)

Another student while interning at Hilton Resort wrote:

Already I’m starting to see where that accounting class fits in to our tasks . . . If you could, please pass on the message to Dr. Susan Conway in the accounting department that everything she spoke about so far is true and thanks for her help. (Mike Florence, Weekly Report Number 2).

CONCLUSION This course is a very practical and has been well received by students, faculty,

and employers. Anyone who wishes to develop a similar course is encouraged to contact the authors. A comprehensive case study for use in the course follows. Additional comprehensive case studies written by Susan Conway and Angela Savocchia are available upon request.

BLOOM MUSIC CENTER CASE STUDY ACCOUNTING FOR DECISION MAKERS

Bloom Music Center (BMC) is an outdoor amphitheater located outside a major metropolitan city on a major interstate. BMC has only been in operation for three years. The owners fired the prior manager for a variety of reasons, including poor management, inadequate bookkeeping, security problems, and customer



complaints. BMC has yet to show a profit. You commenced your job as the new head manager at BMC on October 1, 1998. BMC follows a calendar year for accounting purposes. The owners have communicated to you that on November 20, 1998, they would like to meet with you and review the budget for calendar year, 1999, as well as your ideas and plans to make BMC profitable. The only piece of information you find in the files is the current year’s expense budget, disclosing actual expenditures incurred versus the expenditure budget. (See Exhibit A). Since the amphitheater is only open for five months of the year (May, June, July, August, and September), the ten month information is fairly complete and can be used to budget next years’ numbers. Being the ambitious and levelheaded manager you are, you roll up your sleeves and go to work. Within the first two weeks you managed to do the following:

A. You interviewed the person who works in accounting and reviewed the accounting files. The notes you made are on Exhibit B.

B. You reviewed the list of concerts for the upcoming season on Exhibit C, along with the information the concert promoter gave you.

C. You interviewed the Head of Security and Maintenance for his input regarding his staffing needs. See Exhibit D.

D. You interviewed the Head of Concessions for her input. See Exhibit E. E. You also interviewed the Head of Parking for his input into the budget. See Exhibit F.

Overall, your review of the file and the interviews with key personnel enabled you to compile the following information: 1. The amphitheater was built in 1995 and commenced operations in 1996. The amphitheater has

incurred operating losses for the last three years. 2. Budgets were prepared, but management never analyzed the variances, or took corrective actions.

Furthermore, the prior manager did not pay attention to detail and tended to predict estimated figures based on actual information, but without further analyses. Despite this, at least you were able to verify that some expense totals were accurate as you reviewed the documentation. However, you question the propriety of certain expenditures and conclude that last years’ budget was not adequately prepared.

3. There are three major sources of revenues:

a. Ticket Sales b. Parking Revenue c. Concession Revenue

4. Administrative staff consists of eight people. Their salaries in 1998 were as follows: a. Manager $70,000 Married with kids b. Accountant $40,000 Married, no kids c. Jr. Accountant $28,000 Single d. Receptionist $22,000 Single e. Parking Manager $45,000 Married with kids Copyright 1999 Susan Lynn Conway f. Concession Mgr. $38,000 Single g. Security/Maint. Mgr. $40,000 Married, no kids h. Promotions Mgr. $50,000 Single 5. BMC’s administrative staff work full-time all year. 6. BMC offers the following benefits:



Medical Insurance: Premiums: Single: $100/month

Married, no children: $200/month Married, children: $300/month Dental Insurance: Premiums: Single: $20/month All others (married with kids or without kids): $40/month Medical and dental insurance premiums are paid 80% by the company and 20% by the employees. Pension: BMC contributes 10% of all administrative salaries each year into a pension fund. 7. Payroll Information Federal withholding tax is withheld as follows: Single: 20% of gross pay Married with no kids: 16% of gross pay Married with kids: 14% of gross pay BMC pays FUTA tax of .8% on the first $7,000 of all administrative salaries. BMC pays its share of FICA taxes at 6.2% on the first $64,500 in salaries of each worker. In addition, BMC pays 1.45% in Medicare taxes on the salaries of all administrative workers. BMC pays state unemployment tax to the state of New Sunnyville of 1% for all administrative employees on the first $7,000 in wages for each employee. No overtime is paid to administrative staff. Administrative salaries are expected to increase next year. 8. BMC has 30,000 seats underneath the pavilion and four main lawn areas that can accommodate

2,500 customers each. Depending on who is performing, BMC may or may not be full. 9. BMC is open from May 1st to September 30th and presents concerts four times a week. (Each month

has four full weeks.) 10. The parking lot can accommodate up to 45,000 cars. The cost to park a car at the concert is $15.00.

The cost to park a bus at a concert is $45.00. The cost to park a car in the reserved parking lot is $30.00. The parking revenue varies depending on the number attending, and the mix of cars, buses and reserved vehicles.

11. The administrative staff is located in an office building occupying approximately 3,500 square feet.

The building cost $350,000 to build and has a useful life of 20 years. This building is used all year long. All costs associated with the building are fixed.

Copyright 1999 Susan Lynn Conway 12. There are three other buildings on the grounds. Building A stores the maintenance equipment and is

9,000 square feet; it cost $100,000 to build and has a useful life of 20 years. Building B is used for security purposes. Building B has 2,000 square feet and cost $40,000 to build. It has a useful life of 20 years. Building C cost $50,000 to build; it also has a useful life of 20 years and covers 3,000 square feet. Building C is used for concession storage.

13. In addition there are ten concession huts. Each hut cost $ 4,000 to build and is being depreciated over



a useful life of five years.

(All storage buildings and huts have electric, but no heat. In addition, all buildings and huts have at least one telephone line.) The security and maintenance building have two phone lines.

14. There are four main bathroom facilities located at BMC. Each of these buildings covers 3,000 square feet. There are no phones and no heat in these facilities. These buildings are fully depreciated.

15. Equipment (grounds and administrative) cost $400,000 and is being depreciated for five years on a

straight-line basis. Copyright 1999 Susan Lynn Conway

BLOOM MUSIC CENTER BUDGET VS ACTUAL EXPENDITURES FOR 1998

EXHIBIT A

1998 1998 BUDGET ACTUAL VARIANCE VARIABLE EXPENDITURES Credit Card Expense $2,300,000 $2,280,000 $(20,000) F Electric 1,000,000 1,500,000 500,000 U Food & Beverage Cost 3,000,000 3,800,000 800,000 U Maintenance 5,000,000 7,000,000 2,000,000 U Trash Removal 500,000 750,000 250,000 U Sewage 2,000,000 2,300,000 300,000 U Telephone 200,000 275,000 75,000 U Performer Fees 50,000,000 55,000,000 5,000,000 U Commissions 4,000,000 3,700,000 (300,000) F TOTAL VARIABLE EXPENDITURES

$68,000,000 $76,605,000 $8,605,000 U

FIXED EXPENDITURES Administrative Salaries $280,000 $333,000 $53,000 U Administrative Payroll Taxes 65,000 85,000 20,000 U Administrative Benefits 60,000 52,000 (8,000) F Administrative Pension 28,000 32,000 4,000 U Staff Hourly Wages 7,000,000 8,000,000 1,000,000 U Maintenance Hourly Wages 2,000,000 2,600,000 600,000 U Payroll Taxes for Staff and Maint Hourly 1,800,000 2,300,000 500,000 U Maintenance Wages Full-Time 125,000 129,000 4,000 U Advertising 4,000,000 4,750,000 750,000 U Dues and Subscriptions 100,000 90,000 (10,000) F Landscaping 6,000,000 6,500,000 500,000 U Insurance 500,000 475,000 (25,000) F Licensees and Fees 120,000 100,000 (20,000) F Postage 25,000 26,000 1,000 U Office Supplies 40,000 32,000 (8,000) F Printing 80,000 81,000 1,000 U Legal and Accounting fees 250,000 200,000 (50,000) F Repairs and Maintenance 65,000 60,000 (5,000) F Utilities 4,000 5,000 1,000 U Sewage 500 600 100 U Telephone 6,000 7,000 1,000 U



Trash Removal 100,000 100,000 - Depreciation, Buildings 46,500 46,500 - Depreciation, Equipment 80,000 80,000 - Software Amortization 3,800 3,800 - TOTAL FIXED EXPENSES $22,778,800 $26,087,900 $3,309,100 U TOTAL VARIABLE & FIXED EXPENSES

$90,778,800

$102,692,900

$11,914,100 U

Copyright 1999 Susan Lynn Conway EXHIBIT B BMC Expense Information Information pertaining to variable expenses: 1. Normally 90% of all ticket sales are paid with credit cards (parking revenues and concession revenues

are all paid for with cash). The credit card company charges a 3% fee for processing. 2. BMC pays a 5% commission on ticket sales revenue to Ticks Master for processing all ticket sales. 3. A large portion of the electric bill is variable due to the parking and amphitheater lights used during

concerts. Electric is expected to increase in cost by 10% from last year’s actual. 4. Cost of Food and Beverages (see Exhibit E). 5. The sewage cost has been renegotiated and the fixed portion is expected to be the $1,000 and the

variable is expected to be the same as 1998’s budgeted amount. 6. The trash removal contract has been renegotiated based on both a fixed fee and variable rate per ton. It

is anticipated that total trash removal will cost approximately $1,000,000; 10% of this amount is fixed, the remainder is variable.

7. According to the entertainment industry standards, maintenance for all building, parking lots, pavilions and lawn areas should be approximately 15% of ticket revenues.

8. Telephone charges are excessive. It was determined that there was no control over any of the part-time help in prior years and anyone could use the phone for long-distance and 1-900 calls. This year, a new software package was installed on the phones and now long distance calls are logged. Furthermore, all phones except the administrative offices can only make local calls. The telephone representative has reviewed your bills and indicated that with these new security features, your total telephone bill should be $280,000 for 1999. 40% of this is fixed and the rest is projected to be variable.

9. The manager of promotions is responsible for negotiating the fees to be paid to the performers. Prior management used to negotiate this and was taking a kickback from the promoters. However, the new manager of promotions has successfully negotiated performer fees to be 50% of ticket sales.

Information pertaining to Fixed Expenses: 1. Administrative salaries (including yours) are expected to increase by 10% for 1999. 2. Hourly staff salaries are expected to increase to $8,500,000 for 1999 due to the increase in the

minimum wage that will be effective January 1, 1999. 3. You are to calculate the full time maintenance workers payroll and use this total number for the

budget. Use the attached formatted sheets to set up your schedules. 4. Part-time maintenance workers payroll will total $1,800,000 for 1999. 5. Advertising was high for 1998 because BMC undertook a special public relations campaign to

advertise its new and improved image. Advertising for 1999 should be budgeted at 80% of 1998’s budgeted amount.

6. Dues and subscriptions for 1999 are expected to be 50% less than 1998’s actual. 7. Landscaping costs should decrease because all major landscaping has been completed and now all

BMC has to do is maintain the grounds. EaZ landscaping has just negotiated their contract with you for 1999. Total cost $1,500,000.

8. The insurance company informs you that BMC’s insurance premiums will be raised for 1999 due to vandalism and damage incurred during two Buffe concerts and a personal injury suit filed against BMC and settled. Insurance will be increased $25,000 from 1998’s actual amount incurred.

9. Licenses and fees will be the same as 1998’s actual amount.



10. Postage is expected to be the same as actual for 1998. 11. In the past employees were stealing office supplies because supplies are not locked and requisitions

forms were not completed. It is anticipated that supplies should cost the company about $20,000 for 1999.

12. Printing costs for brochures, banners, concession stands and kiosks were part of the public relations campaign undertaken last year. This year printing costs are expected to be only 50% of the amount budgeted for 1998.

Copyright 1999 Susan Lynn Conway 13. Legal and accounting fees cost approximately $25,000. The 1998 calendar year was a bad year due to

litigation against BMC that was subsequently settled. There is no potential for litigation anticipated in 1999; therefore, you should use the original amount for the 1999 budget.

14. Repairs and maintenance on the three buildings (A,B,C) are expected to be $15,000 per building, $20,000 for the administrative building and $500 for each of the huts. The maintenance for the stage and pavilion is expected to be $80,000.

15. Utility companies are at it again! Rate hike. Increase the 1998 budget amount by 10% for 1999. 16. Sewage—see variable information above. 17. Telephone—see variable information above. 18. Trash Removal—see variable information above. 19. Calculate depreciation for the buildings and equipment. All depreciation is on a straight-line basis.

Amortization for computer software is calculated at an accelerated rate; use $2,800 for 1999. Copyright 1999 Susan Lynn Conway EXHIBIT C 1999 CONCERT SEASON INFORMATION ANTICIPATED ATTENDANCE WEEK 1 SHOWS FOR BMC

BOTCH BOYS 80% CAPACITY PEPPER GIRLS SOLD OUT NJ SYMPHONY 50% CAPACITY RAFFLES 40% CAPACITY

WEEK 2 JAZZ FESTIVAL SOLD OUT NATALIE COLT SOLD OUT COMEDY JAM SOLD OUT NJ SYMPHONY 50% CAPACITY WEEK 3 GRATEFUL ALIVE SOLD OUT MITCH CRAWFORD SOLD OUT OLDIES CONCERT SOLD OUT NJ SYMPHONY 50% CAPACITY WEEK 4

JIM BENSON 80% CAPACITY HOTTFISH AND BLOWIE SOLD OUT DISCO REUNION SOLD OUT NJ SYMPHONY 80% CAPACITY WEEK 5 VAN MORRIS SOLD OUT JEWELS SOLD OUT



YAWNY 90% CAPACITY NJ SYMPHONY 80% CAPACITY WEEK 6 DONNY & CHER 70% CAPACITY JOURNEY ON BY SOLD OUT JOHN TISHY 70% CAPACITY NJ SYMPHONY 90% CAPACITY WEEK 7 PHIL VILLAS SOLD OUT ROD STEW SOLD OUT SMASHED CRANBERRIES SOLD OUT NJ SYMPHONY 90% CAPACITY WEEK 8 PUMPKINS SOLD OUT TIM TRITT SOLD OUT SWING KIDS SOLD OUT SKYLINE 90% CAPACITY WEEK 9 DIANA ROSSI 60% CAPACITY BEST OF BLUE GRASS SOLD OUT NJ SYMPHONY SOLD OUT BILLIE RAY WEED SOLD OUT Copyright 1999 Susan Lynn Conway WEEK 10 STRING SOLD OUT JOE CASH 60% CAPACITY SELTZER SOLD OUT EAGLES FLY SOLD OUT REVENUE INFORMATION The pavilion seats cost $30.00 each. The lawn seats cost $20.00 each. If sold out, there are 30,000 pavilion seats and 10,000 lawn seats. If the concert is not sold out, prior experience illustrates that the ratio of pavilion seats to lawn seats is 80% pavilion to 20% lawn seats. NOTE: Detailed information has only been provided for the first ten weeks out of a 20 week season. The remaining ten weeks worth of concerts (ten weeks at four concerts a week) are at 90% capacity each. Copyright 1999 Susan Lynn Conway EXHIBIT D Security and Maintenance Manager The manager of Security and Maintenance provided you information pertaining to the payroll for the five, full-time, maintenance employees. The other maintenance workers are part-time hourly people. The payroll amount for the hourly part-time workers is listed on Exhibit B. Note: this amount does not need to be calculated and was given to you. Please see attached detail for the five, full-time, maintenance workers. The Security and Maintenance Manager has no accounting or budgeting experience. Therefore, you will need to calculate all information for these particular workers. Next year you are going to train him how to prepare the budget for the full-time maintenance staff.



EXHIBIT D-1

BLOOM MUSIC CENTER PAYROLL FOR FULL-TIME SEASONAL MAINTENANCE WORKERS FOR TEN MONTHS ACTUAL AND TWO

MONTHS PROJECTED, DECEMBER 31, 1998

HOURS 1998 HOURLY 1999 BUDGETED MARITAL EMPLOYEE WORKED RATE** HOURS STATUS Edgar 1,920 $8.50 1,920 S Layman 1,700 $6.00 1,920 S Palm 2,220 $7.50 2,000 S Simm 1,983 $10.00 1,960 S Garfunk 2,101 $11.50 2,000 S

Additional Facts: 1. All hours over 1,920 hours are considered overtime. 2. All hourly employees receive overtime pay at 1 1/2 times their regular pay rate. 3. ** The hourly wage rates for 1999 will be increased by $1.50. 4. BMC pays 6.2% in FICA taxes on the first $64,500 that each employee earns. 5. Medicare taxes are paid on total wages at 1.45%. 6. State unemployment (SUTA) and federal unemployment (FUTA) are paid on the first $7,000 in wages. SUTA = 1% and FUTA = .8%. 7. Federal withholding tax is withheld at a flat rate of 18% on all wages. TO DO: Prepare a detailed budget for 1999 based on the above information. To get credit you must submit your worksheets detailing how you calculated your numbers and your final answer must be submitted in the format attached. Copyright 1999 Susan Lynn Conway EXHIBIT D-2 Suggested format for showing your detail. BLOOM MUSIC CENTER PAYROLL BUDGET FOR FULL TIME SEASONAL

WORKERS FOR THE YEAR ENDING, DECEMBER 31, 1999

EDGAR LAYMAN PALM SIMM GARFUNK TOTALS Regular Pay $- $- $- $- $- $- Overtime Pay Federal W/H Tax FICA Medicare FUTA SUTA TOTALS $ $ $ $ $ $

EXHIBIT E Concessions Manager



The Concession Manager tells you that Food and Beverage Revenues are approximately 10% of total ticket sales and that the cost of food and beverages is approximately 5% of the revenue derived from food and concessions. All her people (excluding the Concessions Manager) work part-time. She maintains fairly accurate records for her area and you feel confident in the percentages she gave you. You will use these this year and do a detailed review of her area next year. Given her competence, you feel she can easily be trained to calculate a detailed budget for concessions. EXHIBIT F The Parking Manager has indicated to you that for concerts with attendance greater than 55% of capacity, parking revenues are normally collected on 20,000 vehicles each concert. Of the 20,000 vehicles, 80% are for cars for normal parking, 10% are buses, and 10% of the cars are in reserved spots. For concerts with less than 55% in attendance, parking revenues are collected on average for 10,000 vehicles each concert. Of the 15,000 vehicles, 80% are for normal parking of cars, 10% are for buses and 10% of the remaining cars park in reserved spots. REMEMBER: YOU ARE GIVEN DETAIL FOR FORTY CONCERTS, HOWEVER FOR THE REMAINING FORTY CONCERTS YOU WERE GIVEN A CERTAIN CAPACITY RATE FOR EACH OF THOSE CONCERTS. DO NOT FORGET TO CALCULATE PARKING FOR ALL 80 CONCERTS. Copyright 1999 Susan Lynn Conway INSTRUCTIONS First: Prepare the revenue budget. Show all detail and present your final answer in the format below: Ticket Sales Concession Revenue Parking Revenue Revenue Second: Prepare the payroll budget for the administrative employees. Please use the format provided. Third: Prepare the payroll budget for the five full-time maintenance workers. Fourth: Prepare the expense budget for fixed and variable expenses. Fifth: Complete the final budget for 1999 in the format provided. Sixth: Write a detailed analysis on how you plan to make BMC profitable, better manage your people, and implement internal accounting controls. Please make sure to write down all the assumptions you made when preparing the various budgets. READ CAREFULLY BE NEAT CHECK YOUR WORK Copyright 1999 Susan Lynn Conway



THIS IS THE FORMAT YOUR FINAL ANSWER MUST BE IN.

BLOOM MUSIC CENTER BUDGET FOR 1999 BUDGET 1999

Revenues Ticket Sales $ Concession Revenues Parking Revenues Total Revenues $ Variable Expenditures Credit Card Expense Electric Food & Beverage Cost Maintenance Trash Removal Sewage Telephone Performer Fees Commissions Total Variable Expenditures $ Fixed Expenditures Administrative Salaries $ Administrative Payroll Tax Administrative Benefits Administrative Pension Staff Hourly Wages Maintenance Hourly Wages-Part Time Maintenance Wages Full-Time Advertising Dues and Subscriptions Landscaping Insurance Licenses and Fees Postage Office Supplies Printing Legal and Accounting Fees Repairs and Maintenance Utilities Sewer Telephone Trash Removal Depreciation, Buildings Depreciation, Equipment Software Amortization Total Fixed Expenses $ Total Variable and Fixed Expenses INCOME FROM OPERATIONS $ Less: Taxes (40% of income from operations) BUDGETED NET INCOME $ Copyright 1999 Susan Lynn Conway



ACCOUNTING FOR STOCK OPTIONS: THE CONTROVERSY CONTINUES

Dr. Apostolou, Nicholas G., CPA

Louisiana State University [email protected]

Dr. Crumbley, D. Larry, CPA

Louisiana State University [email protected]

ABSTRACT

FASB 123 does not replace the intrinsic value based method of accounting prescribed by APB 25

for stock - based employee compensation plans. Instead, FASB 123 allows companies to choose either the intrinsic value method or the fair value method. However, if a company chooses to use the intrinsic value method, disclosure must be made in the footnotes of the effect on earnings if the fair value method had been used. Since the great majority of publicly - traded firms continue to use the intrinsic value method, reported earnings are not diluted by the granting of these options. Thus, stock options continue to be "stealth compensation," deductible for tax purposes without diluting financial earnings.

Among the critics of accounting for options is the legendary investor and CEO of Berkshire-Hathaway, Warren Buffet. He states succinctly in his letter to shareholders included in the 1998 annual report of Berkshire: "If options aren't a form of compensation, what are they? If compensation isn't an expense, what is it? And, if expenses shouldn't go into the calculation of earnings, where in the world should they go?"

A survey of 30 companies' 1998 annual reports illustrate the effect on earnings of using the fair value method (SAFS 123) rather than the intrinsic value method (APB 25). The difference in some situations is so large that decisions of financial statement users could be adversely affected.

The accounting for stock options continues to be one of the most controversial issues in

accounting. For years stock options have been considered "stealth compensation:" not a cost against financial income but deductible for tax purposes. However, stock options are not free to shareholders because they dilute earnings. In 1999, SAFS 123 was passed which establishes financial accounting and reporting standards for stock-based employee compensation plans, such as stock options. Also, the FASB in April of 1999 issued a proposed interpretation that could result in significant accounting charges for many companies. The two significant issues raised by the FASB and addressed in this article are the accounting for repricing of employee stock options (SFAS 123) and the definition of an "employee" for purposes of applying APB No. 25.

DEFINITION OF AN EMPLOYEE

The proposed Interpretation expands the definition of an employee. After the three-month

comment period, the final Interpretation will be effective upon issuance, but will cover events that occur after December 15, 1998. APB 25 only applies to stock of the company issued to officers and other employees of the company. The proposal supports the common law definition of "employee": an individual is considered an employee "if an entity has a right to direct and control the individual's work, both as to the final results and the details of when, where, and how the work is to be done." Under the Internal Revenue Code, an individual who meets the common law definition of an employee is classified as an employee for payroll tax purposes. According to the interpretation, "the designation of an individual as an employee for



payroll tax purposes generally determines whether an individual qualifies as an employee for purposes of applying APB No. 25." Consequently, grants to independent directors and contractors, and other service providers who are not employees for payroll tax purposes, should be accounted for at fair value in accordance with SFAS 123.

REPRICING OF STOCK OPTIONS

The repricing of stock options is a particular bone of contention. The FASB proposal would

require any company that reprices stock options to recognize compensation expense for the difference between a stock option's price and its market value on the financial statement date. This method is referred to by the FASB as variable-award accounting. The proposal is not really a new requirement but rather a stricter interpretation of Accounting Practice Bulletin 25, which was originally published in 1972. The initial ruling states that companies changing option prices after the grant date will, henceforth, use variable-award accounting. The FASB now intends to strictly enforce this ruling.

Although repricing has been relatively rare because of the strength of the stock market, its use clearly would accelerate if the market turned southward. An example of repricing occurred in February 1998, when Applied Magnetics tried to revive the value of 300,000 stock options owned by its CEO by cutting their exercise prices. By the Fall of that year, the company realized that the strategy had failed when the stock fell even further. The company responded by again slashing the exercise price. Further, it repriced an additional 400,000 of the CEO's options for the first time. Other companies that recently have repriced their options include Cendant and 3Com.

Predictably, the FASB proposal has drawn vigorous opposition - particular from the high-tech industry. The Information Technology Association of America issued a release that called the ruling "a real threat to the ability of high-tech companies to attract and retain skilled workers and experienced board members." Opponents claim that the measure could weaken the industry's most powerful compensation vehicle and could even hurt stock market valuations by increasing the complexity of financial statements.

BRIEF HISTORY

This controversy is the latest chapter in the saga of accounting for stock options faced by the

accounting profession. This subject was first addressed by ARB 43, later by APB 25 and several interpretations of that standard, and, in 1995, by SFAS 123. The principal debate has involved two main accounting issues: should compensation expense be recognized for stock options and, if so, over what periods should it be allocated. When the FASB issued a proposal in 1993, a groundswell of massive opposition resulted, led primarily by those industries making significant use of stock options. The industry particularly affected was the high-technology industry. The FASB compromised by issuing SFAS 123 in late 1995, which supports, but does not require, that compensation cost resulting from the granting of stock options be measured and reported in the income statement.

APB 25 measured stock options using the intrinsic value method, whereby compensation expense was determined as the excess of the stock price at the measurement date (generally, the grant date) over the option exercise price. Since most stock options had exercise prices at least equal to current market prices, no compensation expense was recognized. This approach was unsatisfactory to the accounting profession because it ignores the possibility or even likelihood that the stock price will exceed the exercise price in the future.

THE SFAS 123 COMPROMISE

The FASB attempted to recognize the reality of stock option value by issuing a proposed SFAS

123 that required the option value to be measured based upon the many factors that reflect its underlying value. Therefore, total compensation expense is computed based on the fair value of the options expected to vest on the grant date. No adjustments would be made after the grant date in response to subsequent changes in the stock price. Fair value is to be estimated using an option pricing model (Black-Scholes or binomial models). This approach is referred to as the fair value method.

This proposed statement aroused strong controversy, particularly from the high-tech industry and other industries making heavy use of stock options to compensate executives. Even the U.S. Congress



considered a bill prohibiting implementation of this proposal. In response, the final statement recommended, but did not require, adoption of fair value approach. However, SFAS 123 does now require footnote disclosure for those firms continuing to follow APB 25 of the effect on the financial statements if SFAS 123 had been adopted. Warren Buffet addressed this issue in Berkshire's 1998 annual report: "A distressing number of both CEOs and auditors have in recent years bitterly fought FASB's attempts to replace option fiction with truth and virtually none have spoken out in support of FASB."

As a result of the adoption of SAFS 123, firms which grant stock options to employees can choose to follow either APB 25 or SFAS 123. The fair value method must be used for nonemployee situations where warrants are issued in return for goods or services. For those adopting SFAS 123, all stock option plans will result in compensation expense, which is recognized in the income statement over the vesting period. Firms that choose to continue using APB 25 will generally not recognize compensation cost.

Since the APB 25 approach most often results in overstating earnings, the great majority of the reporting firms have not adopted the fair value method in SFAS 123. However, SFAS 123 does now require footnotes disclosures of what the effect on net income would have been if SFAS 123 has been adopted.

Since relatively few firms have adopted SFAS 123, the compensation cost of granting stock options is still not reflected in the income statement. The most prominent critic of the firms that continue to follow APB 25 is Warren Buffet. Buffet has repeatedly stated his belief that stock options represent compensation expense and should be accounted for as such. His latest broadside was included in Berkshire's 1998 annual report where he states that "existing accounting principles ignore the cost of stock options when earnings are being calculated, even though options are huge and increasing expense at many corporations." He characterizes this accounting policy as "outrageous" and an "egregious flaw in accounting procedure." Further, he states that he has had to often adjust reported EPS numbers of other companies by 5%, "with 10% not at all uncommon." Once he had made that adjustment, it has affected his portfolio decisions "causing him to pass on a stock purchase he might otherwise have made."

SURVEY OF 1998 FINANCIAL STATEMENTS

To test the recognition of expense associated with stock options and the effect on net income if

SFAS had been adopted rather than APB 123, we surveyed 30 companies by examining their 1998 annual reports (see Exhibit 1). This survey is not intended to be a random survey. Predominantly, the firms are prominent ones engaged in the high-tech industry. We included several others as a basis of comparison.

Interesting enough, Buffett's assertion that an adjustment to reported earnings of 5-10% for stock option compensation expense is clearly conservative in some cases. The difference between reported earnings (under APB 25) and adjusted earnings (under SFAS 123) exceeds 10% for some companies (e.g., Microsoft, Intel, Xilinx, Micron, Biogen, KLA, Amazon, Adaptec) and is approximately halved in others (e.g., Siebel, PeopleSoft, Adobe). For example, PeopleSoft, Adobe, Seibel and Amazon's earnings are overstated by 123%, 93%, 90%, and 56% respectively. Some companies that are reporting profits would under SFAS 123 be reporting losses (e.g., Yahoo, Broadvision, America Online). America Online drops dramatically from $92 million earnings to a negative $11 million, and Yahoo crashes from $25 million earnings to a loss of $10 million. There is a great deal of phantom income present when companies use the APB 25 approach, and investors and other users of financial statements could be misled.

All of the 30 companies surveyed continue to follow APB 25 in the preparation of their financial statements. The SAFS 123 disclosures are reflected, as required, in the footnotes. The companies often express their displeasure with the requirements of SFAS 123. A typical example is the PeopleSoft disclosure in its 1998 Form 10-K:

Limitations of the effectiveness of the Black-Scholes option pricing model are that it was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable and that the model requires the use of highly subjective assumptions including expected stock price volatility. Because the Company's stock base awards to employees have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock-based awards to employees.



BLACK-SCHOLES OPTION PRICING MODEL

All of the firms (McDonald's does not specify the model it is using) use the Black-Scholes Option Pricing Model (see Exhibit 2) which is the preferred method by the FASB (other alternatives are various binomial models). The Black-Scholes Option Pricing Model was developed by Fischer Black and Myron Scholes in the early 1970s. This model attempts to calculate the grant date present value of a stock option, based on specific information about the terms of the option and assumptions about future stock price performance. The value of an option reflects the estimate of the price that someone would pay in the market today for the option. It is the point at which an investor would be indifferent between receiving the option or the amount of cash equal to its value. The method is considered a "probability" model, because it assumes that the underlying stock behaves in such a way that possible future prices can be modeled by a probability distribution. One of the variables in Black-Scholes is the estimated future volatility of stock price (see Exhibit 3). This measure can be defined as the estimated future variance of the stock price based on historical stock price movement and/or expectations for future stock movement. Volatility measures the stock price fluctuation relative to itself and should not be confused with beta which measures the stock price fluctuation relative to a market average. Volatility is expressed as a percentage, and this variable is a relative measure of the expected difference between the stock price at the end of the stock option's expected life and the stock price at the date of grant. Volatility is, in effect, the standard deviation of the expected price of the stock. Since future volatility is not known, SFAS 123 suggests that historical volatility be used to measure future volatility. This amount is often forecasted by using stock prices over a historical period of time equal to the expected life of the options being granted. The volatility computation is clearly the most difficult variable to compute in Black-Scholes. The estimate of volatility can have a dramatic effect on the value assigned to the options (see Exhibit 4). Our survey shows a wide variation in the amounts computed for volatility, particularly between the small high-tech companies (e.g., Broadvision, 112%; Amazon, 82%) and the giant international companies such as Coke (24%), McDonald's (18%), and GE (22%). However, much of this difference can be justified based on the greater historical volatility in the stock prices of smaller firms in the high-tech sector. Another variable in the model is the risk-free interest rate at the time of grant. This amount can be determined by reference to the rate on treasury bills or notes having a remaining term or maturity equal to the expected life of the options being computed. Again, there is wide variation in the rate chosen ranging from 4% (Coca-Cola) to in excess of 6% (e.g., Dell). Some of this variation is due to the difference in the expected life of the options that are granted.

One of the objectives of SFAS 123 is to allocate compensation cost to the periods in which services are provided to the firm granting the options. Typically, the options granted are not exercisable until some later date, called the vesting date, which usually occurs several years after the grant date. Compensation cost should be accrued in the intervening period from the grant date to vesting date, based on an estimate of the number of options expected to vest or an estimate of the number of options expected to be exercised. In the Black-Scholes model, one of the variables is the expected life of the stock option which is defined by SFAS 123 as the expected period of time that the option will remain outstanding before being exercised or forfeited. In our survey, the expected period of time ranges from less than a year (e.g., Broadvision) up to 10 years for Stone Energy.

CONCLUSION

Stock options are the fastest growing segment of executive pay. Business Week's Executive Pay

Scoreboard for 1998 published in the April 19th issue shows that long-term compensation - mostly from exercised options - make up 80% of the average CEO's pay package. The survey also revealed that the CEO at a large public company made an average $10.6 million last year. Options worth millions of dollars have become commonplace in today's corporate environment.

The failure to record option expense does more than overstate earnings. The lack of accounting consequences encourages directors and managers to overpay their employees. Financial statements should reflect the substance of events. Certainly a drop in earnings from a positive $92 million by America Online



to a negative $11 million is material. The granting of options is compensation expense which should be recognized as a dilution of earnings.

As our survey indicates, there is considerable variation in the estimates used to compute the fair value of the options granted. But the difficulty in measurement should not obscure the need for measurement. Options are universally acknowledged to be additional compensation and should be accounted as such. As experience is gained in making the required estimates, we suspect that there will be less variation in the amounts incorporated in the model to compute the compensation cost of granting stock options.



ACCOUNTING METHOD NEGOTIATIONS

BETWEEN CORPORATE AND TAX AUTHORITIES: A HISTORICLA PERSPECTIVE

BASED ON THE 1944 TAX AUDIT OF THE SPRINGFIELD STREET RAILWAY COMPANY

Bruns, Sharon

Northeastern University [email protected]

Rupert, Timothy


ABSTRACT

Recently, Congress and taxpayers have focused considerable attention to the IRS and the way that

it conducts itself during the audit process. As a result, the management of the IRS has diligently tried to implement reforms mandated by Congress to ensure that the agency treats each taxpayer fairly. This paper chronicles the history of one company’s audit experience nearly fifty years ago with the hope that this historical perspective will help us a better understanding of both the differences and consistencies that exist in IRS-taxpayer relations in the past and present.

INTRODUCTION

In devising the Internal Revenue Code (IRC), Congress has traditionally granted the Internal Revenue Service (IRS) broad powers in situations where it is believed that taxpayers may be able to abuse the system. For example, the current IRC contains Section 446 which grants the IRS broad power in dictating the method of accounting that must be used if the IRS determines that the method chosen by the taxpayer does not clearly reflect income. During the early 1990s, the IRS aggressively applied their powers to dictate the method of accounting used. In fact, in several cases, the IRS even declared that income calculated under generally accepted accounting principles (GAAP) did not clearly reflect income (see, for example, Honeywell v. Commissioner and Apollo Computer v. Commissioner). While the IRS has enjoyed some success in persuading the courts to uphold their power to dictate the method of accounting, current developments in IRS oversight may have curbed this power in recent years. In 1997, Senate hearings included a parade of taxpayers who gave accounts of apparent abuses by revenue agents. As a result of these hearings, the IRS has been under additional scrutiny. These hearings have raised the question of whether the culture of the IRS has led the agency to abuse the power that has been granted to them by Congress.

In the present paper, we contribute to the understanding of the evolution of IRS action in situations for which it has been granted broad powers by examining an audit case that arose fifty years ago. In the 1940s, the IRS challenged the accounting methods used by the Springfield Street Railway Company (SSRC). Based on accounts provided by executives of the company, we provide a historical perspective on the way in which the IRS formerly conducted investigations that included questions about accounting methods. We note how the interaction between SSRC and the IRS compares with the type of current interaction expected based on the principles that shaped the recent IRS restructuring and reforms.



HISTORY OF THE SPRINGFIELD STREET RAILWAY COMPANY—THE EARLY YEARS 1860-1915

The Springfield Street Railway Company (SSRC) was incorporated in 1860 with its original role as a provider of horse-drawn rail cars. Rail was laid in the center of unpaved streets and main roads of Springfield. The invention of the electric generator solved the practical cost problems of electric power, and in 1888, Frank J. Sprague opened the first successful electric street railway in the United States, in Richmond, Virginia. Electric cars soon began to replace the horse-drawn variety. By about 1910, the SRRC had completely converted to electric streetcars, requiring capital expenditures in overhead railway lines, poles, underground cable, heavy-weight tracts and additional lines which extended to suburban communities. Rail transportation in New England between 1910 and 1915 was dominated by the Mellon family interests who controlled the New York, New Haven and Hartford Railroad Company. Part of their strategy of acquiring a monopoly on rail transportation in the region included purchase of nearly 100 percent of SSRC outstanding stock. In turn, SSRC acquired both the Palmer Street Railway Company, which owned routes to Springfield and Sturbridge, and the Westfield Street Railway Company with its routes that joined those of the SRRC and local routes in Westfield, Massachusetts. The purchase of the latter two companies was accomplished using a one-to-one stock swap which resulted in 100 percent ownership by SSRC.

THE EARLY TWENTIETH CENTURY YEARS 1913-1940

Several important developments during the early part of the twentieth century affected the eventual financial health of the SSRC. Notable among these was the introduction of federal income taxes in 1913 which will be addressed in more detail subsequently. During the 1920s, motorized coaches, forerunners of the modern bus, began to be seen more frequently, particularly as means of reaching more outlying populations. The boom times of the twenties produced prosperous times for railway travel, but the Great Depression of the 1930s changed the economic picture dramatically. By 1939, the New York, New Haven and Hartford Railroad Company was in bankruptcy. With bond obligations of $1,000,000 due to mature within one year, the company addressed some of its problems by selling its shares in SSRC to a group of investors from Chicago headed by George Stevens, to the treasurer of the Greyhound Corporation. The Chicago group purchased the shares for only $2,200, which was the cost of the transfer tax stamps, but they also took on a large number of the outstanding bond debt at 40 cents on the dollar. This sale relieved New York, New Haven, Hartford from any subsequent responsibilities for the operations of SSRC. However, SSRC was in no shape itself to take on the payments of the bonds, which were to mature imminently at their par value of $1,000,000. Barring unknown developments, the company would have to declare bankruptcy. Assistant Treasurer Edward Anderstrom recalled the atmosphere of the company at that time, writing, “The five wild men from Chicago arrived in Springfield to attempt to save the SSRC from bankruptcy and turn it into a profitable bus company. My memory is still good enough that I remember each of their names… Hiram Bollum…Henry Church…Clarence Tillberg… Robert Bullivant…Clifford Anderson……I was 19 when Cliff came to Springfield, having been hired two years before right out of high school as backup stenographer and telephone operator in the main office. These men were greeted with a great deal of suspicion by the Springfield and Boston ‘establishment’ –who had no inclination to offer help or assistance to this ‘western’ group.” The Group took immediate action to fend off the pending debt crisis. They petitioned the Public Utility Commission of Massachusetts to allow them to postpone the due date of the bonds by ten years, arguing that this time delay would allow them to convert the company from a trolley car company to a bus company thus increasing its profitability and ability to pay off the debt. The PUC was not anxious to accommodate these strangers to their region, but found it difficult automatically to turn down the request because that would surely force the company into bankruptcy. Despite its misgivings the PUC agreed to this postponement, but put a seemingly insurmountable condition on the postponement. The company would have to secure the permission of 90 percent of the bondholders for the ten year postponement. Clifford Anderson and Henry Church accomplished this seemingly impossible task by early 1940. The bonds were held in mostly small lots which were scattered throughout the United States, Canada, and some foreign countries. Brochures outlining the planned conversion of all trolley operations to motor bus



were sent to all known bondholders. These brochures argued that the trolley-to-bus transformation would ultimately increase the value of the bonds in addition to avoiding immediate bankruptcy. Personal visits and telephone calls supplemented the mailings and ultimately the company finalized the bondholders’ approval after buying out some reluctant holdouts.

WORLD WAR II YEARS The Second World War produced full employment throughout the country, finalizing the end of the Great Depression. Transportation companies benefited not only from the relative prosperity of the populace but also from price controls in effect during the war. Prices of materials and labor were under control, whereas incoming revenues were not. In addition, the lack of rubber for domestic consumption led to a shortage of tires. Combined with gas rationing and auto restriction, there was an increasing reliance on modes of transportation other than the personal car. These were extraordinarily profitable years for the SSRC.

ACCOUNTING TREATMENT OF RAILWAY ASSETS OF SSRC The replacement depreciation method was a common acceptable method used by railroads, and as a subsidiary of a railroad SSRC had followed this method from 1910. Essentially, the replacement method capitalized the initial cost of roadbeds and upgrading were undertaken. This method has some of the characteristics of LIFO in that current costs tend to be matched against current revenues; it also can lend itself to manipulation of income in that timing of expenditures for capital improvements directly affects current income. The replacement depreciation method was not an unreasonable one for SSRC in that roadbeds are essentially land, and many of the company’s assets had indeterminable lives if maintained well.

Although depreciation had its purposes in measuring income for stockholders and for determining taxable income after 1913, its major purpose for railroads and public utilities was as a component in the rate of return allowed these companies by their respective Public Utility Commissions (and later the Interstate Commerce Commission). All public utilities were allowed to earn a “fair and reasonable” return and upgradings could be planned to keep earnings reasonable. Before 1930 railroads were able to keep their properties in first class condition and remain profitable; between 1930 and 1942, the tremendous drop in revenues made it impossible for most railroads to earn profits at all.

TAX TREATMENT OF THE CONVERSION FROM RAILWAY TO BUS COMPANY

The SSRC accounted for its conversion to a bus company in a four stage process from 1940 to 1943, writing various classes of rail assets off as losses for tax purposes in each of the four years. In 1940, all trolley cars and railway equipment rolling stock were scrapped or sold, with the book value written off in 1941, and the book value of the underground cables and miscellaneous equipment in 1942. In 1943, the track and roadway was sold to the City of Springfield for $1 with the resultant loss written off.

The company paid no income taxes between 1929 and 1943. Despite the write-offs of railway assets, the company posted a substantial profit in 1943 and made its first tax payment in fifteen years. Increasingly large tax payments continued in years 1944 through 1948, at which point the Internal Revenue Service targeted the company’s 1944 tax return for audit. (The IRS has three years from the date the tax return is due to challenge the report unless there is evidence of fraud. In the SSRC case, the IRS requested an extension of the time limit at the last moment. The company complied rather than refuse and risk an immediate large scale “unfriendly” audit.)

THE INTERNAL REVENUE SERVICE POSITION The IRS took position that the write-off of railway assets should have taken place all in the 1940 tax return, as this matched the physical abandonment of the assets. Furthermore, the IRS took the position that SSRC was a railway company, not a railroad company, and that therefore replacement accounting had not been the appropriate method for depreciation for tax purposes. It held that SSRC assets should have



been treated as depreciable over the years, with the removal of the original cost from the asset base when original assets were replaced with new assets. In a meeting between Mr. Daily from the IRS and Clifford Anderson, ground rules for the audit were established. The IRS would provide a schedule of the number of years over which each class of asset should be depreciated. The SSRC would try to recreate its asset base, with verification to be made by Mr. Daily. Any disagreements would be dealt with by SSRC’s accounting firm, Price Waterhouse, and Mr. Daily’s superiors at the IRS, with tax court as the appeal of last resort. All open tax years from 1944 would be subject to audit. There is conjecture that the IRS doubted SSRC’s ability to recreate its asset base in detail, and that had they known of the extent of the available documentation, they might have set different ground rules for the audit. However, the company’s records were extensive, to the extent that they were able to recreate all acquisitions and dispositions over more than an 80 year period with the exception of the disposition of one horse!

CORPORATE RECORDS Most railway companies had significantly changed their original corporate form by the 1940s due to extensive mergers and acquisitions. Despite the fact that SSRC had been purchased then sold by the Mellon interests, its corporate form remained essentially the same as when it was established in 186?. Many had diversified into areas such as electric power and subsequently sold off their transportation segments; others went bankrupt …… were taken over by city governments. The constancy of Creeks operations and corporate form contributed to their ability to totally recreate the events in their property and equipment accounts during the IRS audit. Adam Huettner, secretary of the SSRC informed Clifford Anderson that all corporate records existed intact in dry storage in its Hooker Street Car Barn. Many of the records were handwritten in the beautiful script used before the advent of the typewriter. They included minutes of all stockholder and directors meetings, original journals and ledgers, authorities for expenditures (AFEs), blueprints of all tracks and roadbeds, and railway lines. The AFEs were particularly valuable in the task of establishing a value for the asset base. They consisted of subsidiary ledger accounts dealing with each expenditure, whether capitalized or expensed. Each major expenditure was approved by the Board of Directors and an ARE number established. All monies spent were recorded in this account until the project was complete, at which time the AFE was closed into the standard accounts. The closure date was determined as the date of acquisition, and for those assets subject to depreciation, a half-year convention was used.

THE DOCUMENTATION AND VERIFICATION TASK

To support the company’s eventual asset valuation, it was necessary to prepare a schedule for every single year since the company’s incorporation. The schedule included each acquisition, an appropriate amount charged for depreciation and any dispositions or disposals during the year. The depreciation rates provided by the IRS were quickly challenged by Anderson as too fast given the knowledge of hindsight in determining useful lives. For example, use of the IRS schedule would result in a zero book value for the buildings as of 1940. Most of the buildings constructed before 1900 were still in use in daily operations. Strangely enough, the IRS agreed without reservation to accept the longer time period recommended by Anderson. Supporting schedules were provided for all transactions. The asset classifications consisted of roadway; lines, poles, conduits and signaling equipment; buildings; horses; trolley cars, work cars, shop equipment, buses and automobiles. Verification of most of these accounts was relatively straight-forward, being supported extensively by the AFEs and minutes from the Board of Directors. However, verification of the roadway with track, overhead wires and underground conduit and cable was much harder. During the company’s history, track had been completely replaced at least three times. The conversions from horse-drawn to electric-powered cars had required increasing the weight of track several times. Verification of the amounts required the use of the blueprints of track available for every foot of the company’s railway system. “An AFE would define the exact footage and location of each track and roadway replacement. Four different colored pens were used to indicate each improvement in the roadway. This was tedious and exacting work, and each and every one of these changes was examined and verified



by the IRS’s Daily. The IRS agreement to allow longer lives for depreciation resulted in an asset base at the time of abandonment substantially higher than it would have been otherwise. There were several other unexpected factors that contributed to a higher asset base. The first factor resulted from the prosperous early days of railroad travel, when the company had large profits. Because the company’s fares and return on investment were subject to regulation, there were incentives to keep the profits “reasonable.” Frequently, large capital investments were simply expensed rather than capitalized for this reason. Specific examples of this practice were found in the records for purchases of ten to twenty new trolley cars and large roadway, tract and electric line improvements. This expensing occurred before 1913 and thus was not subject to specific IRS regulation, and it represented fairly common practice for profitable railway companies. The extensive records allowed Anderson to recapture these former expenses and add them to the asset base. The second factor related to SSRC’s acquisition of the Westfield Street Railway Company and the Palmer Street Railway company in 1912(check date). The acquisition had been effected by a one-to-one swap of stock without consideration of the market value of the stock. The assets of the acquired companies were recorded at book value rather than at their market value. For purposes of recording the acquisitions at a more reasonable value, market value was reconstructed on the basis of the market value of the SSRC stock on the date of purchase. This change more than doubled the asset value of these acquired assets, most of which were still in use in 1940. The third factor concerned roadway. Under IRS rules, roadway was treated as land and therefore not subject to depreciation. Many of the expenditures of the SSRC had involved upgrading and strengthening of roadway and track. Not only was SSRC able now to capitalize these expenditures, but as land they were not subject to the recreation of depreciation schedules and existed on the books at their historical cost.

PRESENTATION OF THE DEPRECIATION SCHEDULES TO THE IRS The process of reconstruction of the accounts took two years, due to the painstaking detailed nature of the task. Because of the care that was taken in documentation and verification, there was total agreement on the actual numbers by both the SSRC and the IRS. An employee at the time noted, “ Despite the dusty working conditions in the Hooker Street facility, Mr. Daily (of the IRS) never removed his tie or suit coat. My lasting impression of him is his constant look at the results of the years 1942 and 1943 which were no longer subject to audit, with their tremendous tax avoidance.” Despite the agreements on the recreated asset valuation themselves, there was considerable disagreement between SSRC and the IRS as to the amount of tax owed or not owed by the company. One position that the SSRC took was that there was enough evidence to allow the company to use the railroad system of expensing or railway equipment. Price Waterhouse, the company’s auditors, research court cases and assembled precedents supporting this position and newspaper articles were found in the Springfield library that contained some interesting supporting documentation. It seems that companies were so desperate for rolling stock during the Second World War that trolley wheels were put on some buses so that they could be temporarily used on tracks. The SSRC also received verification from the City of Springfield that the company continues to maintain and repair its roadway and track, and to fulfill its obligations for snow removal until it sold its rails to the City of Springfield in 1943. This was offered as evidence that the company was still a “railroad” company because it was fulfilling the requirements of railroad companies to maintain the roadway and tracks. The IRS had its own viewpoint and had also assembled support for its position should the case find itself in Tax Court. The company’s position was that the documentation review and the sizeable write-up of assets provided support for the position that the company had overpaid taxes by $900, 000 and should receive a refund of this amount. The IRS claimed that 1940 should have been used as the abandonment of assets date and that SSRC owed taxes for 1944 of $1,200,000. As neither side wished to go to Tax Court, a compromise was negotiated. The IRS accepted a $650,000 payment and closed all open tax years.

Despite the significant payment to the IRS, the SSRC and its officers believed that they had accomplished a victory of sorts. The company had reserved $ 1,200,000 for any tax contingency. As all of the outstanding bonds had been paid off within the ten-year extension, the company was able to offer its first dividend since 1929 of $7.50 per share.



CONCLUSIONS

While SSRC was able to arrive at a negotiated settlement with the IRS, it is clear that they arrived at this result because of the substantial efforts of some of their employees. To be convinced that this negotiated settlement was appropriate, the IRS required detailed information about the operations and accounting records of the company. However, it is interesting to note that unlike the IRS representatives in some recent accounting method court cases, the representatives in the SSRC audit were willing to work with the corporate employees. In addition, with their willingness to abide by their earlier decisions, they embodied the calls for fair, non-intimidating treatment of taxpayers heard during the recent debates for IRS reform.



AN EXAMINATION OF VALIDITY OF ACCOUNTING MEASURES IN THE VALUATION

OF R&D INTENSIVE FIRMS

Joseph, George Savannah State University

[email protected]

ABSTRACT One of the greatest challenges that accounting will face in the coming millenium is the valuation of intellectual properties. This study examines the treatment of Research and Development [R&D] Expenses, through which intellectual property is generated. The accounting standard, SFAS 2, requires that R & D Expenditure be expensed when incurred. This study uses the criteria laid down by SFAC No. 1, namely information usefulness, in examining this treatment of research and development expenses. Specifically, the study evaluates the information usefulness of different accounting measures affected by R&D investments, to determine the usefulness of such measures, and thereby investigate the appropriateness of current accounting procedures. The results show that cash flows from operations are more value-relevant than accounting earnings before extra-ordinary items for R&D intensive firms. However, earnings before the deduction of R&D are found to be more useful than earnings per share before extra-ordinary items. Therefore, using the information usefulness criteria of SFAC No. 1, it is determined that expensing of the R&D investments reduces information usefulness of earnings. The study also enhances understanding of the price-accounting measures relationships in the context of studies such as Dechow (1994) and Bowen et al (1987). Keywords: Information usefulness, accounting measures, research and development expenses. Data Availability: Data is available from sources identified in the text.

INTRODUCTION The accounting standard on Research and Development [R&D], Statement of Financial Accounting Standards [SFAS] No. 2 issued in 1974, requires the expensing of most R&D expenses. Lev and Sougiannis (1996) note that changes in the environment since the issuance of the standard may have caused the standard to be increasingly insufficient for computing earnings. They find that research and development expenses have "future firm value". The current standard ignores this value due to the difficulties in determining the value of such benefits. This study investigates the information usefulness of accounting measures of firms that invest substantially in R&D (also referred to as R&D intensive firms). The Financial Accounting Standards Board’s [FASB] Conceptual Framework makes "information usefulness" a central criterion in its policy for framing accounting standards. According to Statement of Financial Accounting Concept [SFAC] No. 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" (FASB, 1978, para 34). The Financial Accounting Standards Board set up the Conceptual Statements in order to be able to overcome the political issues faced by its predecessor, the Accounting Principles Board. The guidelines laid down by the Conceptual Statement provides a means of enabling the Board to use objective criteria to evaluate standards. The principle findings of the study suggest that for firms in R&D intensive industries, deduction of R&D expenses from accounting earnings reduces the information usefulness of the earnings number. Accounting earnings before R&D expensing is more useful than than either operating cash flows or accounting earnings net of extra-ordinary items [EPS]. Cross-sectionally, the analysis indicates that the increased information content of R&D expense beyond that of cash flows from operations and accounting accruals is significant and positive.



These results substantiate other studies and conclude that the current standard for expensing R&D expenses result in reported accounting earnings that have reduced information usefulness. Users of accounting information has two alternatives, to use alternative accounting measures, or to adjust earnings to better reflect the impact of the future value of R&D expenses. The use of cash flows from operating activities is seen to be more value-relevant for the firms examined.. This is in contrast to Dechow’s (1994) results of earnings superiority to cash flows. However, earnings adjusted for R&D expenses (i.e., earnings before deduction of R&D) proved to be the most information useful accounting measure of firm value. These results indicate that there is a continued need to search for alternative treatments of R&D expenses, so that accounting measures may be more value relevant. Section 2 provides the theoretical basis, section 3 develops the hypotheses, section 4 provides the methodology, section 5 provides sources of data, analysis and results and section 6 provides the conclusions of the study.

RESEARCH AND DEVELOPMENT EXPENSES

SFAS No. 2 requires that research and development costs are to be expensed when incurred. The Board based its decision to expense research and development on the uncertainty of future benefits and the lack of causal relationship between research expenditures and benefits. Several studies have investigated research and development from different perspectives. One group of studies tried to determine the consequences of the standard on R&D investments. Elliott, Richardson, Dyckman, and Dukes (1984) found that there was a decline in the R&D expenditures of capitalizers after the standard was issued. Similar results were observed by Horwitz and Kolodny (1980) and Baber, Fairfield, and Haggard (1991). In contrast, Dukes, Dyckman, and Elliott (1980) found no evidence of changes in R&D in response to SFAS No. 2. Other studies have investigated the informativeness of earnings for firms affected by SFAS No. 2. Loudder and Behn (1996) investigate changes in earnings informativeness (as proxied by earnings response coefficient) for firms that switched their R&D accounting method as a result of SFAS No. 2, and differences in the earnings informativeness of firms that used different R&D accounting methods prior to SFAS No. 2. Their results indicated that there was a statistically significant decline in the earnings usefulness for firms forced to switch from capitalizing to expensing R&D outlays and that the decline appeared to persist over time. Comparison of earnings usefulness of firms prior to SFAS 2 showed that the capitalizing firms had significantly higher earnings usefulness than expensing firms. Sami and Lee (1995) also observed that the ERCs of capitalizing firms were higher than that of expensing firms. Lev and Sougiannis (1996) specifically counter the Board's contention of no causal relationship between research and development expenses and benefits accruing from such expenditures. They show that earnings adjusted for R&D capitalization are value-relevant to investors. They also show that there is an association between R&D capital and subsequent stock returns. The current study differs from previous studies in that it examines alternative accounting measures affected by R&D expenditures using the information usefulness guidelines set by SFAC No. 1. Usefulness of accounting information is often operationalized by determining whether the information enables users to determine firm value. According to Lev (1989), if an action caused by a change in beliefs can be attributed to a particular information, such information is useful. Therefore, the correlation between the belief and the corresponding action is the measure of the usefulness of the measures. For example, in price/earnings studies, the larger the price/earnings correlation (or R2), the more useful is the earnings number. Alternative accounting measures such as cash flows, accounting earnings per share and earnings adjusted for R&D are evaluated and compared to evaluate the usefulness of accounting measures generated under the current accounting system relative to R&D expensing.

HYPOTHESES

Accounting earnings is found to be the most useful accounting measure of firm value (Dechow, 1994). The measure, however, is also affected by the expensing of R&D expenses. The other popular accounting measure, operating cash flows, are also effected, to the extent that R&D expenses are outflows of cash. However, deferment of cash payments and categorization of expenses of a capital nature under investments would contain the effect of this standard. To remedy the effect of the expensing of R&D,



adjustments can be made to the earnings number. The obvious limitation to this alternative is to decide on the manner of the adjustment. A simple approach is to add back all R&D expenses to earnings (earnings before R&D expenses), under the assumption that all R&D expenses increase firm value. If the benefits of R&D are long-lived, this measure may prove to be a more useful measure of firm value than earnings (after expensing R&D) or operating cash flows. The three accounting measures outlined above, i.e., earnings after expensing R&D (the reported accounting earnings), operating cash flows and earnings before R&D expenses (the adjusted accounting earnings) are compared to determine the impact of the treatment of R&D on accounting measures. The comparison of the information usefulness of the performance measures is examined from two perspectives. In the first case, the measures are compared as summary measures as in Dechow (1994). To provide further insights, the study also investigates the incremental usefulness of the alternative performance measures. The following hypotheses are examined. The relative usefulness hypotheses are as follows:

H1a: For firms in the R&D intensive industries, the association between firm value and operating cash flows is greater than that between firm value and earnings.

H1b: For firms in the R&D intensive industries, the association between firm value and earnings adjusted for R&D expenses is greater than that between firm value and accounting earnings or firm value and operating cash flows.

R&D expenses are expected to provide incremental information content beyond that provided by operating cash flows and accounting accruals. Therefore, the incremental information hypothesis is:

H2: Research and development expenses have incremental information content beyond that contained in contemporaneous cash flows and accrual earnings data for R&D intensive firms.

METHODLOGY

Models

The standard valuation model where price is the discounted present value of expected future cash flows forms the basis of the models used. The model also relies on the hypothesis that the accounting performance measures provide information on the future cash flows of the firm (Beaver, 1989, Ch. 4). The basic model is stated as: Firm value = f (accounting performance measure) Price or annual stock return proxies for firm value. The accounting performance measures are contrasted for their ability to provide information on future cash flows.

TESTING THE RELATIVE INFORMATION HYPOTHESES Following Lev (1989), Tse (1986) and Roll (1988), R2, the variation in the dependent variable explained by the independent variable, is used as the measure of usefulness. The study evaluates the alternative R&D accounting methods on "usefulness" in the light of the guidelines provided by FASB’s Statement of Financial Accounting Concepts. The correlation of price/earnings association is an acceptable measure of earnings usefulness (Lev, 1989). If information contribution of earnings on the future cash flows of the firm is significant, then earnings should exhibit an explanatory power (both cross-sectionally and over time) in relation to stock price (or returns) of that firm. The stronger the relationship, the more useful the measure; therefore, the regression of price (or stock returns) and performance measure correlation, or the R2 of the regression of stock returns on the performance measure, is used to measure information usefulness. The simple non-nested model used is based on the relationship between price (returns) and accounting measures explained earlier. Similar models are used in studies, such as Tse (1986), Ahmed (1994), and Barth, Beaver, and Landsman (1992). Pi = α1 + β1 AMi + εi , (1) where Pi is the stock price of the common equity of firm i at the close of the fiscal year t (Compustat # 199), AM stands for the accounting measures, which include cash flow from operations (Compustat # 308), earnings before extraordinary items per share (Compustat # 119), earnings before extraordinary items but



after R&D expenses (Compustat # (119+27)). The non-nested models can be tested for significance using Vuong’s (1989) test. This is a likelihood ratio test for model selection that tests the null that the two models are equally close to explaining the data generating process against the alternative that one model is closer. The test intuitively allows us to determine the performance measure (cash flows or earnings) that has relatively more explanatory power (Dechow, 1994). The test is two-tailed, where the Z statistic is computed (see Dechow, 1994). If Z is significantly positive, then earnings is a more useful explanatory variable. Alternatively, if Z is significantly negative, then cash flows is the more useful explanatory variable.

TESTING THE INCREMENTAL USEFULNESS HYPOTHESES To test the incremental content of the components of earnings, the models used are: Pi = α1 + β1CFOi + β2 AAi + β3 RDi + εi , (2) where RD is the R&D expense for the year, AA is accounting accruals and CFO is cash flows from operations.

DATA COLLECTION AND RESULTS

Examination by industry is appropriate because duration of R&D benefits are often linked to patents, which most often differ by industry (Lev and Sougiannis, 1996). Such a view was held by the Board in SFAS No. 2 and was also suggested in an early study by Newman (1968) who found that the length of time for R&D expenditures to result in increased sales differed from industry to industry. In line with Lev and Sougiannis (1996), R&D intensive industries are selected based on the number of firms in the industry that have R&D expense to total sales ratio greater than 0.02. Two-digit industry codes are used as to make the analysis more manageable. Only industries with a total of more than 100 firms-years are chosen for the analysis. The resultant sample consists of SICs that are similar to Lev and Sougiannis (1996) except for the inclusion of industry SIC 73 (Business Services). The other industries selected were Chemicals and Pharmaceuticals (SIC 28), Machinery and Computer Hardware (SIC 35), Electrical and Electronics (SIC 36), Transportation Vehicles (SIC 37), Scientific Instruments (SIC 38), and “Other” SIC codes which do not fall into the above industries but have R&D by Sales ratio greater than 0.02. The summary statistics of the R&D intensive industries are provided in Table 1.

Table 1 Summary Statistics

SIC Obsns Var. Mean Min. Max. S.D. 28 1093 PR 21.6346 0.0310 166.5000 22.9615 EPS 0.4009 -22.1200 12.8200 2.0482 EPR 1.4233 -19.4139 19.0706 2.7308 CFO 1.1091 -4.5389 21.3049 2.7724 35 1128 PR 14.7906 0.0310 125.0000 15.8033 EPS 0.3345 -18.5000 10.5100 1.9553 EPR 1.6459 -13.0323 20.9987 2.4803 CFO 1.1786 -5.6983 21.8099 2.3052 36 1100 PR 11.2264 0.0310 117.0000 13.3885 EPS 0.3038 -24.0900 6.5000 1.4243 EPR 1.1578 -22.2735 13.8848 1.9574 CFO 0.8971 -4.3190 14.4012 1.7207 37 125 PR 24.4572 0.0620 83.5000 21.5296 EPS 1.5484 -15.3400 13.6400 3.0400 EPR 3.8845 -5.9812 29.1521 5.0033 CFO 3.4293 -3.2933 47.4993 5.9043 38 1258 PR 12.7943 0.0310 111.2500 14.9742 EPS 0.3546 -13.6600 12.9200 1.5025 EPR 1.1938 -11.4009 20.0077 2.1529



CFO 0.7945 -7.2035 21.9117 2.0445 73 823 PR 13.3562 0.0310 88.0000 14.1607 EPS 0.1656 -11.8900 3.1500 1.1921 EPR 1.0962 -9.4008 9.8664 1.7238 CFO 0.9128 -4.1689 16.4263 1.7773 Other 543 PR 15.3237 0.0160 119.8750 16.9641 EPS 0.4719 -6.5200 6.5000 1.5066 EPR 1.1392 -3.8676 11.4172 1.9679 CFO 1.4750 -5.3359 18.7018 2.6722

PR = Closing Price per share as at fiscal year end; EPS = Earning per Share; EPR= Earnings per share (before extra-ordinary items) plus R&D expenses; CFO = Cash Flow from Operations per share; Obsns. = Number of Observations; S.D. = Standard Deviation The sample is based on data for the years 1988 to 1983. The criteria used is (R&D Expenditures/Total Sales)>0.02. If the total number of firms in the industry exceed 100, that industry is considered R&D intensive.

Results of the Relative Information Hypotheses (Hypotheses 1a and 1b)

The analysis of the measures are conducted for a pooled sample as well as year-wise samples (years 1988-1993). The purpose is to provide greater validity; pooled samples may suffer from heteroscedasticity and also may not reflect structural changes that may occur for the different years examined. Comparison of earnings per share and cash flow from operations. The R2 and Vuong’s Z test results are provided in Table 2 by industry (SIC codes).

Table 2 Comparison of Earnings per share and Operating Cash Flows

Panel A: Pooled sample of 1988 - 1993

SIC N R2(EPS) R2(CFO) Vuong Z

28 1093 0.3983 0.4818 -1.5152 35 1128 0.2090 0.4224 -3.4333a 36 1100 0.2762 0.4920 -3.2683a 37 125 0.2814 0.4749 -1.9609b 38 1258 0.3936 0.4011 -0.1161 73 823 0.2981 0.2814 0.2413 Other 543 0.5039 0.4761 0.4511

Panel B: Year-wise results of Vuong Z only

SIC 1988 1989 1990 1991 1992 1993 28 3.5736a 0.9299 0.5051 -1.8339c -2.1043b -1.3065 35 -0.2018 0.7306 -1.5101 -3.0441a -1.9043c -1.3965 36 -0.7292 1.6520c -4.2132a -0.7533 -1.3616 -2.1919b 37 2.4970b 1.9271c -3.6528a -1.6113 -2.1289b -1.9446c 38 -1.4667 3.1377a 4.5879a 1.2385 1.9158c -0.8517 73 2.2038b 0.7537 0.8376 0.2075 -0.1442 -0.4634 Other 1.5681 0.4969 1.1389 -0.0104 -0.6836 -0.1829

Panel A provides the R2 and results of the pooled sample for the years 1988 to 1993 for each of the industries. Panel B provides the year-wise results of the Vuong test only. All R2 values are adjusted. EPS= Earnings per share (before extra-ordinary items); CFO=Cash flows from operations. aZ is significant at 1% level of significance; bZ is significant at 5% level of significance; cZ is significant at 10% level of significance. The results in Panel A (the pooled sample) show that cash flows from operations are found to be



superior to earnings per share for two-digit SIC codes 35, 36 and 37. The R2s for each SIC codes were 0.42, 0.49 and 0.47 respectively, and the Vuong Z was significant at the 0.01 level of significance for SIC codes 35 and 36 and at the 0.05 level for SIC 37. For SIC codes 28, 38 and “Others” however, the results of the two accounting measures are not significantly different from each other. The results of Panel B (the year-wise samples) are generally consistent with those of Panel A, though they display variations between different years. This may be on account of the structural changes, as anticipated. For the years 1988 and 1989, it is found that earnings are generally superior to cash flows, but for later years, cash flows were superior, except for SIC code 38. Therefore, the year-wise results are generally mixed. Although cash flows are more favorable for SIC codes 35 and 36, earnings appeared more significant for SIC code 38. Comparison of Earnings before R&D and Earnings per share. The results for the comparison are provided in Table 3 by SIC codes. Panel A indicates that earnings before research and development appear to be a consistently superior measure to earnings per share before extra-ordinary items as indicated by the R2. Vuong Z is found to be significant for all the industries examined, except for the “Other” category.

Table 3 Comparison of Earnings before R&D and Earnings per share

Panel A: Pooled sample of 1988 - 1993

SIC N R2(EPR) R2(EPS) Vuong Z

28 1093 0.5471 0.3983 1.8686c 35 1128 0.4871 0.2090 3.8533a 36 1100 0.5032 0.2762 2.6297a 37 125 0.6118 0.2814 2.9441a 38 1258 0.5422 0.3936 2.2666b 73 823 0.4220 0.2981 1.9315c Other 543 0.5630 0.5039 1.0493


SIC 1988 1989 1990 1991 1992 1993 28 1.6529c 4.2358a 3.3782a 2.6157a 1.8698c 3.8790a 35 2.9781a 2.8811a 3.2016a 3.1804a 2.6193a 4.6767a 36 2.9744a 1.0517 1.8925c 2.3196b 2.9816a 3.6985a 37 -1.7574c 1.8643c 4.4587a 2.4484b 3.6211a 4.8304a 38 3.8786a 0.1622 -3.4699a 1.0121 1.4583 2.3975b 73 -0.0180 1.4325 0.2785 0.2757 0.8287 1.2882 Other -0.2949 -0.0733 -0.7478 1.0441 1.0318 0.7883

Panel A provides the R2 and results of the pooled sample for the years 1988 to 1993 for each of the industries. Panel B provides the year-wise results of the Vuong test only. All R2 values are adjusted. EPS= Earnings per share (before extra-ordinary items); EPR=Earnings per share (before extraordinary items) plus R&D expenses. aZ is significant at 1% level of significance; bZ is significant at 5% level of significance; cZ is significant at 10% level of significance. The results in Panel B indicate that for year-wise, the results are generally consistent and indicate that earnings before R&D are superior to cash flows. For SIC 28, 35 and 36, the results are significant for each of the years examined. For SIC 37 and SIC 38, the results are also generally consistent, except in 1988 for SIC 37 and 1990 for SIC 38. Comparison of Earnings before R&D (EBR) and Operating Cash flows. The R2 and Vuong’s Z test results are provided in Table 4 by industry (SIC codes). Again, earnings before R&D appear to be a superior measure compared to operating cash flows, for each of the SIC codes examined. In the overall analysis (Panel A), the results are significant for SICs 37, 38 and 73. The year-wise analysis (Panel B) is generally consistent with the overall results. In fact, Panel B provides stronger results for the superiority of EPR. SICs 28 and 36 were not significant in the overall analysis, but in the year-wise analysis, were found



to be significant in four out of the six years examined. Results of the Incremental Information Hypothesis (Hypothesis 2)

The issue is examined further to determine whether the R&D expense has incremental information content. The results provided in Table 5, show that R&D expense has a coefficient that is positive and significant for each of the SIC Codes examined. This provides further evidence that R&D expenses has positive and incremental information content, indicating that the market does not treat such expenditure as expenses that are to be written off, but as expenses that increase the value of the firm.

Table 4

Comparison of Earnings before R&D and Operating Cash Flows Panel A: Pooled sample of 1988 - 1993

SIC N R2(EPR) R2(CFO) Vuong Z

28 1093 0.5471 0.4818 1.3331 35 1128 0.4871 0.4224 1.2478 36 1100 0.5032 0.4920 0.2007 37 125 0.6118 0.4749 1.6550c 38 1258 0.5422 0.4011 2.4604b 73 823 0.4220 0.2814 2.1897b Other 543 0.5630 0.4761 1.4774


SIC 1988 1989 1990 1991 1992 1993 28 4.9552a 4.2197a 2.1069b -0.4230 0.4854 1.7955c 35 2.3656b 4.2009a 0.6218 -1.2651 -0.5281 0.1433 36 1.6212 2.0816b -2.0516b 2.5119b 1.9908b -0.7773 37 2.7942a 3.9733a -1.1764 0.8187 2.6584a 0.2046 38 0.2328 3.5276a 1.8552c 2.8356a 2.2906b 2.2055b 73 2.1913b 1.9193c 1.0816 0.5207 0.5018 0.7547 Other 1.3548 0.3837 0.6077 0.8525 0.5350 0.5785

Panel A provides the R2 and results of the pooled sample for the years 1988 to 1993 for each of the industries. Panel B provides the year-wise results of the Vuong test only. All R2 values are adjusted. EPR= Earnings per share (before extra-ordinary items) plus R&D expenses; CFO=Cash flows from operations. aZ is significant at 1% level of significance; bZ is significant at 5% level of significance; cZ is significant at 10% level of significance.

Table 5 Incremental Information Content of Accruals and R&D Expenses

SIC β1

(Prob > |T|) β2 (Prob > |T|)

β3 (Prob > |T|)

R2

28 5.1149 (0.0001)

3.0308 (0.0001)

7.7990 (0.0001)

0.5913

35 5.3460 (0.0001)

2.9667 (0.0001)

3.3346 (0.0001)

0.5691

36 5.0146 (0.0001)

2.4139 (0.0001)

4.3386 (0.0001)

0.5758

37 2.2954 (0.0001)

1.8348 (0.0001)

4.1598 (0.0001)

0.6609



38 5.6542 (0.0001)

4.4336 (0.0001)

3.9053 (0.0001)

0.5514

73 6.1611 (0.0001)

5.3471 (0.0001)

3.8627 (0.0001)

0.4262

Other 7.5248 (0.0001)

5.2401 (0.0001)

1.6699 (0.0267)

0.6172

Pooled sample (1988-1993): Pi = α1 + β1CFOi + β2AAi + β3RDi + εi

CFO=Cash Flows from operations; AA=Total Accounting Accruals; RD=R&D Expenses.

CONCLUSIONS

R&D expenses form a significant expenditure for high technology industries. However, the treatment of R&D expenditures has come under increased criticism, particularly in recent studies. It is contended that the effects of R&D expenditures are long-lived and expensing of R&D in the year incurred results in reduced information usefulness of reported accounting measures (primarily earnings). This study investigates the usefulness of information contained in accounting measures in determining firm value. Specifically, the study compares the information usefulness of different accounting measures affected by R&D investments, to determine whether expensing affects the usefulness of the measures. The study also enhances understanding of the price-accounting measures relationships in the context of studies such as Dechow (1994) and Bowen, Burgstahler, and Daley (1987). Results suggest that cash flows are more value-relevant than accounting earnings before extra-ordinary items, for most R&D intensive industries. However, the most important finding is that reduction of R&D expense from earnings results in reduction in the information usefulness of the earnings number. While cash flows from operations is found to be a superior measure for several of the industries examined, the earnings before R&D expense is also found to be consistently superior to cash flows from operations. Additionally, it is found that R&D expense provides positive and significant incremental information beyond that provided by cash flows and accruals. Therefore, using the information usefulness criteria of SFAC No. 1, it is determined that expensing of the R&D investments reduces information usefulness of earnings. These results suggest that the treatment of R&D expenses will be a major challenge to accountants in the new millenium, as the competitive assets shift from the traditional tangible assets to intellectual property assets.



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Baber, W. R., Fairfield, P. M., & Haggard, J. A. (1991). “The Effect of Concern About Reported Income

on Discretionary Spending Decisions: The Case of Research and Development.” The Accounting Review, October 1991, 818-829.

Barth, M. E., Beaver, W. H., & Landsman, W. R. (1992). “The Market Valuation Implications of Net

Periodic Pension Cost Components.” Journal of Accounting and Economics, March 1992, 27-62 Beaver, W. H. 1989. Financial Reporting: An Accounting Revolution, 2nd ed. Englewood Cliffs, NJ:

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Economics, 9, 231-58. Dechow, P. M. 1994. “Accounting Earnings and Cash Flows as Measures of Firm Performance.” Journal

of Accounting and Economics, July 1994, 3-42. Dukes, R., Dyckman, T., & Elliott, J. (1980). “Accounting for Research and Development Costs: The

Impact of Research and Development Expenditures.” (Supplement): 1-37. Easton, P. D., & Harris, T. S. (1991). “Earnings as an Explanatory Variable for Returns.” Journal of

Accounting Research, Spring 1991, 19-36. Elliott, J., Richardson, G., Dyckman, T., & Dukes, R. (1984). “The Impact of SFAS No. 2 on Firm

Expenditures on Research and Development: Replications and Extensions.” Journal of Accounting Research, Spring 1984, 85-102.

Financial Accounting Standards Board. (1974). Statement of Financial Accounting Standards No. 2.

Accounting for Research and Development Costs. Stamford, CT: FASB. Financial Accounting Standards Board. (1978). Statement of Financial Accounting Concepts No. 1.

Objectives of Financial Reporting by Business Enterprises. Stamford, CT: FASB. Horwitz, B., & Kolodny, R. (1981). “The FASB, the SEC and R&D.” The Bell Journal of Economics,

Spring 1981, 249-262. Johnson, G. (1967). “A Consequential Approach to Accounting for R&D.” Journal of Accounting

Research, Autumn 1967, 164-172. Kothari, S. P., & Zimmerman, J. L. (1995). “Price and Return Models.” Journal of Accounting and

Economics, March 1995, 155-92. Landsman, W. R., & Magliolo, J. (1988). “Cross-Sectional Capital Market Research and Model

Specification.” The Accounting Review, October 1988, 586-603. Lev, B. (1989). “On the Usefulness of Earnings and Earnings Research: Lessons and Directions From Two

Decades of Empirical Research.” Journal of Accounting Research, Supplement, 151-92. _______, & Sougiannis, T. (1996). “The Capitalization, Amortization, and Value-Relevance of R&D.”

Journal of Accounting and Economics, February 1996, 107-38.



Loudder, M. L., & Behn, B. K. (1996). “Alternative Income Determination Rules and Earnings Usefulness:

The Case of R&D Costs.” Contemporary Accounting Research, Fall 1996, 185-204. Miller, P. B. W. (1985). “The Conceptual Framework: Myths and Realities.” Journal of Accountancy,

March, 62-71. Newman, M. S. (1968). “Equating Return From R&D Expenditures.” Financial Executive, April 1968, 26-

33. Ohlson, J. A., & Shroff, P. K. (1992). “Changes Versus Levels in Earnings as Explanatory Variables for

Returns: Some Theoretical Considerations.” Journal of Accounting Research, Autumn 1992, 210-26.

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Journal of Accounting Research, Supplement 1986, 112-33. Roll, R. (1988). “R2.” Journal of Finance, July 1988, 541-66. Sami, H. & Lee, B. (1995). “The Effect of R&D and Advertising Outlays on Earnings Response

Coefficients.” Working Paper, Temple University, Philadelphia, PA. Tse, S. (1986). “Intra-Year Trends in the Degree of Association Between Accounting Numbers and

Security Prices.” The Accounting Review, July 1986, 475-97. Vuong, Q. H. (1989). “Likelihood Ratio Tests for Model Selection and Non-Nested Hypothesis.”

Econometrica, March 1989, 307-33. White, H. (1980). “A Heteroscedasticity-Consistent Covariance Matrix Estimator and a Direct Test for

Heteroscedasticity.” Econometrica, 48, May 1980, 817-38. **I have benefited from the insights of Dr. Roland Lipka and Dr. H. Sami of Temple University and members of the Doctoral Consortium at the Eastern Regional Conference of the AAA.



AN EXPERIMENTAL STUDY OF THE OPTIMAL LEVEL OF BUDGETARY GOAL DIFFICULTY

Dowd, Joe E. Eastern Washington University

[email protected]

ABSTRACT

Budgets are used both to motivate and plan. To maximize elicited effort, budgets used to motivate need to be challenging and so may not reflect expected outcomes. On the other hand, in order to coordinate organizational activities, budgets used for planning purposes need to reflect the organization’s best estimate of actual outcomes. Therefore, to the extent that the optimal level of budgetary goal difficulty for motivational purposes yields budges that differ from the organization’s best estimates, then these two types of budgets are inconsistent and the purposes are in conflict.

In order to provide insight into the optimal level of budgetary goal difficulty for motivational purposes, an experiment was conducted that measured effort elicited from subjects assigned to either a budget-based or linear (piece-rate) compensation scheme. Subjects were assigned goals with a priori probabilities of attainment equal to 10%, 25%, and 50% (very difficult, difficult, and medium goals). Results indicate that within the medium goal difficulty treatment the linear scheme elicited more effort than the budget-based scheme. Within the difficult goal treatment subjects assigned the budget-based scheme exerted more effort than subjects assigned the linear scheme. Within the very difficult goal treatment, subjects assigned the linear scheme exerted slightly more effort than subjects assigned the budget-based scheme.



ASSESSING THE ACCOUNTING PROGRAM: MANDATED EXERCISE OR LEARNING

EXPERIENCE?

Hrncir, Theresa J. Southeastern Oklahoma State University

[email protected]

Oliver, Robert E. Southeastern Oklahoma State University

[email protected]

ABSTRACT

A consumerism movement placed pressure on legislative bodies and led accrediting agencies to mandate assessment of higher education programs. Programs and schools of accounting implemented various measures or used tools such as standardized, nationally-normed exams, departmentally developed surveys, or portfolios to validate the educational effort.

The purposes of this paper are two fold: (1) to discuss the issues, history, and commonly used methods of assessment, and (2) to discuss the experience of one institution after six years of using a standardized nationally-normed exit exam. The authors also discuss continued efforts to refine assessment methods and to improve their program.

INTRODUCTION

A consumerism movement placed pressure on legislative bodies and led accrediting agencies to mandate assessment of higher education programs. Schools of business administration and departments within the schools have debated the meaning of assessment and struggled with concepts of what or how to assess the educational program as unit, group, or individual(s). These schools endeavored to learn what or where to obtain the tools of assessment, to implement the assessment, and finally to actually assess the defined unit, group, or individual(s).

The purposes of this paper are two fold: (1) to discuss the issues, history, and commonly used methods of assessment, and (2) to discuss the experience of one institution after six years of using a standardized nationally-normed exit exam. The purposes of this paper are neither to critique any standardized examination nor to reveal confidential information as to test content or student scores. All evaluative comments of the authors represent their interpretations of the relative scores of students at one institution over a six year time period.

ISSUES, HISTORY, AND FREQUENTLY USED METHODS OF ASSESSMENT

There are multiple issues that surface when the topic of assessment is introduced into a paper or discussion. First, the term assessment implies the assessment of quality, and there are issues related to the term quality. What does quality mean? Like the concept of materiality in accounting, quality is an elusive ideal which varies with the individual. Tan (1986) definitively states that no clear concept of quality exists. However, Tan continues with the suggestion that in higher education there may be some common elements of quality as a means of ranking or rating which may be used to create agreement. The terms assessment and accountability seem to have become increasingly important in higher education. Of the two terms, assessment seems least clear. What does it mean and why is it important? According to Sell (1989) the term



can be used interchangeably with other terms such as testing, evaluation, or appraisal. Much has been written about assessment as being the answer to a myriad of concerns for higher education. These writings have been related to the quality of education and recently to accountability to the public for funding.

Resnick and Goulden (1987) have taken a historical perspective in looking at assessment. They noted that expansion in higher education can be measured by three indicators: total enrollment, institutional size, and portion of the eligible age group enrolled. They also have found that two critical periods-1918 to 1928 and 1952 to 1975 (with some continuance to 1983)--included increases of all three indicators in both periods. They also found the greatest growth in the second period came from expansion of the two-year community college with an increase in part-time, older, vocationally oriented student attendance, and from an almost doubling of business majors.

Institutions which receive public funds were and still are under pressure to be accountable for funding by the public. Astin (1987) states that the public wants to be sure it gets its money’s worth for higher education. This sentiment of responsibility and accountability is also reflected by others (Ewell, 1985; Folger, 1984: Jaschik, 1985; and McMillan, 1988). The current move for assessment in higher education follows a similar movement in elementary and secondary education and a general dissatisfaction with common education.

Resnick and Goulden (1987) found that with expansion came a perceived need for re-evaluation currently expressed in the movement for assessment and accountability. In the more recent period the student population both grew and changed. Part-time, older, vocationally oriented students, who attended two-year community colleges, comprised about 40 percent of the undergraduate student population. There have been shifts in major areas of student study. There has been an increase in student population and a shift in emphasis which lead to the belief that quality of higher education may have decreased. The issue of assessment of quality resurfaced. Assessment of quality still continues to be an important, unresolved issue in higher education.

There have been (and continue to be) some traditional approaches to assessment. Astin (1987) categorizes these as measures of reputation and resources. More specifically, he writes that measures of reputation are polls or surveys and are often equivalent to popularity contests. The resources categories are such quantitative measures as test scores of entering freshmen, endowments, physical plant size, faculty salary, and scholarly productivity. Neither type of general category assures student academic development but both set up win-lose situations among institutions. Folger (1984) echoes this thought with the comment that a negative assessment so discourages potential students and donors that no public assessment at all is better than a negative assessment. Astin proposes that “talent development” might be a better method of student assessment. His term of talent development is more commonly referred to in the literature as “value added.”

Generally, value added holds the most promise for the issues of accountability and assessment. Some existing programs measure only inputs, such as the traditional measure of entering freshmen ACT scores or any output measures such as initial salaries of recent graduates or number of students passing the CPA examination, as a measure of institutional success. Value-added methods require both input and output measurement or other comparison to indicate improvement. The expectation or end-products of value-added measures are likely to be a demonstration of improved critical thinking or communication skills. The benefits of using value-added methods are feedback for measurement and change and also better learning. The problems of using a value-added method include teaching to the test; teaching not matching the test and thus not adding value; and not finding a test to measure the teaching or the necessary materials to be learned. At least four additional problems exists in many institutions. These problems include: (1) Students who complete part of their major course work at one institution and graduate from another; (2) Students who work part-time or full-time and gradually complete course work; (3) Students who choose to “stop out” for one or more semesters while to completing a degree program; (4) Changing degree programs where students within a single program are following degree programs with different major requirements. The current generation of students tend to be more mobile and may complete courses at several institutions.

Assessment programs are not new for colleges and universities. Course grades, class standing, faculty evaluation, promotion and tenure, and state funding allocations represent forms of assessment. However, programs implemented to measure value-added or some measure of a common core of knowledge for accountability are recent additions to the literature.



SIX YEARS OF ASSESSMENT

Oklahoma mandated that programs develop assessment measures. Within Southeastern’s School of Business Administration, all business majors must take an exit assessment examination. While there are other examinations given to other business disciplines, in recent years the students in the Accounting Program at Southeastern Oklahoma State University have taken the Achievement Test for Accounting Graduates (ATAG) developed by The Psychological Corporation.

The decision to adopt the ATAG was not instantaneous. Faculty and administrators within the school of business considered more than one option. However, through faculty input, the decision was made to use this exam which claims to measure student achievement in the areas of financial accounting, taxation, managerial/cost accounting, auditing, and information systems. Because all these areas of study are discussed at least in part or are taught as a separate class, the examination was thought to be a reasonable tool for assessment. The purpose in choosing the ATAG was to select an instrument which could offer an objective measurement of student performance in the program.

Any time an evaluation of a program is undertaken, several concerns surface. Among the issues that made this decision more difficult were the following: struggling with the implementation of the administrative mandate for assessment; ideal versus standard measure; the idea of evaluating the program rather than the individual students, individual instructors, or even the test itself; teaching an effective program rather than teaching to the test; and adjustments to the curriculum. For various reasons, the greatest factor in choosing an instrument was lack of time to develop an in-house measure, and faculty chose not to develop their own assessment instrument. Faculty members of the accounting department, chose the ATAG as a reasonable measure of what was being taught or what should be taught for an accounting student.

Selecting the assessment instrument was the easiest task. The other concerns and new issues continued through the years. Concerned with the ideal versus standard measure created some uncertainty as to the appropriateness of examination. As an externally developed, nationally-normed examination, the ATAG offers the conversion of raw scores to percentile rankings. However, the question remains does it give an accurate measure of accounting education as offered by Southeastern Oklahoma State University? The accounting program is one of the larger programs on campus, but the number of graduates for most years are too small to offer statistically significant results. Also, students are required to take the examination, but are not required to achieve any particular score. There are no grades, sanctions, or penalties for indifference or low performance.

After five years’ time, the collective data seemed to allow for measurement and comparison among the years and against the normed scores. (An additional year’s data is being added, but it added little to our findings). Again, the authors’ purposes were neither to evaluate the ATAG nor to reveal confidential information or statistics. The purpose of the analysis was to make sense of the data; and using an externally developed set of normed scores seems to add objectivity to the measure.

After the initial screening for an acceptable instrument to use for assessment, faculty have not viewed questions on the ATAG. Faculty in the department were and are concerned with measuring program effectiveness rather than having the results tainted with any perception of teaching to the test. With the exception of two semesters, every examination has been administered by one individual. With one exception the examination administrators are authors of this paper. Nevertheless, faculty have been aware of the overall scores or the trends on the separate components of the ATAG examination.

Over six years’ time of ATAG use, accounting degree core requirements changed. Students entering college prior to Fall 1992 were required to complete 21 hours of accounting beyond principle courses and could choose among upper division courses. Students entering college in Fall 1992 to Fall 1996 were required to complete courses in intermediate accounting, individual income taxes, managerial-cost, advanced accounting, and auditing. This degree plan required six hours of electives in accounting or economics as well as the two principles courses. Beginning with the fall of 1996 entering college students and students first declaring accounting as a major were required to complete the fundamental courses along with intermediate accounting courses, both individual and corporate income taxes, both managerial-cost and advanced managerial, accounting information systems, auditing, and three hours of accounting



electives chosen from governmental, advanced accounting, or commercial law. These requirements are still in place. As with any accounting program, these changes were made in response to program reviews; to strengthen perceived weaknesses in the program; and/or to use faculty expertise to enhance the accounting program.

Many of the students at Southeastern Oklahoma State University were and continue to be nontraditional students attending school on a part-time basis. There are still students graduating under the pre-fall 1996 degree program. All these potential variables can be assumed to confound evaluation results.

FINDINGS AND RESULTS

Because many variables exist in the population of Southeastern’s accounting students, the authors attempted to isolate questions which would reflect changes in degree requirements. The authors read all questions from the ATAG and decided which questions were likely to be covered by current accounting elective courses. The selection of questions was based on the authors judgment and experience as accounting educators. While this was an interesting investigation, even after six years, there were no absolutely clear patterns of student improve for the questions selected. At best, the researchers could show some support for their intuition and insights, such as requiring two tax courses lead to improved scores in the area of taxes.

To test a theory that there may be a direct link between ATAG scores and course grades, an approximate 50 percent sample of student grades in one course, Intermediate Accounting I, were plotted. Figure 1 and Figure 2 reflect these comparisons. Figure 1 compares scores in financial performance on the ATAG (all financial accounting courses including governmental accounting and advanced accounting) with scores in Intermediate Accounting I. Figure 2 compares individual student ATAG composite scores with course grade for intermediate Accounting I. Course grade of 1 = D to 4 = A are used for the course grade scale. While there is no clear pattern to the overall performance on the financial section one pattern clearly appears in the second figure--students who earn marginal grades in Intermediate Accounting I only scored in the lowest quartile. At Southeastern students are allowed to take advanced courses even with a grade of “D” in required core courses. This finding needed to be addressed for the accounting program at Southeastern. Many accounting schools and programs require at grade of “C” or better for all major course work. This finding offered define feedback information for the Accounting Program. Faculty of the department changed graduation requirements for the major.

The Accounting Department has a limited number of faculty. Specialized areas of accounting such as taxes, governmental, or auditing are taught by only one individual professor. The faculty debated the merits and shortcomings of requiring a student to repeat a particular course with a low, but passing grade. The final decision was to let the grade stand as earned. Faculty reasoned that if a student were required to repeat a course, taking the same course with the same instructor might not inspire the student to increase learning and might create other problems. Another reason for the faculty decision was that students lacking the ability to successfully complete an accounting program would generally self-select to leave or change majors when they first make a grade of “D” or at least for the second one. However, the department and the School of Business Administration has proposed a change in policy to not allow transfer in of any business course with an earned grade of “D.”

Schick (1998) argued that information about students passing the CPA exam should be included in program evaluation. Scores on the ATAG for students known to have passed the CPA exam were compared against scores of students who passed the exam at multiple sittings of the CPA exam. (See Figure 3.) There was a definite pattern where those students who passed the CPA exam on the first sitting scored in the upper two quartiles of the ATAG on every area of the test except for the managerial cost accounting

Figur

Financial Performance ATAG vs Intermediate Accounting

0

20

40

60

80

0 1 2 3 4 5

Course Grade

AT

AG

Per

cen

tile



section, and that score was near the middle percentile. There is no effective way to include the scores of students who attempt the CPA exam and never successfully complete the exam.

CONCLUSIONS

Program assessment is and

should be a dynamic endeavor leading to more questions and possible future changes. Does using the ATAG give an accurate measure of accounting education as offered by Southeastern Oklahoma State University? Would further examination of the existing data be helpful? Does the accounting department need to find another instrument to use as an exit examination? What, if anything significant, was learned from this study. These are all worthy questions to ask and answer.

Does using the ATAG give an accurate measure of accounting education as offered by Southeastern Oklahoma State University? With all the variables included in student scores, it is difficult to discern this information, and no clear cut answers exist. The students are traditional and nontraditional. Some attend school full-time and complete a degree in four years, while others require several years to finish the degree requirements. Some students transfer in accounting coursework or change majors to or from accounting. As previously stated there are no grades, penalties, or sanctions for indifference or low performance on the assessment test. Nevertheless, conducting this study has sparked the authors’ interest to attempt further examination of the existing data, and further benefits are anticipated.

Does the accounting department need to find another instrument to use as an exit examination? Probably not. The ATAG has not been updated or revised since its issue, however it still has valid questions. The ATAG seems to give a reasonably good evaluation of the accounting program at Southeastern Oklahoma State University. Any perceived shortcomings of using it could be found in any assessment instrument. The American Accounting Association (1992-93) addresses such issues when it stated that “measurements of learning are imprecise, by the very nature of what is being measured. We are dealing with people, and people are dynamic....No one instrument exists that is robust enough to measure outcomes on a comprehensive level for all students, or for all accounting programs.”

What, if anything significant, did we learn from this study? Surprisingly, we gained some good insights. The charted results of student scores in the financial area and intermediate accounting I led to changes in transfer requirements. The latter finding is a “carrot” to offer students prior to taking the ATAG exam--those who do very well on the ATAG exam are more likely to pass the CPA exam on the first sitting. Of course, not all students plan or will take the CPA exam, but it represents a reward for some.

Figure 3

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REFERENCES

Astin, A. W. (1987). Assessment, value-added, and educational excellence. New Directions for Higher Education, Volume 59, 89-106. Ewell, P. (1985). November/December). Assessment: What’s it all about? Change, 32-36. Folger, J. (1984). Assessment of quality for accountability. New Directions for Higher Education, Volume 48, 75-85. Jaschik, S. (1985, October 2). As states weighs value-added tests, Northeast Missouri offers model. The Chronicle of Higher Education, 21-22. McMillan, J. H. (1988). Beyond value-added education. Journal of Higher Education, Volume 59, Number Five, 564-579. Report of the Outcome Assessment Committee (1992-93). Teaching and Curricular Section of the American Accounting Association (AAA). Resnick, D. P., & Goulden, M. (1987). Assessment, curriculum, and expansion: A historical perspective. New Directions for Higher Education, Volume 59, 77-87. Sell, G. R. (1989). An organizational perspective for the effective practice of assessment. New Directions for Higher Education, Volume 67, 21-41. Schick, A. G. (1998). Should undergraduate education in accounting be evaluated, in part, based on

ATAG Compositevs Grade in Intermediate Accounting I

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graduates’ performance on the CPA examination? Issues in Accounting Education, Volume 13, Number Two, 417-426. Tan, D. L. (1986). The assessment of quality in higher education: A critical review of literature and research. Research in Higher Education, Volume 24, Number Three, 644-664.



EVIDENCE OF THE SIGNIFCANCE OF THE AICPA’S COMPREHENSIVE MODEL OF BUSINESS REPORTING IN FINANCIAL

ANALYSTS INFERENTIAL DECISION MAKING PROCESSES

Austen, Lizabeth Anne University of Arkansas [email protected]

ABSTRACT

The American Institute of Certified Public Accountants (AICPA) Special Committee on Financial Reporting (the “Jenkins Committee”) recently proposed a comprehensive model of business reporting. Within the comprehensive business reporting model the Jenkins Committee recommended the inclusion of ten elements of information. The purpose of this research is to examine the significance and usefulness of those information elements to financial analysts in their inferential decision making processes. The research question was addressed using multiple experimental methods. The first, a survey, was administered to determine the degree to which financial analysts sought each of the information elements, the availability of each element of information to the analysts, and the importance of each element of information to financial analysts when valuing stock. The second, an experiment, was administered to provide additional evidence on the significance and use of forward-looking information in the decision making process. Written protocol analysis combined with survey data was used to gather additional evidence on the inference making processes of financial analysts. Results from the survey indicated that “The entities opportunities and risk, including those resulting from key trends” (forward-looking information) was deemed very important or important by 90% of the survey respondents. Sixty seven percent frequently sought that information and fifty percent indicated that the information is only sometimes or rarely available. In relation to the other information elements, this element ranked second in terms of importance and frequency sought, yet ninth in availability, providing evidence that it’s inclusion in business reporting would provide added value to financial analysts. Results from the experiment confirmed the importance of the inclusion of forward looking information in financial reporting. The results indicated that forward-looking information had a significant effect on analysts’ sales predictions. A majority of the participants in the experiment ranked forward-looking information as important or very important, sought forward-looking information frequently, and found forward-looking information to be never, rarely, or sometimes available.

Survey results and written protocol analysis indicate analysts use a firm’s historical data and information from other firms within an industry to infer absent information. Historical data was more likely to be used when information from other firms within the industry differed. However, when information from other firms within the industry differed, the majority of financial analysts still used that information and engaged in an averaging form of inference making to incorporate it into their decision making processes.

INTRODUCTION

The current business environment is depicted by an increase in the complexity of financial transactions and tremendous growth in information technology creating demands for financial information that is more relevant and diverse (Elliott 1994a, b). In the early 1990’s the American Institute of Certified Public Accountants (AICPA) formed the Special Committee on Financial Reporting (the “Jenkins Committee”) as a part of its broad initiative to improve the value of and the public’s confidence in business



information. In 1994, the committee issued a comprehensive report entitled “Improving Business Reporting-A Customer Focus: Meeting the Information Needs of Investors and Creditors.” Business reporting is defined by the committee as:

The information a company provides to help users with capital-allocation decisions about a company. It includes a number of different elements, with financial statements as one of those elements (AICPA 1994).

The Jenkins Committee developed a framework of information needs based on how investors value companies and how creditors assess the prospect of repayment. The Committee’s report culminated with the presentation of a comprehensive model of business reporting. The comprehensive model of business reporting contains ten elements of information that the Committee deems both useful to the decision maker and cost effective for the provider (see figure 1). The Jenkins Committee addressed the costs and benefits of providing these ten elements and the flexible nature of the information to be reported under the comprehensive model is a direct result of those criteria. Disclosure is voluntary with the elements considered a menu of choices. The result is a flexible reporting system in which both users and providers negotiate and agree upon the elements that are ultimately reported.

FIGURE 1 Ten elements of information

Recommended for Disclosure in the Comprehensive Business Report v Financial statements and related disclosures v High-level operating data and performance measures that management uses to

manage the business v Management’s analysis of financial and non-financial data v The entities opportunities and risk, including those resulting from key trends v Management’s plans, including critical success factors v Comparison of actual business performance to previously disclosed opportunities,

risks, and management plans v Information about managers and shareholders, including major transactions and

relationships among related parties v The entities broad objectives and strategies v The scope and description of business and properties v The impact of industry structure on the company

Financial analysts use financial reporting when performing financial analysis and are among the primary users of financial accounting information. The Association for Investment Management Research (AIMR)1, in its position paper, Financial Reporting in the 1990's and Beyond (AIMR 1993), cites the function of financial reporting in financial analysis as:

The function of analysis is to allow those who participate in the financial markets to form their own rational expectations about future economic events, in particular the amounts, timing, and uncertainty of an enterprise’s future cash flows. Through this process, analysts form opinions about the absolute and relative value of individual companies, make investment decisions or cause them to be made, and thereby contribute to the economically efficient allocation of capital and clearing of the capital markets.... It is the

1The AIMR has 24,000 members, 64 percent of whom hold the designation of Chartered Financial Analyst.



function of financial reporting to provide data useful to analysts making assessments of an enterprise’s future cash flows and its value today (AIMR 1993). (Emphasis added)

The report also states that “At the top of every analyst’s list is the annual report to shareholders. It is the major reporting document, and every other financial report is in some respect subsidiary or supplementary to it (AIMR 1993 p.16).”

Financial analyst forecasts are important as they provide input to the decision problems of others. For example, analysts’ forecasts are used by investors in making buy/sell decisions.2 Management may use analysts’ forecasts to determine “target” earnings or in making disclosure decisions.3 Audit firms sometimes use analysts’ forecasts as an analytical procedure to detect possible earnings management.4 Finally, accounting researchers use analysts’ forecasts as a proxy for market earnings expectations. One purpose of this paper is to examine the significance and usefulness of the ten information elements proposed by the Jenkins Committee to financial analysts in their decision making processes. Several research questions pertaining to the information elements are addressed.

RQ1 How often do financial analysts seek each of the ten information elements recommended for inclusion in the comprehensive business report when valuing stock?

RQ2 How available are the ten information elements recommended for inclusion in

the comprehensive business report to financial analysts? RQ3 How important are each of the ten information elements recommended for

inclusion in the comprehensive business report to financial analysts when valuing stock?

Answers to these research questions will help establish those information elements that are currently sought by, important to, but not available to financial analysts. Assuming management attends to

2Individual investors consider analyst reports among the most influential sources of information for investment decision making (Hirst, et al. 1995).

3The information that analysts seek and use comes from a variety of sources, with firm management considered a primary source (AIMR 1993). Managers periodically disclose information to comply with mandated institutional standards (e.g., SEC, FASB, IRS). Yet, not all information is disseminated by managers to analysts through mandated standards, and managers determine which private information to voluntarily disclose. A manager’s incentive to disclose or withhold information is motivated in part by investors’ expectations in the absence of the information (Verrecchia 1983). In addition, when earnings appear to fall short of earnings forecasts, managers may disclose bad news to lessen the negative “earnings surprise” (Skinner 1994).

4One incentive for managers to manipulate earnings is to meet earnings expectations.



the importance of institutional recommendations, the Jenkins Committee report should result in increased disclosure of those information elements. Yet the committee recommendations do not mandate disclosure and intend flexible financial reporting based upon cost-benefit analysis by management. Thus, some firms will choose disclosure while others will not. In view of the differential reporting of these information several research questions arise.

RQ4 What type of inferential decision making processes will financial analysts use when forecasting sales for a firm that fails to disclose an important information element when other firms within the industry disclose that information?

RQ5 What are financial analysts beliefs concerning managements motives for

nondisclosure? The research questions were addressed using multiple experimental methods. The first, a survey,

was administered to determine the degree to which financial analysts sought each of the information elements, the availability of each element of information to the analysts, and the importance of each element of information when valuing stock. The second, an experiment, was administered to provide additional evidence on the significance and use of forward-looking information in the decision making process. Written protocol analysis combined with survey data was used to gather additional evidence on the inference making processes of financial analysts.

The remainder of this paper is organized as follows. Section two is a review of the literature on inference-making from consumer behavior research integrated with research on information transfer and financial analysts decision making processes. Section three presents the research design and results. This is followed by a the final section which summarizes that paper and presents its contributions.

REVIEW OF THE LITERATURE

Accounting is an interesting institutional setting for the study of inference making and its effect on

investor’s expectations. Research on inference making in accounting is limited but previous research in inference making has been undertaken in the consumer behavior setting which is similar, in certain respects, to the accounting setting. An analyst’s evaluation of a firm and forecast of future value has some parallels with a consumer’s evaluation of a product and a decision concerning a purchase of that product. In addition, research on information transfer and financial analysts’ decision-making processes do exist in an accounting setting. Inference-making is broadly defined as drawing conclusions by reasoning from known facts or evidence. In this broad sense, all financial analysts engage in inference-making during the decision-making process. Inference-making is more specifically defined for the purposes of this study as the act of estimating a value for missing data and incorporating that value as an information cue in the decision-making process. Consumer behavior researchers have conducted various experimental studies in an attempt to ascertain the sources of information and the manner in which information is used when inference-making takes place. In that line of research, the sources of information considered when an attribute5 for a specific brand of product was absent included information pertaining to (1) other attributes of the brand and (2) information pertaining to the absent attribute in other brands within the product class. Considering information about other attributes within the brand implies the use of evaluative consistency. If the presented attributes are above (below) average, the absent attribute is assumed to be above (below) average (Ford & Smith 1987, Dick et al. 1990, Simmons & Lynch 1991, Santonmatsu et al 1992, Broniarczyk & Alba 1994a,b). As an example, consider purchasing a car where information about the trunk capacity was missing. If other attributes of the car (e.g. head room, leg room) were above average it would be assumed that the trunk capacity was above average.

Another source of information for inference-making is the value of the attribute across alternative brands. Research by Meyer (1981), Dick et. al (1990), and Ross & Creyer (1992) indicates that the value

5The term product “attribute” is synonymous with the usage of the term “information cue”.



of an absent attribute may be inferred as a function of the average of the value of that attribute across the brands. In the example above the trunk capacity of similar cars by different manufacturers would be averaged to provide an estimate of the car’s trunk capacity.

Only recently have consumer behavior researchers considered historical data as a source of inference-making. Broniarczyk & Alba (1994b) in seeking to determine potential boundary conditions for their findings that theory-based cues were dominant over data-based cues, examined whether the intuitive relationship could withstand the effects of contradictory historical performance of the attribute within the target brand. Their results showed that it did not, implying that the presence of historical data is influential.6 Again, in the example of the car, the buyer would determine if trunk capacity for that model was available in previous years and use that as a basis for inferring the current trunk capacity.

This research contributes to the consumer research on inference-making by considering inference rules that should be accessible in memory when a financial analyst makes decisions. Financial analysts are trained to make comparisons of firms with similar characteristics within an industry (AIMR 1991). Research into information transfer indicates that significant price movements of nondisclosing firms takes place when one firm in an industry group discloses (Baginski 1987, Pownall & Waymire 1989). In addition, one firm’s disclosure causes investors to update their assessment of another firm (Schipper 1990, Dye & Sidhar 1995). Thus, I consider intra-industry relationships to be an important source of information for financial analysts and inference making as a possible mechanism that facilitates information transfer. This is akin to the value of an attribute across alternative brands.

In addition, accounting information is presented in a multi-period framework. Even if the analyst does not have access to current period firm-specific data, past realizations of the information are available for both the target firm and other firms within the industry. Thus, I consider a firms historical data to be of importance in financial analysts inferential decision making.

The proposed research differs from that in consumer research in several respects. The subjects in this research are financial analysts skilled in making earnings forecasts on a regular basis. Subjects in consumer research were primarily students (Slovic & MacPhillamy 1974, Yates et al. 1978, Meyer 1981, Levin et al. 1984, Johnson & Levin 1985, Ford & Smith 1987, Lim et al. 1988, Simons & Lynch 1991, Sanbonmatsu et al. 1992, Ross & Creyer 1992, Broniarczyk & Alba 1994) and evaluations were made of consumer products such as televisions, cameras, refrigerators, and carpet cleaners. Although efforts were made to enhance subject involvement in the task through payments, lotteries and gift-giving scenarios, the subjects were not engaged in a task that they performed on a frequent basis. Neither were the subjects experts on the product they were evaluating. One exception is Sanbonmatsu et al. (1992) where subjects were pretested to determine their knowledge of the product and classified as high knowledge or low knowledge subjects. High knowledge individuals were more likely than low knowledge individuals to recognize the absence of information in making a judgment.

To summarize, it is predicted that when financial analysts perform financial analysis in an environment in which a firm chooses not to disclosure an information element and others within the industry choose to disclose the information, inference-making takes place. The research question is

6Product reputation was created by providing historical descriptions of the products over three years. Previous research had indicated that individuals intuitively form a positive relationship between durability and warranty. One of three products (the target product) was given the highest historical durability in the study phase of the experiment. In the test phase the subjects were given warranty and asked to infer durability. The target product in the test phase had the lowest warranty, yet three quarters of the subjects assigned the target product the highest durability consistent with the effect of historical performance overriding the intuitive relationship between warranty and durability.



whether financial analysts inferences are based upon the historical data of the firm, current-period information obtained from other firms within the industry, neither, or both.

RESEARCH METHODS AND RESULTS

Several methodologies were used to examine the research questions of this study. The first, a survey, was used to answer research questions one through three. An experimental methodology was used to answer research question four and a follow up question in that study was used to answer research question five. There are a number of advantages to using an experimental methodology for this research. An experiment, as opposed to an archival approach, allows the researcher to manipulate the variables of interest and control others. An additional advantage of the experimental method is the ability to present alternatives that do not currently exist in the environment. Previous consumer behavior research on inference-making stresses the importance of absent information to the decision in order for inference-making to take place. Yamagishi & Hill (1983) developed an evaluation model that incorporated absent data by explicitly assuming that only important absent information is inferred and incorporated into the evaluation process. Experimental results from Simmons & Lynch (1991) and Sanbonmatsu, et al. (1992) imply that one necessary condition for information to be noted as missing (by consumers) is its importance. In accounting research, protocol analysis in accounting by Bouman et al (1987) and Anderson (1988) indicate that analysts use checklists to limit and focus their information search to those items considered “important” to the earnings prediction task. Therefore, it is important to the analysts’ prediction task that the information be important enough to be sought by the analysts yet not always available to them.

The information examined was selected from the ten elements of information recommended for voluntary disclosure by the Jenkins Committee report. A survey was constructed to determine (1) the extent to which analysts seek each of the information elements, (2) the availability of each of the information elements when it is sought, and (3) the importance of each of the information elements to the prediction of earnings. The survey also provided an initial pre-test of the inference-making process by asking the analysts to indicate the manner in which they make inferences when information is sought and found to be absent. The survey was mailed to 140 members of a local chapter of the Financial Analyst Society of the Association for Investment Management and Research (AIMR) in a large metropolitan city. Twenty-seven surveys were returned for a response rate of 20%. Five of the respondents indicated that they did not value a company’s stock, resulting in 22 usable responses. The level of experience ranged from 2 to 49 years, with a mean level of 17 years of experience. Fifty percent were chartered financial analysts. Job titles ranged from portfolio manager to president and owner. Table 1 summarizes the subject data.

TABLE 1 Subject Information: Survey

Percentage of Financial Analysts

Predict Future Earnings...

On a daily basis 42%

At least once a week 8%

Less than weekly but several times a month 33%

Infrequently, less than once a month 17%

Make Buy/Sell Recommendations...

On a daily basis 30%



At least once a week 35%

Less than weekly but several times a month 30%

Infrequently, less than once a month 5%

Chartered Financial Analyst 50%

Years Employed in This Profession (mean) 17 years

Ninety-one percent of the responding analysts made buy/sell recommendations and 55% indicated that they predicted earnings. Of those who made buy/sell recommendations, thirty percent made buy/sell recommendations on a daily basis, 35% at least once a week, 30% less than weekly but several times a month, and 5% infrequently. Of those who predicted earnings, 42% predicted earnings on a daily basis, 8% at least once a week, 33% less than weekly but several times a month, and 17% infrequently. The survey responses were analyzed for the sample as a whole and for the subsample of those who predicted earnings. Although the sample size is small, it represents a highly experienced cross section of financial analysts.

An objective of the survey was to identify an information element that financial analysts deemed important, sought, and found absent. Table 2, panels A through C summarize these results. “The entities opportunities and risk, including those resulting from key trends” was deemed very important or important by 90% of the subjects in the full sample and 92% of the subjects in the earnings prediction subsample. Sixty seven percent of the full sample and 75% of the earnings prediction subsample frequently sought that information. Fifty percent and 42%, respectively, indicated that the information is only sometimes or rarely available. In relation to the other information elements, this element ranked second (fourth) in terms of importance and second (first) in frequency sought, yet last (eighth) in availability in the full (earnings prediction) sample.

TABLE 2 Financial Analysts Responses to Survey-Panel A

How often do you seek the following for use in valuing stock? Ratings (in percentages)

Jenkin's Committee Ten Elements

Frequently Occasionally

Rarely Because I Have Difficulty Obtaining the Information

Rarely Because I Do Not Find the Information Useful

The entities opportunities and risk, including those resulting from key trends 66 29 5 0

The entities broad objectives and strategies 59 27 14 0

Financial statements and related disclosures 77 18 0 5The scope and description of business and properties. 45 50 0 5Management's plans, including critical success factors. 35 55 5 5

company 55 31 9 5

Comparison of actual business performance to previously disclosed opportunities, risks, and management's plans. 32 50 9 9

Management's analysis of financial and non-financial data 45 27 14 14



Financial Analysts Responses to Survey-Panel B How important are the following items of information when valuing stock? Ratings (in percentages)

Jenkin's Committee Ten Elements Very Important Important

Somewhat Important

Somewhat Un-important

Un-important

The entities opportunities and risk, including those resulting from key trends 45 45 9 0 0

The entities broad objectives and strategies 36 59 5 0 0

Financial statements and related disclosures 73 9 14 5 0

The scope and description of business and properties. 52 29 19 0 0

Management's plans, including critical success factors. 41 45 9 5 0The impact of industry structure on the company 36 36 18 9 0

Comparison of actual business performance to previously disclosed opportunities, risks, and management's plans. 32 36 23 9 0

Management's analysis of financial and non-financial data 23 32 27 18 0

High-level operating data and performance measures that management uses to manage the business. 18 32 32 18 0

Information about managers and shareholders, including major transactions and relationships among related parties. 14 36 36 14 0

Financial Analysts Responses to Survey-Panel C When you seek the following items of information, how available are they to you? Ratings (in percentages)

Jenkin's Committee Ten Elements Always Available

Usually Available

Some-times

AvailableRarely

AvailableThe entities opportunities and risk, including those resulting from key trends 14 36 41 9The entities broad objectives and strategies 32 45 18 5Financial statements and related disclosures 64 27 9 0The scope and description of business and properties. 50 27 23 0Management's plans, including critical success factors. 9 45 36 9The impact of industry structure on the company 32 36 23 9Comparison of actual business performance to previously disclosed opportunities, risks, and management's plans. 9 50 27 14Management's analysis of financial and non-financial data 18 45 32 5High-level operating data and performance measures that management uses to manage the business. 5 14 36 45Information about managers and shareholders, including major transactions and relationships among related parties. 23 41 27 5



Table 3 presents the average ratings of each element and indicates the relative size of the gap between the availability of the element and it’s importance. “Management’s plans, including critical success factors” were high in importance but sought occasionally. “High-level operating data and performance measures that management uses to manage the business” was cited as being rarely available but low in importance. In keeping with previous research “Financial statements and related disclosures” was highest in importance, frequently sought, and most available.

TABLE 3

RANKINGS OF INFORMATION ELEMENTS AND GAP BETWEEN AVAILABILITY AND IMPORTANCE

Average Ratings Jenkins Committee Ten Elements Sought Available Important Gap between

availability and importance*

The entities opportunities and risk, including those resulting from key trends

1.1 2.3 1.5 0.8

High-level operating data and performance measures that management uses to manage the business.

2.7 3.1 2.4 0.7

Management's plans, including critical success factors.

1.7 2.3 1.7 0.6

Comparison of actual business performance to previously disclosed opportunities, risks, and management's plans.

1.8 2.3 2.0 0.3

The entities broad objectives and strategies 1.4 1.8 1.6 0.2 The impact of industry structure on the company 1.5 2.0 1.9 0.1 The scope and description of business and properties.1.5 1.6 1.5 0.1 Financial statements and related disclosures 1.3 1.3 1.4 -0.1 Management's analysis of financial and non-financial data

1.9 2.1 2.3 -0.2

Information about managers and shareholders, including major transactions and relationships among related parties.

1.8 2.1 2.5 -0.3

Note: The lower the ranking, the greater the importance, availability, and degree to which sought. * A negative gap indicates a greater degree of availability than importance.

My initial belief, prior to the survey, was that “Management’s plans, including critical success factors” were important, sought, and found absent. Thus, the questions pertaining to inference-making in the survey pertained specifically to management plans. Respondents were asked to indicate any, and all, inference processes that they used when management plans were sought and found absent. In the full (earnings prediction) sample 52% (67%) indicated they would discount the stock's value because the information was missing. While 29% of the full sample indicated they would ignore the information, only 8% of the earnings prediction subsample indicated they would ignore the information. One-third of the respondents indicated they would make specific inferences. One-fourth of both samples indicated they would use similar management plans from other firm's in the same industry to infer the absent information. Fourteen (twenty-five) percent indicated they would use the realization of similar management plans from the same firms historical data to infer the absent information. Other responses included “Look for more information;" “Question management’s long term plans if the information is not available. Can understand, short term, withholding details while specific plans for future being made, but overall long term plans a key



to success of company;" “I would get the information or not buy the stock;” and “Talk to competitors and suppliers." In summary, a majority of the respondents indicated the absence of the information would affect their valuation of a company’s stock. The second instrument was an experiment. Analyst inferences were examined within two voluntary disclosure environments. The first environment evolves from the recommendations of the American Institute of Certified Public Accountants (AICPA) Special Committee on Financial Reporting (the “Jenkins Committee”) (AICPA 1994) comprehensive model of business reporting. The second environment evolves from the recommendation of the Australian Society of Certified Practising Accountants (ASPCA) External Reporting Centre of Excellence report on management discussion and analysis. The Centre recommends the inclusion of four items of information to ensure comprehensive financial reporting. In both environments, if the recommendations for disclosure are adopted by some firms and not others, a natural setting for inference making will evolve.1 In these settings, the analyst, who seeks specific information about a target firm and finds that information absent, may find that same information disclosed for other firms within the industry. The recency of the Jenkins Committee and External Reporting Centre of Excellence recommendations limit the availability of actual firms who have adopted their reporting recommendations. Cases were developed using the comprehensive business reporting recommendations, allowing a prospective, rather than retrospective, examination of the issue. The design of the experiment was such that analysts could engage in one or more inference making behaviors-use similar information from other firms in the same industry, use the firm’s historical data, or ignore the information provided. The experiment was implemented as a 2 x 2 between-subjects experiment (see table 4). To measure the effect of information disclosed by other firms the independent variables were the expected 19x9 sales of market pulp as disclosed by two intra-industry firms. Disclosure took place in the form of “opportunities and risks including those resulting from key trends”2 for the paper and pulp segment. Two trends were disclosed by the related industry firms. The first, an opportunity, predicted growth in unit sales for pulp and is the same in all conditions. The second, a risk, predicted falling prices for market pulp in the upcoming years. Two levels of this variable consist of either a 3% to 5% price decline or a 30% to 40% price decline in 19x9. While seemingly drastic, the actual price of market pulp dropped 35% during the first quarter of 1996 resulting in significant revisions of EPS (downward) by financial analysts who follow the paper and wood products industry. The dependent variables were a prediction of pulp and paper sales and confidence in the prediction.

TABLE 4 EXPERIMENTAL DESIGN

Independent Variables Current Period Disclosure: Firm 1

3-5% price decline

30-40% price decline

Current Period Disclosure: Firm 2

3-5% price decline

cell 1 S1 . . . .n

cell 2 Sn+1 . . . 2.n

1The salience of absent information should also be enhanced if analysts are aware of the Committee’s recommendations and hence note that recommended disclosures are absent.

2These fall under the more general heading of forward-looking information in the United States and future-oriented information in Australia. A definition of forward-looking (future-oriented) information was also provided in the case materials.



30-40% price decline

cell 3 S2n+1 . . . 3n

cell 4

S3n+1 . . . .N

Financial analysts were solicited to serve as subjects in the experiment. In developing it’s comprehensive business reporting model the Jenkins Committee considered professional investors as a primary user of business reporting and cited as a main benefit of informative disclosure the reduced likelihood that analysts will misallocate their capital (AICPA 1994, p. 45). The financial analysts were recruited from two sources. In the United States, the analysts were recruited from the Association for Investment Management and Research (AIMR), 64% of whom hold the designation of Chartered Financial Analyst and 70% of whom hold degrees beyond the baccalaureate. In Australia, the analysts were recruited from the membership of the Securities Institute of Australia. The Securities Institute of Australia is the national not-for-profit professional organization representing people engaged in, and connected with, investment and securities markets in Australia. Members are admitted as either Associate or Affiliate members. Associate members are graduates of the Graduate Diploma in Applied Finance and Investment. Affiliate members are graduates of the Certificate in Financial Markets. Participants were recruited through a letter describing the research project as dealing with corporate disclosure and investor decision-making processes. Potential participants were advised that the task would require approximately a half hour of time to complete. The task was administered in the form of a four page booklet, packaged with the previously described invitation to participate and a pre-addressed, postage paid reply envelope. In the task materials the participants were presented with (1) an introduction informing them of the AICPA (ASCPA) recommendations for disclosure of forward-looking (future-oriented) information, (2) case instructions directing the participants to estimate pulp and paper sales for fiscal 19x9 for a fictitious company (Forestking) in the paper and forest products industry,3, 4 (3) a case, and (4) a questionnaire. Each case indicated that the target firm (Forestking) had not adopted the AICPA (ASCPA) recommendations for disclosure yet one or more competitors of the target firm had chosen to disclose the information. The competitors’ forecasts of opportunities and risks were provided along with both a table and a graph5 providing the target firms’ and competitor(s) pulp and paper sales for the previous eight years

3The fictitious company, Forestking, was based upon Boise Cascade Corporation, an actual company within the paper and forest industry.

4The pulp and paper industry was chosen since information transfer research by Pownall and Waymire (1989) indicated a significant coefficient for information transfer effects within this industry. In addition, a significant change in pulp prices (a 35% price decline) for the first quarter of 1996 took place. Firms with a December 1995 year end who released their reports during the first quarter of 1996 would have been aware of this information and could have chosen to disclose it as forward-looking (future-oriented). An examination of firms within the industry in both the U.S. and Australia indicated differential disclosure of this information across firms. Thus, the potential for inference making by investors existed at that time.

5Hutchinson and Alba (1995) find that, in general, individuals enlist various heuristics and exhibit



(see table 5 for an example of the stimulus materials). An estimate of fiscal 19x9 pulp and paper sales for Forestking and the analysts’ confidence in their prediction (on a scale of 0-100%) were solicited at the end the case. Analysts were also asked to provide a brief description of the decision-making process used. These descriptions provided a written protocol for additional analysis. Lastly, demographic and decision making questions followed the cases. All individuals were advised that they and their firms would remain confidential and that they may request a copy of the results.

TABLE 5 STIMULUS MATERIAL-INDEPENDENT VARIABLES

Sales of pulp and paper ($ in millions) Company 19x1 19x2 19x3 19x4 19x5 19x6 19x7 19x8 Forestking* 2,499 2,491 2,329 2,071 1,930 1,921 1,942 2,518 Pulpmaster 1,905 1,806 1,848 1,749 1,602 1,488 1,539 1,971

Paperland 2,612 2,732 2,684 2,552 2,554 2,396 2,524 2,932 *Forestking is the target firm that did not disclose forward looking information for 19x9.

Pulp and Paper Sales

$0$500

$1,000$1,500$2,000$2,500$3,000

19x1 19x2 19x3 19x4 19x5 19x6 19x7 19x8

Sal

es

Forestking Pulpmaster Paperland

biases in determining correlations. Financial analysts, who are trained to determine and use correlations, should be less likely to exhibit these biases. However, to further insure that analysts recognized the prior-period relationship, the information was presented graphically.



Forty-three experimental instruments were returned.6 Two of the respondents did not provide a sales prediction, resulting in 41 usable responses.7 The level of experience ranged from 1 to 35 years, with a mean level of 12 years of experience. Twenty-eight percent were from Australia and 72% percent from the United States. Sixty-seven percent were chartered financial analysts (58% of United States respondents) or held a certificate in financial markets (92% of Australian respondents). Job titles ranged from analyst to CFO. Table 6 summarizes the subject data.

TABLE 6 SUBJECT INFORMATION-EXPERIMENT

Percentage of Financial Analysts . . .

Country: Australia United States

28% 72%

Certification: certificate in financial management or certified financial analyst.

67%

Experience in the profession: 1-9 years 10-19 years more than 20 years

53.3% 30% 16.7%

Job title: portfolio manager director/manager of investments/ research V.P., president or CFO analyst other

23% 28% 19% 14% 16%

Predict future financial data as part of their employment. 79%

Do not specialize in a particular industry. 63%

Familiar with the pulp and paper industry. 14%

Familiar with actual fluctuation in pulp prices during the previous year.

9%

As further evidence of the significance of this information element to financial analysts, participants were asked to rank forward-looking information. Eighty-four percent of the respondents in the 6The response rate was four percent. A low response rate is typical with this particular subject group. Several analysts either returned the research instrument, phoned, or e-mailed with a response that their company did not allow participation in research of this nature. Others indicated a willingness to participate but a lack of available time.

7The two individuals who did not provide a sales forecast for testing the main hypothesis did answer the post experimental questionnaire and were included in the analysis of those results.



experiment ranked forward-looking information as important or very important, 67% sought forward-looking information frequently, and 63% found forward-looking information to be never, rarely, or sometimes available. As the specific forward-looking information provided in the case materials was a price prediction, participants were asked to state the single piece of information they considered most important when making predictions of future sales, irrespective of the information given (not given) in the case material. Thirty-seven participants responded to this query. Of those, 28% cited price and/or cost information, 28% cited supply and/or demand information, 18% mentioned trends, 13% mentioned past sales, and 13% mentioned market share or market size.8 Also mentioned were industry data, management estimates, and unit volume growth rates. This provides further evidence that the information provided to the analysts was considered to be important to their sales prediction.

Research question four was concerned with the methods used by financial analysts when engaged in inference-making behavior. Previous consumer behavior research would suggest an averaging of the predictions by the intra-industry firms and/or the use of historical data. The cells in which the information from the intra-industry firms was identical (i.e. each firm reported a identical price drop) would preclude the averaging of the information but provide evidence of the use of historical data. These cells also provide evidence of a discounting affect that may take place when one firm fails to disclose and another (or others) disclose the information (also documented in consumer behavior research). The cells in which current-period data is different (e.g. one firm reports a 3-5% decline and the other a 30-40% decline) can provide evidence of averaging behavior. In addition, comparison of behavior in the different types of cells can provide evidence as to the conditions under which analysts use historical data rather than, or in addition to, information from other firms within the industry. For example, do they use historical data only when the current-period data is different or does the use of historical data of the firm dominates the use of current period disclosure of intra-industry firms?

Table 7 presents the results from the experiment for each dependent variable, the forecast of sales (panel A) and the financial analysts’ confidence in their forecast (panel B). There was no significant difference in sales forecast between the cells that presented the differing information, a 2-5% price decline for one firm and a 30-40% price decline for the other. Thus, there were no firm effects (i.e. the analysts were unaffected by whether the information was disclosed by Pulpmaster versus Paperland). There was a significant difference for the experimental conditions in which the participants were presented with identical (within cell), yet different (between cells), pulp price declines. The forecasted sales were significantly different for the 30-40% price decline information ($1,970) and the 2-5% price decline information ($2,466) indicating that financial analysts attended to the current-value price decline information. In addition, the forecasted sales for the cells containing information that differed ($2,393 and $2,244) were between these two extremes providing preliminary evidence of averaging behavior. The analysts were no less confident in their sales forecasts when the information was different rather than identical. While initially unexpected, the result may be indicative of the analysts willingness to use information from other sources when a given firm fails to disclose information regardless of whether the information is identical or different. This result may also be a consequence of the analyst using an averaging strategy. In this case, the analyst believes both firms in the differing conditions are providing relevant information, averages the information, and is no less confident in their prediction than those analysts who received identical information.

Table 7 Experimental Results

Panel A: Dependent Variable-Forecast of Sales (in millions)

8Although the analysts were asked for a single important piece of information, several analysts cited more than one. Thus the percentages total more than 100%.



*ANOVA results indicate these cells are significantly different at the .01 level.

Panel B: Dependent Variable-Confidence in Sales Forecast

Independent Variables Firm 1 2-5% price decline 30-40% price decline Firm 2 2-5% price decline 48% 58% 30-40% price decline 53% 56% Anova results reveal no significant difference between the cells.

As with the initial survey, respondents in the experiment were asked to indicate any, and all,

inference processes that they used when forward-looking information they felt was important for predicting future financial data was sought and found absent. Only 2% indicated they would ignore the information in making their prediction. Eighty-eight percent indicated they would use similar information from other firms within the industry to infer the absent information and 77% indicated they would use the firm’s historical data to infer the absent information. Fifty-three percent indicated they would seek other information such as industry information (55%), information on the economy (32%), and government information (18%). Ten percent replied that in the absence of the information they would talk to management.

Although a vast majority of the analysts indicated they would use similar information from other firms within the industry and/or the firm’s historical data to make an inference when information deemed important for making a sales prediction was absent, it is important to determine if they did, in fact, do so. To provide further evidence of the type of inference making employed by the financial analysts in their decision making process an analysis of the written protocols was undertaken.

Two-thirds of the respondents either specifically mentioned using historical data or demonstrated that they used it in their calculations. As the research instrument was not designed to separate the effects of using the historical data of the target firm from those using the historical data of all three firms, it was difficult to determine precisely which was the case. However, it was evident from examining the protocols that at least 40% of those using historical data used both the data of the target and competitor firms. Some individuals calculated year to year changes in sales for all three firms, others calculated the target firms market share for the previous years, and some mentioned the trend in sales as depicted in the graph. Three individuals specifically mentioned the term “correlation” in their protocols. Twenty-three percent used only the historical data of the target firm. Use of historical information in the condition where information differed was twice that of the condition in which the information was identical.

In addition to the presence of historical data, current-period intra-industry information was available. Of those individuals in the condition where a 2 to 5% pulp price decline was forecasted by both firms, 12% used a 5% decline in their sales prediction, representing a conservative use of the information. Fifty-five percent used an average 3.5% decline and 33% used an optimistic 2% decline. Of those individuals in the condition where a 30-40% pulp price decline was forecasted by both firms, 11% used a conservative 40% decline, 67% used an average 35% decline, 22% used an optimistic decline of 30% or

Independent Variables

Firm 1

2-5% price decline 30-40% price decline

Firm 2 2-5% price decline $2,466* $2,244 30-40% price decline $2,393 $1,970*



less. It is interesting to note that the majority of the analysts used an averaging process even in the conditions where the information was identical for both disclosing firms.

Of even greater interest is the decision-making behavior of those analysts in the conditions where forecasted pulp price declines were 2-5% for one company and 30-40% for the other. Three individuals (13%) in this condition chose to ignore the pulp price decline forecast. Of the remaining, one-third of the individuals used either the 30-40% price decline or the 2-5% price decline (an equal number chose each). Of the two-thirds who chose a decline between the two extremes, one-third chose a pulp price decline that ranged from 8.5-12%, one-third chose 20% and another one-third chose 22.5-28%.9 Thus, the majority of the analysts used an averaging process. To summarize, financial analysts use both historical information and intra-industry firm information in their inferential decision making processes. The majority of financial analysts use an averaging form of inference making when considering attributes across alternative (intra-industry firm information). Historical information is more likely to be used when intra-industry firm information differs. Future research could examine in greater depth the conditions under which financial analysts rely upon historical versus intra-industry information. Research question five addressed analysts beliefs in managements reasons for nondisclosure. Agency literature such as Feltham & Xie (1992) and Dye & Sridhar (1995) is predicated upon the investors beliefs in management’s reason for nondisclosure (e.g. keep bad news from the market, keep good news from competitors). Participants were asked if, in their examination of the case materials, they considered the reason that management of the target company did not disclose the forward-looking information. Surprisingly, two-thirds of the respondents did not. Of the fourteen participants who indicated they considered a reason for non-disclosure, 36% believed it was due to volatile sales and poor predictability, 36% believed the news was bad or would affect share price, and 29% believed it was due to competitive considerations. Other factors cited were privacy and the increased burden of additional disclosure.10 Future research could address this issue in more depth to determine if these responses are due to the nature of this particular case or if analysts, in general, do not consider reasons for nondisclosure.

CONTRIBUTIONS Management may benefit from this research since the inferences analysts draw when managers fail to voluntarily disclose firm-specific information provides additional evidence concerning analyst expectations in the absence of information. This research provides evidence that analysts incorporate the information disclosed by other firms within the industry into their predictions of the sales of the firm who chose not to disclose the information. It may be beneficial for management who face the possibility that adverse industry conditions will be forecast by others to address the adversity and provide firm-specific characteristics that may indicate the extent to which their firm will or will not be affected in the future. Alternatively, disclosing positive information may also counteract the effect of the adverse disclosure via the averaging process. However, this behavior by management may not be successful in future periods due to a reputation effect. Management may also benefit from the report by analysts that in the presence of information disclosed by intra-industry firms, the majority of analysts did not consider management’s reason for nondisclosure and only twelve percent of the analysts believed the reason for nondisclosure was that the news was bad or would affect share price. Contributions to the literature on information transfer research results from specifically investigating a mechanism (i.e. inference making) that may be responsible for information transfer and the manner in which the transfer takes place. This research provides evidence that an averaging process is present during information transfer.

9It is interesting to note that one individual assigned a 65% probability of the price dropping 35% and a 35% probability of the price dropping 3%.

10The percentages do not sum to 100 as some participants gave multiple reasons.



This study provides insights into analyst behavior concerning analysts' forecast bias. Recent capital markets research on analysts’ forecasts has observed that analysts’ forecasts are systematically biased (Debondt & Thaler 1990, Butler & Lang 1991, Ali et al 1992, Francis & Philbrick 1993, and Dreman 1995). One goal of the proposed research was to analyze factors that contribute to analysts’ forecast bias. Analysts’ behavior revealed a positive bias in that twice the number of analysts in the conditions where information was identical chose the lesser decline in pulp prices than chose the greater decline. However, the majority of the analysts chose an average in all conditions indicating that any positive bias is this context was not dominant among analysts.

This paper has benefited from the comments of William Messier, Jr., Joe Alba, and Karl Hackenbrack, of the University of Florida, John Lynch of Duke University and workshop participants at the University of Arkansas, Virginia Polytechnic University, and New Mexico State University. The author also acknowledges the support of the University of New South Wales.



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THE SUPREME COURT'S CENTRAL BANK DECISION: ASSESSING THE IMPACT ON AUDITOR LITIGATION

Gilbertson, David L.

Western Washington University david.gilbertson@wwu. edu

ABSTRACT

In April of 1994, the U. S. Supreme Court handed down its decision in Central Bank of Denver,

N.A. v. First Interstate Bank of Denver, N.A., in which it held that a private plaintiff may not maintain an action for aiding and abetting under Section 10(b) of the 1934 Securities Exchange Act. Since accounting firms were often the targets of lawsuits alleging aiding and abetting under the securities laws, many observers predicted that this decision would reduce their litigation exposure.

This study examines the impact of Central Bank on auditor litigation at the micro and macro levels. First, at the micro level, it studies 27 decisions on motions to dismiss in cases involving auditors as codefendants. From these analyses, it appears that the relief which the Court sought to provide in Central Bank did not ensue. This result is most likely due to the fact that plaintiffs typically allege multiple violations in securities lawsuits. For the macro part of the analysis, a sample of 348 settlements was examined for changes in the frequency with which auditors were named as codefendants, and for differences in the amounts of reported settlements. These analyses fail to discern any meaningful pattern of reduced auditor litigation experience resulting from the Court's decision in Central Bank

These results hold several implications for the current debate over reforming the securities laws. First, since securities lawsuits are rarely single issue lawsuits, single issue "reforms" of the law, either legislative or judicial, such as the Central Bank ruling, are likely to prove ineffective. Second, because the preponderance of the identified cases were able to survive motions to dismiss even after the Central Bank ruling, these cases may have more substance than some critics, including accounting firms, have claimed. Finally, the extent to which any effort to reform the securities laws can effect meaningful change in securities litigation will no doubt be checked by the ingenuity of the plaintiffs' attorney. INTRODUCTION

In 1993, the Big 6 accounting firms reported to the Securities and Exchange Commission that more than $30 billion in claims were pending against them: more than 20 times the combined capital of all the firms' partners (Mednick & Peck 1994). This litigation explosion led accounting firms to the forefront of those calling for reform of the Securities Acts. The Big 6 firms and the AICPA combined with other businesses and groups in forming the Coalition to End Abusive Securities Suits (CEASS) in 1992 (Andersen, et al. 1992). There has also been an expansion of interest in litigation research in recent years (Kinney 1993, 1994). Much of this interest was motivated by a desire to support the accounting profession's push for securities law reform (Elliott 1994). Securities class action lawsuits are the source of nearly a third of all lawsuits against auditors, and account for more than half of the firms' settlement payments (Arthur Andersen, et al.1992; Mednick & Peck, 1994). In April of 1994, the U. S. Supreme Court handed down a decision which has been termed "the most important federal securities law decision in several years" (Seligman 1994, 1430). In Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A. (Central Bank 1994) the Court held that a private plaintiff may not maintain an action for aiding and abetting under Section 10(b) of the 1934 Securities Exchange Act. This provides a rare opportunity for accounting researchers to evaluate the impact of a major change in federal securities law on auditor litigation.

The Central Bank opinion, which "delighted 'deep pockets,' shocked the plaintiffs' bar, and befuddled neutral observers" (Steinberg 1995, 489), swept away a cornerstone of liability which had been upheld "in hundreds of judicial and administrative proceedings in every circuit in the federal system, the courts and the SEC" (Central Bank 1994, 1456). Since accounting firms were often the targets of lawsuits alleging aiding and abetting under the



securities laws, some observers predicted that this decision would reduce their litigation exposure. Moreover, it is apparent from the text of its decision that the Supreme Court intended to provide relief for lawsuit-weary accountants. The purpose of this research is to assess the effectiveness of the Central Bank decision in providing that relief.

This study examines the impact of Central Bank on auditor litigation in two ways. First, at the micro level, it studies 27 decisions on motions to dismiss in cases involving auditors as codefendants. Second, at the macro level, it analzes a sample of 348 securities class action settlements. If auditors are often accused of aiding and abetting securities fraud, and this is their only alleged involvement in the fraud, then we would expect to see a number of lawsuits against auditors being dismissed subsequent to the Central Bank ruling. Without the "deep pocket" auditor, the dollar amounts of securities class action settlements should also be reduced.1 Conversely, if aiding and abetting is but one of many ways in which plaintiffs allege that accounting firms have violated securities laws, then the frequency and severity of securities litigation against auditors may not be significantly reduced by the Supreme Court's opinion.

1Settlement amounts increase substantially when an accounting firm is named as a codefendant (Marino & Marino 1994, Gilbertson & Avila 1999).

American Society of Business and Behavioral Sciences Conference page111

The remainder of this paper is organized as follows. The next section discusses the Central Bank decision, including the issues encompassed by the Court's decision, the factual background of the case, and reactions of the legal community to the decision. The following section develops several research questions. Then empirical results are presented. These results are discussed and conclusions drawn in the final section. THE CENTRAL BANK DECISION

PRIMARY VERSUS SECONDARY LIABILITY

The distinction between primary liability for a securities violation and liability as an aider and abettor seems clear, at least in principle. To be guilty of a primary violation, a person must have made the allegedly fraudulent statement himself or, in the case of an omission, had an affirmative duty to disclose the omitted information. However, for secondary liability to attach, the person need only have rendered substantial assistance to the primary violator. The respective legal standards were articulated by the Tenth Circuit Court of Appeals in Anixter v. Home-Stake Production (Anixter 1996):

To establish a primary liability claim under '10(b), a plaintiff must prove the following facts: (1) that the defendant made an untrue statement of material fact, or failed to state a material fact; (2) that the conduct occurred in connection with the purchase or sale of a security; (3) that the defendant made the statement or omission with scienter; and (4) that plaintiff relied on the misrepresentation, and sustained damages as a proximate result of the misrepresentation. (cit. omitted) This contrasts with aider and abettor liability, which required plaintiff to prove (1) the existence of a primary violation of the securities laws by another; (2) knowledge of the primary violation by alleged aider and abettor; and (3) substantial assistance by the alleged aider and abettor in achieving the primary violation. The critical element separating primary from aiding and abetting violations is the existence of a representation, either by statement or omission, made by the defendant, that is relied upon by the plaintiff.

The Supreme Court reviewed the issue of aider and abettor liability under Section 10(b) of the 1934 Securities Exchange Act in its Central Bank (1994) decision.

FACTUAL BACKGROUND1

The securities which were the subject of Central Bank were issued by the Colorado Springs - Stetson Hills Public Building Authority. The combined $26 million in bonds were issued in 1986 and 1988 to finance public improvements in Stetson Hills, a residential development. Central Bank of Denver was the trustee for the bonds, which were secured by landowner assessment liens. First Interstate Bank and Jack Naber had purchased $2.1 million of the 1988 bonds. The bond covenants required the developer to annually certify that the property values were at least 160 percent of the bonds' outstanding principal and interest. In early 1988 Central Bank received a letter from one of the underwriters for the 1986 issue, expressing concern that property values were declining in the Colorado Springs area, and that the trustee was relying on an appraisal over 16 months old. After consulting with the developer, Central Bank agreed to delay a new appraisal until after the 1988 issue had been completed.

Before the appraisal was completed, however, the issuer defaulted. First Interstate Bank and Jack Naber sued the issuer, the 1988 underwriters, a director of the developer, and Central Bank for violating '10(b) of the Securities Exchange Act of 1934. While the other defendants were charged with primary liability, the complaint alleged that Central Bank was secondarily liable for aiding and abetting the fraud. The District Court granted summary judgment for Central Bank. However, the Tenth Circuit Court of Appeals reversed, holding (1) that Central Bank's awareness of the inadequacies of the appraisal could be found to be a departure from standards of ordinary care, and (2) by delaying the review of the appraisal it could be found to have rendered substantial assistance to the primary wrongdoers.

1Unless otherwise noted, all facts are taken from the Court's published decision: 114 S.Ct. 1439.



In its appeal to the U. S. Supreme Court of the Circuit Court's decision, Central Bank assumed the existence of an implied right of action for aiding and abetting, an issue not raised in either the trial or appellate courts. It asked the Supreme Court to consider two issues. The first issue was whether an indentured trustee could be liable for aiding and abetting absent a breach of fiduciary duty (Eisenberg 1995). Second, it argued that recklessness, without conscious intent, was not sufficient to satisfy the scienter2 requirement for aiding and abetting liability. The SEC, appearing as "Friend of the Court," urged the Court to review the second issue, but not the first (Gorman, 1994). The Court, in agreeing to hear the appeal, raised an issue which neither of the parties nor the District Court nor the Court of Appeals had considered: the very existence of aiding and abetting liability under Section 10(b).

Although there were no accountants involved in the case, the AICPA submitted a "Friend of the Court" brief, in support of petitioner Central Bank. In stating its interest in the case, the AICPA (1994, 2) claimed that the case was

* * * of particular importance to the Institute and its members. The recognition and expansive application by the lower courts of an implied private cause of action for aiding and abetting a violation of Section 10(b) has resulted in an uncontrolled and incoherent expansion of secondary liability against accountants * * * Accountants, whose role in auditing and reporting on the financial statements of public companies makes them inviting "deep pockets" targets, are routinely sued for aiding and abetting under the statute.

The Securities Industry Association also filed a brief supporting Central Bank. "Friends of the Court" supporting respondent First Interstate were the Trial Lawyers for Public Justice, the U.S. Public Interest Research Group, the National Association of Securities and Commercial Law Attorneys, the Association of the Bar of the City of New York, and the Securities and Exchange Commission.

The Supreme Court issued its ruling on April 19, 1994. It reached its decision using am approach known as "strict textualism, " sometimes referred to as the "plain meaning" rule (Eisenberg 1995). Following this approach, the Court reasoned that there was no liability for aiding and abetting under section 10(b) because it was "uncontroversial . . . that the text of [that section] does not itself reach those who aid and abet a ' 10(b) violation" (1448). Because there was no express provision for aiding and abetting liability under the statute, there could be no liability imposed under rule 10b-5. Thus, the court completely eliminated a cause of action under which accountants had been "routinely sued" (AICPA 1994, 2).

ANALYSIS

The Central Bank decision is atypical in several respects. One of these, noted above, is that the Supreme Court chose not to address the issues raised by the parties on appeal, but directed the parties to argue a question which neither had considered. Instead of letting the attorneys raise the issues on appeal, the Court itself chose the issues it wished to address. This practice is sometimes known as "judicial activism." As Justice Stevens contends, in his dissent:

. . . the adversary process functions most effectively when we rely on the initiative of lawyers, rather than the activism of judges, to fashion the questions for review (1457 n.4)3

2Scienter means knowingly (Black 1990). In the context of a Section 10(b) lawsuit, the Supreme Court has defined scienter as ". . . a mental state embracing intent to deceive, manipulate, or defraud. In certain areas of the law recklessness is considered to be a form of intentional conduct for purposes of imposing liability . . . ." (Ernst & Ernst v. Hochfelder 1976, 1381).

3Justice Stevens also cites his dissent in New Jersey v. T.L.O., 468 U.S. 1214, 1216; 104 S.Ct. 3583, 3584 (1984).



A second reason the Central Bank decision is unusual is that the Court chose to review an area of the law which most securities lawyers considered settled. This is, perhaps, the most unusual aspect of Central Bank. Neither party questioned the existence of aiding and abetting liability, since the both considered the law clearly established on that issue. While the Court claimed that it had chosen to hear this case "to resolve the continuing confusion over the existence" of a Section 10(b) aiding and abetting action (p 1444), the holding was, in reality, reversing what had become a well-established rule in every federal judicial circuit (Grundfest 1995).

While the Court premised its decision on a 'strict textualist' approach to the statute, it is clear that policy considerations were also important. Specifically, the majority was sensitive to arguments that 10b-5 litigation was harmful to professionals, to start-up companies, and to the economy in general:

This uncertainty and excessive litigation can have ripple effects. For example, newer and smaller companies may find it difficult to obtain advice from professionals. A professional may fear that a newer or smaller company may not survive and that business failure would generate securities litigation against the professional, among others. In addition, the increased costs incurred by the professionals because of the litigation and settlement costs under 10b-5 may be passed on to their client companies, and in turn incurred by the company's investors, the intended beneficiaries of the statute (1454). Finally, the Central Bank decision was unusual in that the Supreme Court specifically cited arguments

advanced by accounting firms, even though there were no accountants involved in the lawsuit. Litigation under 10b-5 thus requires secondary actors to expend large sums even for pretrial defense and the negotiation of settlements * * * in 83% of 10b-5 cases major accounting firms pay $8 in legal fees for every $1 paid in claims (1454).

From this, it can be reasonably inferred that the Court expected, and perhaps intended that its decision would reduce the litigation exposure of the public accounting profession.

RESEARCH QUESTIONS The Supreme Court's ruling "came as a surprise to most observers" (Jorgenson 1994, 641), and has generated a surge of interest among securities professionals and legal scholars.4 In the four years prior to the Court's ruling, there were over 2000 judicial decisions involving Section 10(b) litigation, one-fourth of which included aiding and abetting claims (Jorgenson 1994, note 76). Almost immediately after the decision, a "significant portion" of SEC actions against alleged aiders and abettors were dismissed, and Congress began hearings to consider overturning the Central Bank decision (Jorgenson 1994, Roberts 1995).

Many considered the ruling a special boon to the accounting profession. As the editor of Securities Class Action Alert wrote:

The decision is especially charitable to accounting firms, apparently making them unaccountable to investors for approving fraudulent financial statements. Accountants have been favorite targets of aiding and abetting suits, especially when they are often the only solvent party left in a securities fraud debacle. For example, accountants and lawyers paid $275 million in the Keating matter, but they would not be liable after the Supreme Court's ruling. (Newman 1994, 72)

Hanson & Rockness (1994, 40) hailed the decision as "long overdue and very welcome news" for the accounting profession and predicted "diminished legal liability for CPAs." According to Gorman (1994), Central Bank actually provides a greater limitation on SEC enforcement power than that sought by advocates of

4A recent index search by the author revealed over 100 articles about the Central Bank decision published in legal journals in the two years subsequent to the Court's ruling.



Congressional legislation to reform the securities laws. "Those seeking to limit the scope of Section 10(b) liability through congressional action have had much of their request granted, not by Congress, but by the Supreme Court" (Gorman 1994, 257). A reduction in auditor litigation might manifest itself in several ways. First, there might be a reduction in the number of lawsuits filed against accounting firms after the Central Bank decision. Unfortunately, such a decrease might not be detectable empirically because (a) data on lawsuit filings are difficult to obtain and are frequently unreliable, and (b) any observed decrease might be attributable to the major amendments to the securities laws5 which were passed less than two years after the Supreme Court's ruling was announced. However, since Central Bank reinterpreted existing law, it can be expected to have influenced previously filed cases which were still pending at the time of the decision. As Gorman (1994, 254) predicted: "Central Bank of Denver undoubtedly will result in the dismissal of a large number of defendants from pending Section 10(b) cases who otherwise may have been found liable." This expectation leads to the following research questions: RQ1: Will there be an increase in dismissals of securities lawsuits pending against auditors subsequent

to the Central Bank decision? RQ2: In a sample of securities class action lawsuits, will the proportion naming auditors as

codefendants be smaller in lawsuits settling after the Central Bank decision than in lawsuits settling before the Central Bank decision?

Additionally, assuming some relationship between the merits of the cases and settlement amounts,6 an overall reduction in auditor liability exposure might be reflected in settlement amounts. RQ3: Will relative settlement amounts be smaller in securities class action lawsuits settling after the

Central Bank decision than in lawsuits settling before the Central Bank decision. In the empirical analyses which follow, the first question is investigated by examining published decisions on actual cases. Research questions two and three are evaluated by using a large sample of settlements of securities class action lawsuits. The selection of the samples is described in the following section.

EMPIRICAL ANALYSIS SAMPLE SELECTION

Research question one calls for an examination of dismissals of securities lawsuits involving auditors.

LEXIS/NEXIS was used to search federal securities decisions during the two years following the Central Bank ruling. The FEDSEC, COURTS library was searched using the terms CENTRAL BANK and DATE > 4/1/94 and DATE < 4/1/96 and (AIDING and ABETTING) and (ACCOUNTANT or AUDITOR). Cases in which accountants were mentioned but were not primary litigants were then eliminated. This search yielded a sample of 27 rulings on auditors' motions to dismiss, where Central Bank was cited as precedent. While the sample contains some class action lawsuits, not all of these suits are class actions. The rulings were fairly evenly distributed across the two year sample period, and included 23 district court rulings and four appellate court decisions. A listing of these cases is found in Table 1.

The investigations of research questions two and three are based on a sample of 348 settlements of securities class action lawsuits. These settlements7 were reported in Securities Class Action Alert (SCAA) between

5The Private Securities Litigation Reform Act (P.L. 104-67) was passed in December 1995.

6However, empirical evidence to date does not support the assumption that settlement amounts are reflective of the merits in securities class-action lawsuits (Alexander 1991; Dunbar & Juneja 1993; Dunbar, et al. 1995; Gilbertson 1998).

7Settlement is the prevailing means of resolving securities class actions, with fewer than one percent reaching trial (O'Brien 1991). SCAA is the leading source of information about these settlements.



October, 1992 and December, 1995. Settlements reported in SCAA during April 1994, the month of the Central Bank decision, were excluded. Settlements reported during the following two months were also excluded from the sample, to allow for possible delays in reporting of settlements. The resulting sample included 156 settlements in the 18-month period before Central Bank (October 1992 through March 1994), and 192 settlements in the 18-month period after Central Bank (July 1994 through December 1995).

MOTIONS TO DISMISS

When the Court re-interprets a statute, as it did in Central Bank, all pending cases which were brought under that statute are subject to the new interpretation. This can lead to numerous motions, new trials, and even dismissals. Newman (1994, 71) predicted that an "avalanche of motions to dismiss" would be filed by "accountants and other ancillary professionals" in the days following the Central Bank ruling.

As discussed above, a search of cases citing Central Bank during the two years following the decision found only 27 rulings on auditors' motions to dismiss. This result seems somewhat short of the "avalanche" predicted by Newman (1994). A listing of these cases is found in Table 1. In five of the cases, all involving Big 6 accounting firms, the complaints against the auditors were dismissed. Unfortunately, there is no good benchmark against which to test whether these five dismissals constitute a meaningful increase. Mednick and Peck (1994) report that about 25 of the 10(b) cases pending against U. S. accounting firms were dismissed in 1992. By comparison, an increment of five cases seems small.8 Table 2 lists, for each case, the statutes or common law duties the auditors are alleged to have violated. Where known, the table also identifies whether the accounting firm was accused of a primary violation of Section 10(b), or of aiding and abetting. The accountants are accused of violating Section 10(b) in all of the cases. In only 10 of the 27 cases are the auditors accused only of Section 10(b) violations.9

Perhaps the most important factor limiting the effect of the Central Bank decision on auditor litigation is the availability of other statutory and common law causes of action against accountants. Auditors can still be sued for violations of Section 11 of the 1933 Act (when involved in public offerings), for primary violations of Section 10(b), for common law fraud, or for violations of state securities laws. Two of the cases listed in Table 1 are used below to illustrate the courts' distinction between primary liability and aider and abettor liability.

In Cascade International (1995) investors alleged that Cascade violated securities laws by grossly overstating the number of retail outlets that it owned and operated, and by making public statements that it was very profitable when, in fact, it was losing significant amounts of money. Coopers & Lybrand had been engaged to audit two of Cascade's subsidiaries -- Fran's Fashions and Conston Corporation -- but not the parent company. According to the District Court:

It is interesting to note at this point what Plaintiffs are not alleging. They are not alleging that C & L's audits of Fran's Fashions or Conston contained material misrepresentations or omissions. In addition, Plaintiffs are not alleging that Defendant C & L audited Cascade's financial statements, and therefore, are not alleging that C & L made assurances to the public about the accuracy of Cascade's financial statements. (442)

Thus, the plaintiffs alleged that C & L aided and abetted Cascade in the preparation of financial statements, which it knew or should have known were fraudulent, not that C & L itself made any material misrepresentations. This led the Court to conclude:

8Nevertheless, the savings to the accounting firms from these five dismissals is substantial. Arthur Andersen, et al. (1992) report that the average settlement per claim was $2.7 million in 1991, and the average legal cost per claim was $3.5 million. And Mednick & Peck (1994) report that the average legal cost per litigated claim in 1992 exceeded $10 million.

9This is a smaller proportion than that reported by Mednick & Peck (1994), who report that, in 1992, of 58 resolved cases involving 10b-5 claims, 33 were exclusively 10b-5 claims.



There is little doubt that, with the decision in Central Bank, the securities laws have undergone a significant transformation the results of which will not be settled for many years. The import and scope of that decision has compelled the Court to reconsider its earlier ruling regarding the liability of Defendant C & L. Upon reconsideration, the Court has determined that Plaintiffs have failed to adequately allege a cause of action against Defendant C & L under '10(b) for which relief can be granted. (439) In Vosgerichian v. Commodore Int'l. (1994), plaintiffs accused Commodore of financial statement

misrepresentation. In 1987, Commodore issued stock warrants to Prudential Insurance Co. in connection with a $60 million loan. In 1989 & 1991, when the warrants were re-purchased, the transactions were reported as equity transactions, by-passing the income statement. Commodore also treated a litigation loss as an extraordinary item. Both treatments allegedly violated GAAP. Defendant Arthur Andersen (AA) was accused of violating Section 10(b) in two ways. First, plaintiffs alleged that AA violated Section 10(b) by advising Commodore with respect to the above transactions and concurring in the accounting treatments shown. Second, AA issued an unqualified opinion even though the financial statements were not in accordance with GAAP. With respect to the alleged GAAP violations, the Court concluded:

Each and every misrepresentation alleged was made by Commodore. Plaintiff's allegations against AA do not go beyond allegations that AA assisted Commodore in perpetrating securities fraud and are thus not cognizable. (1378)

With respect to the audit opinion, however, the Court held Arthur Andersen primarily liable:

Because plaintiff maintains that AA made false representations itself, in the form of the "clean" opinion, rather than merely assisting Commodore in its scheme to defraud, the claims based on the litigation settlement are not affected by Central Bank. (1378)

Thus, it appears that, because auditors' opinion letters are, in themselves, affirmative representations, alleged securities violations by accounting firms can easily be construed as primary violations, rather than aiding and abetting.

Unfortunately for auditors, most securities lawsuits are similar to Vosgerichian in that they allege multiple violations. As mentioned above, only 10 of the 27 cases contained exclusively 10(b) allegations. Two of these cases included only allegations of primary 10(b) violations. Of the remaining eight, there was only one case, Cascade International, in which aiding and abetting was the only allegation. In twelve of the 27 cases identified in the search, plaintiffs alleged both primary violations and aiding and abetting. Seven cases also alleged violations of Section 11 of the 1933 Securities Act, which relate to public securities offerings. Eleven lawsuits alleged common law torts, and four cases alleged violations of state securities laws. Because securities class action lawsuits involving auditors usually include multiple allegations, of which aiding and abetting is only one, it may be that the Central Bank decision had no significant impact on the settlements of those lawsuits. This possibility is considered in the next section.

SETTLEMENTS Another means of assessing the impact of Central Bank on auditor litigation is to examine lawsuit

settlements reported before and after the Supreme Court decision. If charges against accountants are being dismissed in meaningful numbers, then the proportion of accountant-codefendants should be significantly smaller in the latter group. This comparison was made using the sample of 348 settlements of securities class action lawsuits which was discussed above. The results of this analysis are found in Table 3.

Auditors are codefendants in about 18 percent of the securities class action settlements, and this proportion does not vary significantly between the cases settled before the Central Bank decision and those settled afterward. This finding suggests that securities lawsuits against accountants are not being dismissed in meaningful numbers as a result of Central Bank. Previous research has shown that the frequency with which auditors are named as codefendants in securities lawsuits is affected by the occurrence of a public offering of securities, and by the bankruptcy of the issuer (Gilbertson & Avila 1999). About one-half of the sampled lawsuits involve a public



offering of securities, and this proportion does not vary significantly between the two time periods sampled. However, the proportion of issuers which have declared bankruptcy decreased from 15.5 percent of the corporate defendants in the sample lawsuits before Central Bank, to 6.3 percent in those lawsuits settling after the Central Bank decision (Π2 = 7.8644, p < .0050). It is therefore necessary to control for issuer bankruptcy in this analysis.

Table 4 shows the results of partitioning the sample based on the bankruptcy of the issuer of the securities. As shown in Panel A, auditors were codefendants in about 15 percent of the lawsuits when the issuer was not bankrupt. There was no difference in this proportion between cases settling before the Central Bank decision and those settling afterward. When the issuer had declared bankruptcy, the auditor was named as a codefendant in about 50 percent of the cases, as shown in Panel B. Again, there was no meaningful difference in this proportion between cases settling before and those settling after Central Bank. The answer to research question two appears to be negative. The proportion of settlements of securities class action lawsuits naming auditors as codefendants did not decline after the Central Bank decision.

Next, the effect of the Central Bank decision on the dollar amounts of class-action settlements was considered. Even though accountants have not been dismissed as defendants in substantial numbers since the Central Bank decision, an overall reduction in auditor liability exposure might be reflected in settlement amounts, assuming some relationship between the merits of the cases and settlement amounts. It would be preferable to address this question by examining the settlement amounts paid by accounting firms. Unfortunately, this information was not available, because Securities Class Action Alert does not report the share of the settlement fund paid by accounting firms. However, prior research has shown that a large portion of the total settlements in securities class actions are paid by professional defendants, such as auditors (Marino & Marino 1994, Gilbertson 1998). Therefore, we should be able to assume that the variation in the total settlement amount reflects any variation in the portions of the settlements paid by the professional defendants. The results of the analyses of settlement amounts is presented in Table 5. Because issuer size has been shown to be related to settlement size in securities class action lawsuits (Gilbertson 1998), this analysis was made after scaling the settlement amounts by issuer size (total assets). As shown in Panel A, these amounts did not differ significantly between cases settling before and cases settling after the Central Bank decision. When only suits with auditor codefendants are considered, the mean settlement amounts increase, but there are still no meaningful differences in settlement amounts before and after Central Bank. For information purposes, the mean of the absolute (not scaled) settlement amounts is shown in Panel B. Still, the settlement amounts before and after Central Bank were not significantly different. Thus it appears that research question three is also answered in the negative. There was no decrease in the relative size of securities class action settlements subsequent to the Central Bank ruling. Taken together, these analyses fail to discern any meaningful pattern of reduced auditor litigation exposure resulting from the Supreme Court's Central Bank decision.

CONCLUSION

This paper assesses the impact of the Supreme Court's Central Bank decision on securities litigation against audit firms. Securities lawyers regard this decision as one of the most important recent developments in securities law, and many analysts predicted that it would result in diminished litigation against accounting firms. The Court's decision in Central Bank was also unusual in that the Court's ruling indicated an apparent intent to provide relief to the accounting profession, which claims to have been besieged by securities lawsuits in recent years. Two means are used in assessing this decision's impact. First, 27 court decisions were identified which involve auditors' motions to dismiss and in which the Central Bank ruling was cited as precedent. These published decisions were then analyzed to evaluate the relief provided to auditors as a result of the Court's decision. From these analyses, it appears that the relief which the Court sought to provide in Central Bank did not ensue. This result is most likely due to the fact that plaintiffs typically allege multiple violations in securities lawsuits. Of the 27 cases studied, in only one were the allegations limited to aiding and abetting under Section 10(b). The rest of the cases contained other allegations, such as primary violations of Section 10(b), violations involving public securities offerings (Section 11), common law torts such as fraud, and violations of state securities laws.

For the second part of the analysis, a sample of 348 settlements was examined for changes in the frequency with which auditors were named as codefendants, and for differences in the amounts of reported settlements. When lawsuit settlements were examined, there was no difference in the frequency with which auditors were involved in securities lawsuits before and after the Central Bank ruling. Similarly, there was no significant difference in settlement amounts between cases which settled before the Supreme Court's decision and those which settled



afterward. These macro analyses fail to discern any meaningful pattern of reduced auditor litigation experience resulting from the Court's decision in Central Bank.

Several limitations may affect the interpretability of the results of this research. First, there is no good benchmark against which to assess whether the five dismissals of securities lawsuits involving auditors consistute a meaningful decrease in auditor litigation. If more detailed data on the litigation exposure of accounting firms were available, the significance of these five cases might be inferred more precisely. A second limitation is the lack of data on the amounts of securities class action settlements actually paid by accounting firms. It is possible that a decrease in accounting firms' exposure is being masked by an increase in settlements paid by other parties. This limitation could also be overcome if more detailed data were available about accounting firms' litigation experience. These results hold several implications for the current debate over reforming the securities laws. First, since securities lawsuits are rarely single issue lawsuits, single issue "reforms" of the law, either legislative or judicial, such as the Central Bank ruling, are likely to prove ineffective. Second, since the preponderance of the identified cases were able to survive motions to dismiss even after the Central Bank ruling, these cases may have more substance than some critics, including accounting firms, have claimed. Finally, the tenacity of the plaintiffs' bar should not be underestimated. When the Supreme Court eliminated secondary liability for aiding and abetting in securities cases, most plaintiffs were able to successfully sustain an action against accounting firms under primary liability theories. The extent to which any effort to reform the securities laws can effect meaningful change in securities litigation will no doubt be checked by the ingenuity of the plaintiffs' attorney.



Case

Citation

Accounting Firm

Action

Homestake Sec. Litig

77 F.3d. 1215 (10th Cir 96)

Norman Cross, CPA

Reversed & Remanded

Software Toolworks

50 F.3d. 615 (9th Cir. 94)

Deloitte & Touche

Reversed in part

FPI/Agritech

34 F.3d. 1072 (9th Cir 94)

Ernst & Young

Rev. in part & Remanded

URCARCO

27 F.3d. 1097 (5th Cir 94)

Coopers & Lybrand

Dismissed on other grounds

Duncan v. Pencer

Fed.Sec.L.Rep &99,043

(S.D.N.Y. 96)

Coopers & Lybrand

Dismissed.

Pahmer v. Greenberg

926 F.Supp. 287 (E.D.N.Y. 96)

Deloitte & Touche


Ventre v. Datronic

Lexis 20323 (N.D. Ill 95)

Price Waterhouse

Dismissed.

Allard v. Arthur Andersen & Co.

928 F.Supp. 488 (S.D.N.Y. 96)

Arthur Andersen

Dismissed in part

MTC Electronics Technologies

898 F.Supp. 974 (E.D.N.Y. 95)

BDO Seidman

Dismissed in part

Stamatio v. Hurco Cos.

892 F.Supp. 214 (S.D. Ind 95)

Coopers & Lybrand


Cascade International

894 F.Supp. 437 (S.D. Fla 95)

Coopers & Lybrand

Dismissed

Van de Velde v. C & L

899 F.Supp. 731 (Mass. 95)

Coopers & Lybrand

Dismissed in part

Phar-Mor Inc.

892 F.Supp. 676 (W.D. Pa 95)

Coopers & Lybrand

Not dismissed

CPC Sec. Litig. (McGann v. E.Y.)

Lexis 11116 (C.D. Cal 95)

Ernst & Young

Dismissed

O''Neil v. Appel

897 F.Supp. 995 (W.D. Mi 95)

Price Waterhouse

Dismissed in part

Colonial Partnership

896 F.Supp. 250 (Conn. 95)

Arthur Andersen

Dismissed in part

Faleck & Margolies, Ltd

Fed.Sec.L.Rep. &98,642

(S.D.N.Y. 96)

Patrusky, Mintz, Semel

Dismissed in part

Adam v. Silicon Valley Bancshs.

884 F.Supp. 1398(N.D. Ca 95)

Deloitte & Touche

Not dismissed

Leslie Fay Cos.

871 F.Supp. 686 (S.D.N.Y. 95)

BDO Seidman

Not dismissed

Biben v. Card

Lexis 18132 (W.D. Mo 94)

Peat Marwick

Summary Judgement denied

Employers Ins. of Wausau

871 F.Supp. 381 (S.D. Cal 94)

Peat Marwick

Not dismissed

Kendall Square Research Corp

868 F.Supp. 26 (Mass 94)

Price Waterhouse

Dismissed in part

Vosgerichian V. Commodore Int'l.

862 F.Supp. 1371 (E.D. Pa 94)

Arthur Andersen

Dismissed in part

Fruit of the Loom

863 F.Supp. 708 (N.D. Ill 94)

Arthur Andersen

Dismissed



Ernst & Young Dismissed in part ZZZZ Best

864 F.Supp. 960 (C.D. Cal 94)

Ernst & Young


Cortec Industries v. Sum Holding

858 F.Supp. 34 (S.D.N.Y. 94)

Ernst & Young

Dismissed in part

Checkers Sec. Litig.

858 F.Supp.1168 (M.D. Fl 94)

Peat Marwick

Dismissed in part

Table 1

Cases Involving Auditors In Which Central Bank was Argued

Case

Citation

Alleged Violations

Homestake Sec. Litig

77 F.3d. 1215 (10th Cir 96)

'11, 10(b) (p & a)

Software Toolworks

50 F.3d. 615 (9th Cir. 94)

'10(b) (p & a)

FPI/Agritech

34 F.3d. 1072 (9th Cir 94)

'11,10(b)

URCARCO

27 F.3d. 1097 (5th Cir 94)

'11,12(2),10(b),Texas Laws

Duncan v. Pencer

Fed.Sec.L.Rep &99,043

(S.D.N.Y. 96)

'10(b)

Pahmer v. Greenberg

926 F.Supp. 287 (E.D.N.Y. 96)

'10(b) (p & a), 12(2), RICO, fraud

Ventre v. Datronic

Lexis 20321 (N.D. Ill 95)

'11, 10(b) (p & a), fraud

Allard v. Arthur Andersen & Co.

928 F.Supp. 488 (S.D.N.Y. 96)

'10(b) (p & a), RICO, Mich. Law, fraud, negl,breach

MTC Electronics Technologies

898 F.Supp. 974 (E.D.N.Y. 95)

'10(b)(p)

Stamatio v. Hurco Cos.

892 F.Supp. 214 (S.D. Ind 95)

'10(b), fraud

Cascade International

894 F.Supp. 437 (S.D. Fla 95)

'10(b) (a)

Van de Velde v. C & L

899 F.Supp. 731 (Mass. 95)

'10(b) (p & a), fraud

Phar-Mor Inc.

892 F.Supp. 676 (W.D. Pa 95)

'10(b), fraud

CPC Sec. Litig. (McGann v. E.Y.)

Lexis 11116 (C.D. Cal 95)

'10(b)

O''Neil v. Appel

897 F.Supp. 995 (W.D. Mi 95)

'10(b), fraud, conspiracy

Colonial Partnership

896 F.Supp. 250 (Conn. 95)

'10(b), fraud, Conn. Law

Faleck & Margolies, Ltd

Fed.Sec.L.Rep. &98,642

(S.DN.Y. 96)

'10(b) (a), negligence, breach, fraud

Adam v. Silicon Valley Bancshs.

884 F.Supp. 1398(N.D.Ca. 95)

'10(b)

Leslie Fay Cos.

871 F.Supp. 686 (S.D.N.Y. 95)

'10(b) (p)

Biben v. Card

LEXIS 18132 (W.D. Mo 94)

'17, 10(b) (p & a)

Employers Ins. of Wausau

871 F.Supp. 381 (S.D. Cal 94)

'11, 10(b)

Kendall Square Research Corp

868 F.Supp. 26 (Mass 94)

'11, 10(b) (a), fraud



Vosgerichian V. Commodore Int'l.

862 F.Supp. 1371 (E.D. Pa 94)

'10(b) (p & a)

Fruit of the Loom

863 F.Supp. 708 (N.D. Ill 94)

'11, 10(b) (p & a)

ZZZZ Best

864 F.Supp. 960 (C.D. Cal 94)

'10(b) (p & a)

Cortec Industries v. Sum Holding

858 F.Supp. 34 (S.D.N.Y. 94)

'10(b) (p & a)

Checkers Sec. Litig.

858 F.Supp.1168 (M.D. Fl 94)

'10(b) (p & a), fraud, Florida Law

(p-Primary Liability, a-Aiding & Abetting)

Table 2 Allegations Against Auditors

Before Central Bank

After Central Bank

Auditor Codefendant

29 (18.6%)

35 (18.2%)

64 (18.4%)

Auditor Not a Codefendant

127 (81.4%)

157 (81.8%)

284 (81.6%)

156

(100%)

192

(100%)

348

(100%)

Π2 = .00747, p < .9312

Table 3

Auditors as Codefendants Before and After Central Bank

Panel A: Issuer Not Bankrupt

Before Central Bank

After Central Bank

Auditor Codefendant

18 (13.7%)

28 (15.6%)

46 (14.8%)


113 (86.3%)

152 (84.4%)

265 (85.2%)

131

(100%)

180

(100%)

311

(100%)



Π2 = .19820, p < .6562 Panel B: Issuer Bankrupt

Before Central Bank

After Central Bank

Auditor Codefendant

11 (45.8%)

7

(58.3%)

18 (50.0%)


13 (54.2%)

5

(41.7%)

18 (50.0%)

24

(100%)

12

(100%)

36

(100%)

Π2 = .50000, p < .47950

Table 4 Auditors as Codefendants

Before and After Central Bank Controlling for Issuer Bankruptcy

Panel A: Settlement Amounts Scaled by Issuer Total Assets

Before Central Bank

After Central Bank

All Class-Action

Settlements

118.9

145.8

t = 1.06 p < .290 df = 209

Suits With

Auditor Codefendants

179.8

295.7

t = 1.08 p < .238 df = 52

Panel B: Mean Settlement Amounts

Before Central Bank

After Central Bank

All Class-Action Settlements

7,257,312

8,048,055

t = .66 p < .512 df = 325



Suits With

Auditor Codefendants

12,473,063

17,743,910

t = 1.14 p < .260 df = 55

Table 5

Analysis of Settlement Amounts Before and After Central Bank



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CHECKSHEETS: A VALUABLE COMPONENT OF ON-LINE EDUCATION

Atamian, Rubik, Ph.D.

The University of Texas - Pan American [email protected]

ABSTRACT

This study discusses "checksheets" and their application in instruction and learning. It presents the concept of checksheets and elaborates on the underlying principles guiding their preparation and use. Additionally, it reports on an experimental use of checksheets in two college courses and the results of a systematic evaluation of their effectiveness as a learning tool. Students in four classes instructed using the checksheet method were asked to complete a survey instrument developed to assess their views on the use and effectiveness of checksheets as an instrument of studying and learning. The author suggests that checksheets can be a highly effective supplement to virtually any situation involving learning complex ideas or procedures, including college courses, skill developmental programs, and employee training.

A checksheet is more than a listing of isolated activities to be performed. It is a teaching tool through which an instructor could maintain an effective gradient in the learning process. Additionally, the checksheet could be used to sustain an optimum balance between absorption and creation of knowledge by the student. A checksheet could also be instrumental in assuring that the student understands what is studied and facilitating the presence of the relevant mass desirable for enhanced learning. Checksheets also prove to be effective in motivating students and heightening their interest in learning. Although checksheets may be used effectively in traditional courses, they seem to be even more instrumental in on-line educational settings.

INTRODUCTION

Experts in on-line education readily admit that computer-assisted distance education is not for

every student. To be successful, an on-line student must be both disciplined and self motivated. Additionally he or she must possess good time-management skills and be able to learn with minimal or no supervision. Nonetheless, a structured on-line course coupled with a set of well designed checksheets could open the doors to on-line education for those students who may not be endowed with the necessary self-assurance or the prerequisite characteristics to undertake on-line learning. A checksheet provides a road map to the learner and brings structure to an otherwise potentially awkward higher learning environment. It allows the instructor to breakdown a complicated task into individual steps with a smooth incremental gradient each building on what is learned in the earlier steps hence, facilitating the student's studying process. Inasmuch as each step is a complete cycle of accomplishment, the student is continually reassured of his or her abilities and is motivated to progress through the steps.

WHAT IS A CHECKSHEET?

The term checksheet has a variety of implied meanings in practice. At the Helsinki University of Technology's Lifelong Learning Institute, it is defined as "a tool for recording and organizing data." At the Quality America Inc., checksheets are used to prioritize competing or conflicting problems, so that resources are allocated to the most significant areas. At the Arizona State University, checksheets are defined as "a structured form that makes it easy to record and analyze data." And, according to the Safe Enhancement Business Services, an employee training company, "the checksheet method is an effecting method of employees training and is currently being used by many major companies in Silicon Valley and around the country."

Use of checksheets is not a new concept. Organizations use checksheets for a variety of purposes



such as employee orientation and employment termination. Each of these processes could involve an extensive list of steps that the employee must complete in sequence. An employee termination procedure could entail turning in keys to offices, abandoning computer and entrance passwords, paying outstanding balances, and settling accrued vacation pay, sick leave, and handling the transfer of retirement fund and health insurance policies. A checksheet could markedly standardize this procedure and produce consistent results. Checksheets are also used in technology assisted learning and education centers in the form of worksheets. A relevant example could be found at Cameron Balloons' web site where a checksheet is used to explain the steps in various processes in the design and production of hot air balloons.

Whereas in many of the above instances, the term "checksheet" may be used to describe any document listing a sequence of actions, such is not the case in regards to a checksheet developed for purely instructional purposes. An effective education oriented checksheet is more than a conglomerate of seemingly related steps to be carried out. It is the product of a methodical process and is based on certain fundamentals in education and learning, some of which are elaborated in a book written for young adults by Hubbard titled, "Basic Study Manual."

In the context of this paper, a checksheet is a teaching tool through which an instructor could control the gradient in a learning process as well as the balance between absorption and creation of knowledge by the student. Additionally, a checksheet could assist in assuring that the student understands what is studied and provide a level of relevant mass necessary for enhanced learning. Checksheets could also help student motivation. Although checksheets may be used effectively in structured college courses, their primary intended use is in technology-assisted on-line educational settings.

A checksheet is a road map designed to assist the student to accomplish a particular group of tasks toward an objective. To be effective, a checksheet must have certain characteristics that parallel established educational philosophies. For example, it should expose the learner to the material in a smooth gradient. Although academic textbooks are written with this idea in mind, they do not necessarily maintain an attainable gradient on a consistent basis. We all have noticed the intense frustration in students when confronted with too steep a gradient.

A checksheet must also have a specific objective and a proven end product. It should clearly state the objectives that the checksheet is designed to accomplish as well as give the student an idea as to what he or she could expect to know upon completing the checksheet. Additionally, to the extent feasible, each activity on the checksheet should be self-contained and attainable within a short period of time. Instructions on a checksheet must be unambiguous and executable. The student should be guided through a learning process that offers a balance between the various learning activities such as reading, searching, comparing, analyzing, observing, modeling, listening, viewing, drawing, exploring, demonstrating, and writing. The activities should be aligned such that the student would alternately go through absorbing knowledge and creating knowledge.

Through a checksheet, the instructor could introduce mass to the learning process that are both effective and, at times, essential to students' comprehension of the material. True, real world end-of-semester field projects are beneficial, but the mammoth task inherent in such assignments could overwhelm the students, especially when the students are not gradually prepared for completing such a task. In contrast, a checksheet could require the student to approach a business manager and ask about the square footage of the facilities or about its monthly utility expenses. Subsequently, the students could be asked to visit a business and simply observe a process and prepare a short essay about the experience. Over time, succeeding checksheets could expand on such tasks through a smooth gradient until the course objectives are attained.

I have been experimenting with checksheets for sometime, and recently, I used them in four sections of two courses I taught; a sophomore level Managerial Accounting and a junior level Accounting Information Systems course. Appendix A is a sample checksheet for the Managerial Accounting course. Certainly, a checksheet must undergo testing and be upgraded through repeated use. As such, the sample checksheet should not be perceived to be in its final form. Designing a checksheet is an intense and time-consuming process. Additionally, it calls for a vision and a comprehensive understanding of the subject matter being studied.

DESCRIPTION OF COURSES

I have used extensive electronic communication with my students since 1993, and have



incorporated web-based paperless education in some of my classes since 1996. For the past two years, I have gradually substituted web-based conferencing for e-mail communication. My objective has long been to implement on-line learning in my courses, but did not find it feasible or effective. However, my initial experiment with checksheets were so successful that I decided to run a systematic experiment with checksheets and assess their degree of effectiveness as a learning tool.

Accounting Information Systems, with 23-student enrollment, met in a computer lab setting with a workstation for each student. These workstations are networked and are connected to the Internet. Students registering for this course arrive with varying degrees of elementary computer expertise, but perform equally well as all course materials are introduced to them on a smooth gradient basis. Virtually all classroom activities involve computer use. Students access the computer-based reading materials outside the class. Classroom lectures are presented in sound bytes, by answering individual student's questions, and via short presentations. Occasionally, I solicit the full attention of students by asking them to turn off their computer monitor in order to explain a sensitive topic, but since virtually all class discussions are duplicated on the conference boards, ordinarily, students are not expected to interrupt their work to listen. Inasmuch as students learn through checksheets, virtually all learning is self-paced.

Students in the three sections of Managerial Accounting, on the other hand, met in regular classrooms. A total of 98 students were enrolled in Managerial Accounting. We use a standard Managerial Accounting textbook by Garrison and Noreen.

Although my intention is to develop self-contained on-line courses, presently, I do meet students on a regular basis. Despite students not being required to attend meetings, attendance in both courses match or exceed that in prior semesters. Few students have chosen not to attend class and to rely solely on the checksheets and online conferencing.

To conduct a comparative analysis of student performance and to assess the effectiveness of the checksheet method of instruction, students were administered the same exams as in the previous semester which were safeguarded in anticipation of this experiment.

THE EXPERMIENT

The two courses in this experiment are different in several respects, including the coverage, student

maturity level, student major, and the classroom setting. Nonetheless, both are included in this experiment for comparative analysis and inference purposes. As an example, in the Accounting Information Systems with students majoring in accounting, the course coverage is divided into stand-alone modules without reference to any particular textbook. On the other hand, in the Managerial Accounting course, where students are business, but not necessarily accounting, majors, coverage is based on an established textbook in the discipline. The Managerial Accounting course syllabus describes the overall course objectives and the textbook chapters to be covered in the course.

For each module or chapter, I prepare a checksheet given a specific objective and desired end result. The objectives of a checksheet may deviate from the objectives of a book chapter and may require students to engage in activities that go beyond the chapter coverage. New checksheets are released to students only after completion of earlier checksheets.

CHECKSHEET IMPLEMENTATION TECHNIQUES

An attainable gradient is strictly observed both within and between checksheets. It is, therefore, paramount that students not skip checksheets or individual checksheet steps. Students should complete checksheet steps in an exacting order. Inasmuch as checksheets follow a smooth upward gradient, skipping steps, reading ahead, or jumping around the steps, would counter the effectiveness of the checksheet-based learning.

Developing and administering a checksheet method of studying is time consuming for the instructor. The instructor-time devoted to a course varies in direct proportion to the numbers of students in the class. Although the checksheet method is based on the honor system, completed checksheets must still be verified and validated for many reasons, including the acknowledgment of the student efforts. The student marks the completion date for each step and initials in the appropriate space before proceeding to the



next step. In a supervised environment, completed checksheets could serve as a basis for measuring student

performance rendering quizzes and examinations unnecessary. A general oral or written examination may be administered to gauge the students' overall understanding of the subject matter.

There are several ways that the instructor could verify student progress on a checksheet, confirm completion, and diagnose problem areas. For activities that call for short essays, students are required to prepare them in handwritten form and attach them to their checksheet upon completion. In contrast, for activities that require long write ups or involve numerical analysis and graphs, students are encouraged to use appropriate computer application software to prepare their response, and post them on the conference board. If the checksheet is to be completed over an extended period, students could be asked to turn in their work intermittently upon completing each major section on the checksheet. Periodically, students could also be asked to communicate their answers to checksheet steps via e-mail to the instructor, post them on a conference board, or upload them to their web page. As such, the instructor could verify the students' work and the date they were completed to assess their progress on the checksheet.

There are many ways to deliver the checksheets to students. In this experiment, the checksheets were made available as attachments to conference board messages. An accompanying comprehensive web site is maintained that contains organized links to many accounting, finance, business, government, and news sites to help students with their Internet inquiries. One of the checksheets in the Managerial Accounting course was aimed at educating students about the use of e-mail, conference boards, and the Internet.

CHECKSHEET IMPLEMENTATION ISSUES

Designing a valid and effective checksheet is a time consuming undertaking. Evaluating completed checksheets and student work is also time consuming, especially if they are implemented in a non-supervised setting. Checksheets are ideal for on-line courses that are individualized and where students are not required to adhere to set deadlines. This experiment, however, may produce results with limited applicability to on-line education as it involves scheduled university courses where students regularly attend class and have to observe certain deadlines.

An apparent benefit of checksheets is that students no longer wait until the night of the exam to figure out what to study. Nonetheless, at times, students do not meet the stated deadline for a checksheet or simply fall behind. One cardinal rule that should not be overlooked is that students should not be permitted to proceed with a checksheet if they have not fully completed all prior checksheets in sequence. This assures that students are not jumping gradients even if they become ill or have to interrupt their studies for a week or two. Indeed, this is an advantage of using checksheets as students who miss a lecture or two, could still catch up with the class with due diligence.

Of the 500 points that students could earn in Managerial Accounting, 120 were assigned to checksheet completion. An average course checksheet has between 30 and 40 steps with each completed step earning half a point. The final checksheet score will be scaled to 120 points. Since the underlying idea is to give students the latitude to learn according to their style or habits, their checksheets are evaluated only for completion, and not for neatness or quality. As such, all students are expected to end up with the same overall checksheet score if they turn in acceptable work. If a student fails to complete some of the steps, the checksheet is returned to the student without evaluation with further instructions to complete and return it for reevaluation.

The impetus of the checksheet method of learning is to reinforce a multitude of students' skills and enhance their general ability. This may be in variant with the emphasis of the traditional teaching methods that involve lectures, homework assignments, and sequential studying of textbook chapters. As such, one could reasonably suspect that the testing method in a typical college accounting course may not be appropriate for evaluating students' knowledge, gained ability, and performance in a checksheet based course. Nonetheless, for this experiment I used the exams from the previous semester for comparative evaluation.

ADVANTAGES OF USING CHECKSHEETS



Informal student feedback about checksheet use was enthusiastic. In several straw polls students unanimously voted to continue with the use of checksheets in the course. They found the checksheets to be motivational and helpful in their studies.

In general, textbook authors do not guide students to determine what constitutes a complete task. Students often refrain from beginning study of a chapter thinking that they may not have sufficient time to complete an entire chapter. Without a checksheet, Managerial Accounting students would embark on studying a chapter in the textbook only to be overwhelmed by its complexity and volume. A checksheet provides students with a road map to tackle an unfamiliar subject matter. Each step in a checksheet is designed as a self-contained task and a complete cycle. Therefore, a student who has half an hour of studying time could undertake a step or two on the checksheet. The manageability of tasks on a checksheet offers students a sense of accomplishment. Each time the student signifies the completion of a checksheet step by initialing it, he is assured that he has completed a cycle and a defined task. A side benefit of using checksheets is that they compel students to be up to date on their studies. Additionally, the mix of various learning activities involved in completing checksheets reduces boredom and elevates the level of students' focus and concentration.

At times a textbook chapter may rely on knowledge mastered by the student in a prerequisite course such as algebra or statistics. In the absence of a checksheet, the student may not know where to go to refresh his or her skills on the said subject in order to comprehend the current topic. With a checksheet, however, the instructor could insert a step that would direct the student to a concise refresher or a tutorial on the prerequisite subject.

Checksheets effect active student learning. Without a checksheet, students would spend two to three hours reading a chapter and absorbing page after page of information often without a feedback about their level of understanding or validation of their efforts. Prolonged reading of a chapter is contrary to the notion of active learning, as it is not an optimum process. One way absorption of data for an extended period could even cause drowsiness in the student. A well designed checksheet would break this monotony by ensuring that the student comprehends what he or she reads by intermittently requiring the student to engage in variations of learning activities enumerated earlier in this article.

METHODOLOGY: THE QUESTIONNAIRE

A comprehensive questionnaire comprising 51 questions covering topics such as written communication, message boards, as well as evaluation of the checksheet method of instruction was used as the survey instrument. Nevertheless, the focus of this study is on instrument questions that deal with students' assessment of the checksheet method of instruction. Questions 31 through 42 are formatted as five-point Likert scale of "Strongly Agree," "Agree," "Not Sure," "Disagree," and "Strongly Disagree." These eleven questions were aligned with the informally stated study hypotheses and the premise supporting the development and use of checksheets. These questions were aimed at gauging the students' perceived validity and usefulness of checksheets as a learning tool. Some of the questions dealt with the role of checksheets in technology-assisted online education.

Questions 43 through 49 posed a series of hypothetical scenarios thought to favorably shift the student's viewpoint toward checksheets. For example, question 48 states, "I would have liked the checksheets more if they involved fewer steps." Respondents were asked to answer these questions if they were not absolutely certain about the validity and usefulness of the checksheet method of instruction. Question 50 solicited any questions that the respondents could have about the use of checksheets and/or web-based conferencing, while question 51 asked if the respondent had any suggestions for enhancing the effectiveness of using checksheets and/or conference boards as teaching tools.

The challenge in developing the survey instrument was twofold. First, the survey was going to be administered in two markedly different courses. The subject matters, student classifications, and the classroom environments were widely different for the two courses. And second, given the non-critical nature of the topic being surveyed, the instrument had to raise the interest level of students so that they would provide more thoughtful and/or emotional responses to the questions of importance to the investigation. To accomplish this objective, 13 thought-provoking questions were included in the beginning of the instrument. These questions followed four basic demographic questions, and oriented the student toward the course and their experience with the course. It was anticipated that after responding to these questions, the student would be in a state of mind to better evaluate the questions and be more diligent in



responding to them. The next section of the questionnaire contained 14 questions about message boards and online web-

based conferencing. Seven of the 14 questions required a "yes" or "no" response and also encouraged the students to elaborate on their responses. The remaining seven questions in this section were "true/false" type.

SURVEY

The questionnaire was administered to 84 of the 121 students in the four classes I taught in the fall 1999 semester. The 37 students not included in the survey were either absent on the day of the survey or had withdrawn from the course. Students were informed ahead of time about the survey and were cooperative and eager to participate in the investigation. By survey time, the Managerial Accounting students had completed five checksheets while the Accounting Information Systems students had completed three.

The questionnaire was administered at the beginning of each of the class meetings. Although students were not required to include their names on the completed questionnaire, many had chosen to do so.

ANALYSIS AND RESULTS OF THE EXPERIMENT

The 84 questionnaires were coded and digitized in a spreadsheet file. The raw data were then organized in several result tables envisioned during the instrument development phase. Following is a brief discussion of the more significant discoveries of the study.

The respondent population consisted of 42 males and 42 females. It included 1 freshman, 18 sophomores, 34 juniors, 29 seniors, and 2 graduate students. Of the 84 students surveyed, 34 were accounting majors and 50 had majors other than accounting.

Overall, 54 of the 84, or 65 percent, of the respondents indicated that they were fully convinced of the validity and usefulness of checksheets as an effective instructional and learning tool. The general attitude of students toward checksheets was independent of their gender. Nonetheless, sophomores (67%) and juniors (71%) had a more favorable opinion of checksheets than seniors (55%). Non accountants, on the other hand, viewed checksheets more favorably (70%) than accounting majors (56%). This could be explained by the fact that most accounting majors in the respondent group were also seniors. Therefore, it could not be definitively stated whether the lower enthusiasm about checksheets was due to the students' classification or their field of study.

Fifty-two (62%) of the respondents claimed that they had completed and turned in all checksheets on time while 38% had missed one or more deadlines in completing the checksheets. Students were not penalized for late submission of their checksheets because one feature of the checksheet method as implemented in this experiment was to promote and encourage independent and self-paced learning. Students were well aware, however, that they could not begin a new checksheet unless they had completed all prior checksheets. See "Step 1" of the Chapter 8 Checksheet in Appendix A.

When asked, "In general, do college students need direction as to how to study?" 66 of the 84 students (79%) responded affirmatively. And when asked, "Have you been in a situation where you wanted to study, but did not know where to begin or what to do?" 74 or (88%) of the students indicated that they had been in such a situation. Some students expressed that it was a common occurrence for them.

Students generally preferred that a study session involve a variety of related activities, instead of one type of activity such as reading or writing, by a margin of 72 to 12. They also preferred to complete several small tasks to a single large project by a margin of 88% to 12%. Finally, students overwhelmingly (89%) valued knowing or being told that they had completed a task.

Table 1 summarizes the student responses by classification to questions 31 through 42 that are listed below the table. The table displays both the frequency as well as the weighted-mean of responses to each of the twelve questions by category. Note that questions appear on Table 1 in a descending order of their respective overall mean responses. Students expressed the highest level of agreement with the statement in question 33 with a weighted mean response of 4.333 while they least agreed with the statement in question 38 with a mean response of 2.370.

The widest response gaps among students in the three classes were in respect with questions 38 and 40. Sophomore students expressed less disagreement with the notion that they would have learned the same



amount without the use of checksheets than did juniors and seniors. According to their response patterns, it seems that sophomore students had less certainty about the effectiveness of the checksheets than did students in the upper classifications. Sophomore students not having as much learning experience as juniors and seniors may explain their viewpoint. Similarly, sophomores seemed to have greater difficulty with time management than did junior and senior students as is evidenced by the response patterns of the three groups to question 40. The larger weighed-mean of 4.278 for the sophomore students could reflect their difficulty with managing their time and activities. The junior group had a weighted-mean response of only 3.382, which was considerably lower than that for the senior group (3.621) as well. Although this inverted bell distribution of responses may warrant further investigation, one could assert that senior students have many more commitments as they approach graduation date and employment related decisions.

Tables 2 and 3 show student responses to questions 21 through 42 categorized by student gender and field of study respectively. Curiously, there were no noticeable differences in student response patterns attributable to gender. It is conceivable that since the checksheet method of studying and learning, as described in this study, was a fresh concept for the students, there was little opportunity for the groups to develop any gender biases concerning them. The questions in Table 2 are listed according to the mean-response variations between the two gender groups. The surprising manifestation of the responses is that male students embraced the inherent structure of the checksheets better than the females and they viewed them to be more of a motivating tool than did the female students (question 34). Also surprising was that male students attributed more of their learning to the checksheets than did the female students. Nonetheless, a more in-depth study may be warranted before any definitive statements could be made concerning any gender differences. Table 3 reports the frequency of student responses to questions 31 through 42, categorized by field of study. To investigate the probability of a field of study bias, students were grouped by major. Since the sample size was not sufficiently large to facilitate detail classification of students by major, they were put in only two groups. Accounting students numbering 34 comprised the first group while the remaining 50 students formed the second group. Since Accounting Information Systems is a junior level course, students enrolled in that course were all accounting juniors and seniors. Therefore, it would appear that grouping of students by classification and by major would result in close division among the students as most junior and senior students in the sample were also accounting majors. Therefore, any observable differences between senior and sophomore students could also be attributable to their field of study and vice versa. Nonetheless, accounting students, who also formed most of the junior and senior group, claimed that checksheets would have been more effective if they did not carry a strict due date. This is understandable as these checksheets were initially conceived for self-paced on-line or distant education courses where students are expected to master the subject matters without strict deadlines. The regularly scheduled college courses inherently impose certain restrictions on the instructor, which hamper the proper implementation of this method of learning.

CONCLUSIONS AND RECOMMENDATIONS

Creating, administering, and evaluating the course checksheets was a unique teaching experience unlike any I had had in my long years as a university faculty. The degree of student enthusiasm manifested this semester was unparalleled. The checksheet method of learning provided a rather unique experience for the students as well. Most of the 84 students had completed over 25 college courses, but few had prepared for those courses uniformly throughout the semester. A distinct advantage of the checksheet style of instruction was that students did not have the luxury to wait and cram all their studies the night before the exams. The checksheets brought the course in the forefront of the students' activities and made them continually aware of the course. Since we also made full use of conference boards, web pages, and e-mail in the course, I did not require students to regularly attend class. But, surprisingly, class attendance was no different than what I had experienced in prior semesters. Since a major part of course instruction took place online, class periods became very relaxed and unhurried.


Question SA A NS D SD W-A SA A NS D SD W-A SA A NS D SD W-A SA A NS D SD W-A33 9 9 0 0 0 4.500 15 14 4 1 0 4.265 15 11 1 1 1 4.310 39 34 5 2 1 4.33337 6 11 1 0 0 4.278 12 18 0 4 0 4.118 14 12 1 2 0 4.310 32 41 2 6 0 4.22232 3 14 1 0 0 4.111 9 20 4 1 0 4.088 11 13 5 0 0 4.207 23 47 10 1 0 4.13634 6 9 2 1 0 4.111 10 17 4 3 0 4.000 14 11 3 1 0 4.310 30 37 9 5 0 4.13639 5 13 0 0 0 4.278 8 22 4 0 0 4.118 9 15 2 3 0 4.034 22 50 6 3 0 4.12341 5 10 3 0 0 4.111 11 17 5 1 0 4.118 10 14 4 1 0 4.138 26 41 12 2 0 4.12342 3 13 2 0 0 4.056 10 20 4 0 0 4.176 8 16 4 1 0 4.069 21 49 10 1 0 4.11136 8 6 3 1 0 4.167 11 14 3 6 0 3.882 12 11 2 2 2 4.000 31 31 8 9 2 3.98831 4 13 1 0 0 4.167 6 22 2 4 0 3.882 7 17 1 4 0 3.931 17 52 4 8 0 3.96335 4 5 6 3 0 3.556 12 12 3 7 0 3.853 9 13 3 3 1 3.897 25 30 12 13 1 3.80240 10 4 3 1 0 4.278 8 8 7 11 0 3.382 11 5 5 7 1 3.621 29 17 15 19 1 3.66738 1 1 10 5 1 2.778 0 5 11 10 8 2.382 1 1 7 11 9 2.103 2 7 28 26 18 2.370

Frequency 64 108 32 11 1 112 189 51 48 8 121 139 38 36 14 297 436 121 95 23

* There was one freshman and 2 special students in the sample. These three respondents have been excluded from this table.

31. 32. Checksheets were good because I would read some, think some, search some, and write some. This variety in the activities made studying more enjoyable.

33. Checksheets were helpful because I could stop and start studying without worrying about losing my place.

34. The fact that virtually every step in the checksheets had a beginning and an end, and involved a complete task, helped my motivation to study and sense of accomplishment.

35. Checksheets made studying less stressful for me because I was confident that I would learn something worthwhile by completing almost every step.

36. Because of the checksheets, I felt more comfortable that I could catch up with the class if I missed a meeting.

37. Checksheets helped me understand what I was expected to do, learn, and know in this course.

38. I would have learned the same amount in this course even without the checksheets.

39. Checksheets brought structure to my studying.

40. Checksheets would have been more effective if I were not under strict deadlines to finish them and could complete them at a comfortable pace.

41. If I ever take an online course, I would much prefer for it to include checksheets similar to the ones we use in this course.

42. Checksheet could facilitate offering online courses as they would enable the student to stop and start studying almost at will without much worry about continuity.

For the most part, completing each step of the checksheet prepared me to understand and complete the next (following) step on the checksheet.

Table 1 - Response Patterns to Questions 31 through 42 by Classification

Sophomore (18) Junior (34) Senior (29) Total (81) *



Gender

Difference

Question SA A NS D SD W-A SA A NS D SD W-A SA A NS D SD W-A W-A

34 16 21 4 1 0 4.238 16 17 5 4 0 4.071 32 38 9 5 0 4.155 0.16740 17 8 7 9 1 3.738 14 9 9 10 0 3.643 31 17 16 19 1 3.690 0.09539 13 24 4 1 0 4.167 10 28 2 2 0 4.095 23 52 6 3 0 4.131 0.07133 21 17 3 0 1 4.357 20 18 2 2 0 4.333 41 35 5 2 1 4.345 0.02436 17 15 4 5 1 4.000 15 18 4 4 1 4.000 32 33 8 9 2 4.000 0.00041 15 19 6 2 0 4.119 13 22 6 1 0 4.119 28 41 12 3 0 4.119 0.00031 8 28 2 4 0 3.952 10 25 3 4 0 3.976 18 53 5 8 0 3.964 -0.02432 11 26 5 0 0 4.143 14 22 5 1 0 4.167 25 48 10 1 0 4.155 -0.02442 11 24 6 1 0 4.071 10 27 5 0 0 4.119 21 51 11 1 0 4.095 -0.04837 18 18 2 4 0 4.190 16 24 0 2 0 4.286 34 42 2 6 0 4.238 -0.09535 14 14 6 7 1 3.786 13 17 6 6 0 3.881 27 31 12 13 1 3.833 -0.09538 0 6 13 12 11 2.333 2 2 16 15 7 2.452 2 8 29 27 18 2.393 -0.119

Frequency 161 220 62 46 15 153 229 63 51 8 314 449 125 97 23

Difference

By Major

Question SA A NS D SD W-A SA A NS D SD W-A SA A NS D SD W-A W-A

40 14 7 6 7 0 3.824 17 10 10 12 1 3.600 31 17 16 19 1 3.690 0.22437 17 14 1 2 0 4.353 17 28 1 4 0 4.160 34 42 2 6 0 4.238 0.19338 1 3 13 12 5 2.500 1 5 16 15 13 2.320 2 8 29 27 18 2.393 0.18034 14 13 5 2 0 4.147 18 25 4 3 0 4.160 32 38 9 5 0 4.155 -0.01331 6 23 2 3 0 3.941 12 30 3 5 0 3.980 18 53 5 8 0 3.964 -0.03941 11 16 6 1 0 4.088 17 25 6 2 0 4.140 28 41 12 3 0 4.119 -0.05232 9 19 6 0 0 4.088 16 29 4 1 0 4.200 25 48 10 1 0 4.155 -0.11233 14 17 2 0 1 4.265 27 18 3 2 0 4.400 41 35 5 2 1 4.345 -0.13539 7 22 4 1 0 4.029 16 30 2 2 0 4.200 23 52 6 3 0 4.131 -0.17142 5 24 4 1 0 3.971 16 27 7 0 0 4.180 21 51 11 1 0 4.095 -0.20935 5 16 7 5 1 3.559 22 15 5 8 0 4.020 27 31 12 13 1 3.833 -0.46136 10 13 3 6 2 3.676 22 20 5 3 0 4.220 32 33 8 9 2 4.000 -0.544

Frequency 113 187 59 40 9 201 262 66 57 14 314 449 125 97 23

Male (42) Female (42) Total (84)

Table 2 - Response Patterns to Questions 31 through 42 by Gender

Accounting Majors (34) All Other Majors (50) Total (84)

Table 3 - Response Patterns to Questions 31 through 42 by Major

We could spend an entire class time discussing a single topic or complete an exercise without much worry about not having the time to cover the designated material. The checksheets allowed us to create and maintain a multifaceted learning environment with great flexibility for action.

There was ample anecdotal evidence throughout the semester to validate the usefulness of using checksheets. Nonetheless, the methodology had its drawbacks as well. First, although a fulfilling experience, developing the checksheets turned out to be a tedious undertaking. The average checksheet took between 10 to 12 hours to create and another 7 to 8 hours for evaluation and record keeping. Students not all turning in checksheets at the same time did not simplify the administrative side of my efforts either. Although there was a learning factor, all details had to be worked out with accuracy before students got hold of the checksheets.

Inherently, checksheets slowed down progress in course coverage. But, since the focus of the checksheets was more on enhancing student ability rather than learning by rote, the extent of coverage did not matter much. Although we covered 9 chapters, instead of the usual 10, students read far more material on the Internet and developed greater skills than they would without the checksheets. The checksheets



undoubtedly promoted independent and active learning. The checksheet served as a road map guiding students in their learning activities. Although they

were not intended as a means to provide feedback to students other than acknowledgment of their efforts, nearly a fourth of the course grade in Managerial Accounting class was based on their completion. Hence, the checksheets were evaluated and returned to students. Every checksheet meeting a minimum specification would receive full credit. There were no partial credits assigned to checksheets. Throughout the semester, there was only one instance that I noticed where two students had duplicated each other's work, and when confronted, they offered reasonable, but unacceptable explanation for the occurrence. Since I had assured students that I would not penalize them for their conduct, I simply asked for assurance that these students understood the harmful and negative side of their behavior.

In sum, checksheets could be an invaluable component of technology assisted distance learning. They motivate the learner, facilitate better time management, and provide concrete direction and guideline for the student. Throughout my tenure as a university faculty I have not encountered a teaching strategy that was equally embraced by the good as well as the not so good students. The conscientious students as well as those who look for short cuts received the checksheet method equally well. On several occasions through the semester, I opted to halt the checksheet methodology and return to the regular lecture mode of instruction, but each time, it was met with strong objections from the students.

Regarding the impact on overall student performance, I administered the same Exam I as I did a semester earlier. Students instructed with checksheets scored nearly ten percentage points better than the previous group. Although a controlled study would be warranted before one could reach a definitive conclusion regarding improved test performance, my personal observations lead me to believe that the checksheet methodology could potentially produce more able and confident students. An important factor that is often neglected by instructional innovators is the choice of an evaluation method that is suitable for the teaching methodology employed. As the checksheets indicate, students in the course were compelled to develop a multitude of skills in addition to studying the textbook. As such, the focus of the course was not on memorization of concepts, but rather on accomplishment of relatively complex tasks. This experiment strongly suggests that the success of any teaching innovation could, to a marked degree, depend on the suitability of the student performance evaluation methods employed. Nonetheless, instructors are required to assign a defensible course grade as, regardless of a student's thirst for knowledge and desire for learning, our educational and employment systems view the grade point average as the primary measure of student competence and ability.

Although I do not recommend a full-scale implementation of the checksheet style of instruction for every course, I do believe that there are instances of major activities in virtually every course that would lend themselves to the checksheet method of teaching and learning. As I am writing this paper, I am inclined not to use the checksheet method next semester in the Managerial Accounting course, but I do intend to intensify its application in the Accounting Information Systems course, which I am also converting to an on-line course. A major factor in my decision not to forcefully pursue and explore the suitability of the checksheet method of learning in a structured learning environment is the lack of enthusiastic support by the college administration as reflected in its course assignments. I envision difficulty in implementing the checksheet method in the spring 2000 semester with over 100 students in four courses involving three preparations. I would not recommend embarking on this method if you teach more than two preparations in a semester or have more than 25 students in the course in which you intend to implement this method. Perhaps the results of a checksheet style of instruction could be different in an environment where the entire curriculum is taught using checksheets.

I refrained from employing any rigorous statistical tests of any formally stated hypotheses, as I did not want to assign more significance to the data in this study than warranted. Naturally, if one were to arrive at any authoritative conclusions regarding the checksheet method of learning and instruction, more detailed longitudinal investigations would be necessary.



WEB-SITE REFERENCES

Arizona State University

http://www.west.asu.edu/tqteam/checksh.html

Atamian, Rubik http://w3.panam.edu/~atamian/

Cameron Balloons Company http://www.bized.ac.uk/virtual/cb/factory/production/worksheets2.htm

Helsinki University of Technology: Lifelong Learning Institute Dipoli http://www.dipoli.hut.fi/org/TechNet/org/eurocinet/tool3.html Quality America Inc.

http://www.qualityamerica.com/SPCTopics/SPCSware/spcWhen_to_Use_a_Checksheet.htm

Safe Enhancement Business Services http://home.earthlink.net/~sebservs/co.html

REFERENCES

Atamian, R. (1994). "Are We Ready for Paperless Instruciton?" New Accountant, Vol. 10, No. 3, November/December 1994, pp. 8-12.

Atamian, R. and DeMiville, W. (1998). "Office Hours -- None: An E-Mail

Experiment." College Teaching. Vol. 46, No. 1, Winter 1998, pp. 31-35. Clover, V. and Basely, H. (1974). "Business Research Methods." Grid, Inc.,

Columbous, Ohio 1974, 398 pp. Garrison, R. and Noreen, E. (2000). "Managerial Accounting." McGraw-Hill Higher

Education, 2000, 923 pp. Hubbard, Ron (1992). "Basic Study Manual." Bridge Publishing, Inc., Los Angeles,

California 1992, 286 pp.



APPENDIX A

Prepared by : Dr. Rubik Atamian November 23, 1999

Managerial Accounting ACC 2329

Chapter 8 Checksheet Activity-Based Costing: A Tool to Aid Decision Making

Fall 1999 Semester

Student Name : ________________________ Section : 1 2 3 Date Started : _________________________ Date Completed : __________________ Required Materials: The materials you are required to have as part of this activity include:

Managerial Accounting by Garrison and Noreen, 9th Edition. A blank 3 1/2" Floppy Diskette Notepad and sketching paper A Full-size Dictionary, and Internet Access

How to study Chapter 8: The items on this checksheet are to be studied and drilled in sequence. Each item is signed off as you complete it by writing your initials and completion date in the spaces provided on the right-hand columns. There is a glossary or a set of key terms at the end of each chapter. Use these glossaries and/or a dictionary whenever you encounter a word that you do not understand, or for which you may not have the correct meaning. You will receive greater benefit from your studies if you do so on a consistent basis. Purpose: Chapter 8 discusses a variation of product costing known as "Activity-Based Costing," ABC. It is a relatively new concept and differs from the traditional costing methods in that it is used more for strategy development and decision making than for financial reporting. It has several unique properties that preclude it from being among the generally accepted accounting principles. End Result: A student who has a thorough grasp of product costing issues and procedures and who understands why a costing method could generate figures that may be desirable for decision making purposes but not be acceptable for external reporting. A student who understands the concepts of cost pools, cost drivers, and Activity-Based Management (ABM), and who could expertly discuss the role of ABC and ABM in Total Quality Management (TQM), Continuous Improvement (CI), and Zero Defect (ZD) operations. If you have any questions or difficulties, see me promptly during my office hours or at any other times you find me in my office; do not delay. You are always welcome to visit me in my office. I am here to help you get the most out of this course. Examine this printout and correct it for imperfections, if any. Checksheets with printing defects will not be evaluated. The total estimated time to complete this Checksheet is 7 hours. Turn in all your working papers as well as related solutions and write-ups as attachments to this checksheet.



Section 1: Odds and Ends

Initials Date 1. Complete the "Chapter 7" Checksheet. (Do not proceed prior to

completing the above Checksheet -- no exceptions.) ______ __________ 2. Study the cover page of this Checksheet and, on a separate page,

in your own words, prepare a list of skills that you should expect to gain by completing this checksheet. ______

__________ 3. In the space provided below, write the name of a classmate who could

accept your Checksheets when I return them to class for distribution. Make sure that you obtain your classmate's consent before noting his or her name. Avoid using each other's name on a reciprocal basis. Please Print: ___________________________________________ ______ __________

4. Using Windows Explorer, create a directory (folder) named “Ch08” on

your computer's "C" drive or on a floppy diskette. Download the Chapter 8 Power Point lecture slides from the "FA99-MA Miscellaneous Messages" conference into the "Ch08" directory. If you are saving the slides on your home computer, then make a directory named "Garrison" and in that folder make the Ch02, Ch03, … Ch08 folders (sub-directories) and move all Power Point slide as well as Checksheet files (and other files) into the respective Chapter folder. ______ __________

Section 2: Chapter 8 Activities, Part I - ABC Concepts Initials Date 5. Study page 322. On a separate page, explain which of the five properties

of activity-based costing was most surprising to you, and why? ______ __________ 6. Study Footnote 1 on page 323. On a separate page, prepare three graphs

showing the trend in the cost of material, labor, and overhead as a percentage of total manufacturing costs over the specified periods. ______

__________ 7. Study "Nonmanufacturing Costs and Activity-Based Costing" and

"Manufacturing Costs and Activity-Based Costing" on page 322-323. Consider the factory security guard's wages and commission paid to company salespersons. Which cost could be more legitimately allocated to individual units of a product for the purpose of measuring profitability? Record your response on a separate page. ______



__________ 8. Study "Plantwide Overhead Rate" and "Departmental Overhead Rates"

on pages 323-324. On a separate page, explain which technique would produce a more accurate product cost figure? ______ __________

Initials Date 9. Study "The Costs of Idle Capacity in Activity-Based Costing" on page 324.

Do you agree that the cost of having idle capacity should be separated from production costs? Record your explanation on a separate page. ______ __________

10. Study "Managerial Accounting in Action" on pages 325-326. Using four

common objects, demonstrate the interaction and dialogue between John, Susan, Tom, and Mary. ______ __________

11. Study "Identifying Activities to Include in the ABC System" on

pages 328-330. Do you agree that all companies have virtually the same set of activities? On a separate page, justify your answer. ______ __________

12. Study the SIX “Steps for Implementing Activity-Based Costing” on page 328. Step 2 states, “Wherever possible, directly trace costs to activities and cost objects. On a separate page, distinguish between an activity and a cost object; give an example of each, and name a cost example that could be traced to each of your examples. ______ __________

13. Is the unit of product the only "cost object" to which ABC assigns

cost? Are there other relevant cost objects? If so, list five cost objects for which a company may wish to determine cost. ______ __________

14. On a separate page, complete Exercise 8-1. ______ __________ 15. Study Chapter 8 Power Point slides number 1 through 13, and take

notes to augment your classroom notes and/or those you made while studying the book. ______ __________

Section 3: Chapter 8 Activities, Part II – ABC Techniques and Implementation

Initials Date 16. Study “Tracing Overhead Costs to Activities and Cost Objects” on

page 330-331. On a separate page, record the amount of manufacturing overhead that would be allocated to products under the traditional method. ______ __________

17. Study "Assigning Costs to Activity Cost Pools" on page 332-334.

On Exhibit 8-3, with a pencil, note the “level” for each of the five activities listed across the Table header. ______ __________



18. Study Exhibit 8-4. How would ABC treat the $490,500 accumulated

in the “Other” activity cost pool? Does this amount include any manufacturing costs? Would such manufacturing costs be allocated to individual units? ______ __________

Initials Date 19. Study "Computation of Activity Rates” on pages 334-335. On a separate

page, explain 1) why is the “Other” column in Exhibit 8-5 blank? 2) What does the $19 in the “Order Size” column represent? And, 3) why is the $500 of indirect factory wages being assigned to Customer Relations? ______ __________

20. Study “Assigning Costs to Cost Objects” on pages 337-338, including

Exhibit 8-8A and 8-8B on page 339. On a separate page, explain why is the “Customer Relations” column in both exhibits blank? Also, explain why is the “Product Design” column blank in Exhibit 8-8A, but not so in Exhibit 8-8B? ______ __________

21. Study “Product Margins Computer Using the ABC System” on

pages 338-340, including Exhibit 8-9 on page 340. On a separate page, discuss the relative profitability of each of the two products. Make a recommendation to management, based on the cost report in Exhibit 8-9, about how it should proceed in regards to supplying the two products to Windward Yachts. ______ __________

22. Study “Comparison of Traditional and ABC Product Costs” on

pages 340-342, including Exhibit 8-10, on page 341. On a separate page, explain 1) are costs segregated by activity levels in traditional costing system? 2) does the traditional cost system results show “Customer Margin”? And 3) Would your recommendation in Step 21 remain the same if you were basing it on the traditional cost system results? ______ __________

23. Study “Activity-Based Costing and External Reporting” on page 347.

On a separate page, explain the four reasons why companies do not fully integrate Activity-Based Costing into their formal cost accounting system? ______ __________

24. Study Chapter 8 Power Point slides number 14 through 37, and take

notes to augment your classroom notes and/or those you made while studying the book. ______ __________

25. On a separate page, complete Problem 8-12, in good format. You could

either use a spreadsheet program or prepare a handwritten solution. ______ __________ Section 4: Internet Activity Initials Date 26. Access TheBigHub.Com MetaSearch engine via my web page. Click on



all eight search engines and change the time it waits for each search engine's result from 10 seconds to 15 seconds. In the search text area, type "Activity Based Costing" including the quotation marks and click Find It. Record the total number of hits in the results _________. Which search engine seemed to produce the largest number of results _________________________? ______ __________

Initials Date 27. In the search results above, locate a site with the title, "White Paper: The

Impact of Activity-Based Costing." Access the site; print a copy of Figure 13 in the presentation, study the conclusion part, and then the discussion about the "Bottom-Up Approach" to ABC. ______ __________

28. In the search results above, locate a site with the title, "Cost Management

Conference, activity based cost management, target cos.…" Read the " Activity Based Costing Highlights!" on the front page, and in the space here _______, indicate the percentage of the discussion that you could understand and/or relate to. ______ __________

29. Locate the title "Implementing Activity-Based Costing" in the above search

results or access the site directly at: http://www.rutgers.edu/Accounting/raw/ima/imabc.htm

Read through the parts of the "Institute of Management Accountants Statement on Management Accounting Statement No. 4T, September 30, 1993," that interest you. Post a message detailing your experience with the sites you visited for steps 27, 28, and 29, and with searching the Internet in general, in a reply to: "What's Happening in Practice?" in the "Feedback Per Checksheet Instructions" conference on the MA Message Board. ______ __________

30. On a separate page, discuss the methodology to “Identify and define

activities and activity pools,” in your own words (Step 1 of ABC). ______ __________ 31. Access: http://www.pitt.edu/~roztocki/abc/abctutor/ and study

Power Point slides 1 through 24. According to Dr. Needy, how many Steps are there to Activity-Based Costing: ________? Does your course textbook suggest the same number of Steps to ABC: _________? ______ __________

Section 5: Student Completion I attest that I have:

(a) studied all the materials prescribed on this Checksheet, (b) have visited all the web sites suggested on the Checksheet, (c) made all the postings required by the Checksheet, and (d) a good understanding of the coverage in Chapter 8 of the Managerial Accounting

textbook by Garrison and Noreen.

I also attest that I have achieved the end result stated on the cover page of this Checksheet.



Student Attesting: _________________________________ Date: ______________________



COST ACCOUNTING TECHNIQUES USED BY THE UNION ARMY DURING THE CIVIL WAR

King, Darwin L.

St. Bonaventure University [email protected]

ABSTRACT

This paper discusses the use of budgetary and cost accounting techniques by the Union Army during the Civil War. Even during this early period in our history, it is clear that the maintenance of accurate accounting records was critical to the Army. The paper begins with a review of basic military organization to allow the reader a better understanding of how the Army collected the vast amount of information that related to each of its units. The Company, which consisted of approximately 100 men, served as the basic unit of recordkeeping. Information at the Company level was accumulated in order to provide summary data for a Regiment, which normally consisted of 10 Companies. The importance of the Company Clerk is also discussed because this position represented the heart of cost control for the Army at its most basic level. Military accounting emphasized two basic areas. Recordkeeping related to “men and materials”. These two broad areas required the preparation of many varied reports on a regular basis. In an effort to safeguard assets and ensure the accuracy of the accounting information, numerous standard costing techniques were employed on a daily basis by the Army. These ranged from the fees that the washerwoman could charge a soldier for washing an article of clothing to the standard rate paid to the men for extra duty while serving as a blacksmith or nurse. A number of actual military reports are reviewed in order to better understand the standardized costing system and related controls employed by the Union Army. These documents include the Table of Pay and Forage, the Statement of Cost of Clothing, Camp, and Garrison Equipage, Invoices used for Extra Duty Pay, Travel Expense Vouchers, and Requisitions of Hay for Soldier’s Bedding. Finally, a stationery example shows the details employed by the Army to safeguard even the paper used to prepare the reports.

The purpose of this paper is to document the extent of cost accounting employed by the Army during these most difficult times. Even 135 years ago, the maintenance of a good audit trail and an accurate set of accounting records were of prime importance to the Army. The military leaders realized that the war could not be won without proper recordkeeping that allowed for the efficient use of both men and materials. Accounting Clerks and Quartermasters provided a critical service to the Army that should not be underestimated.

INTRODUCTION The importance of maintaining good cost records has been a part of part of our history for many years. Both governmental and business entities must concentrate on cost control in order to operate effectively. This paper will review some of the budgeting and standard cost systems used by the Union Army during the Civil War. The study of Civil War accounting documents remains in its infancy. The difficulty of locating good examples of old cost reports is a major reason. The author has been fortunate enough to have collected a number of excellent examples of actual Civil War accounting statements, which clearly show the U.S. Army's intent to maintain strict control over costs. The study of battles and leaders in the Civil War has become very popular in recent years for many people. However, the review of accounting systems and cost records of this period has received very little attention. This paper will, therefore, attempt to show the significant historical value of the cost accounting system used by clerks and quartermasters in the Union Army. Many of the record keeping techniques employed by these individuals have served as the basis for cost accounting practices of today.



OVERVIEW OF MILITARY ORGANIZATION

In an effort to better understand the Army's system for record keeping, a brief review of its organization is appropriate. The U.S. Army is organized into corps, divisions, brigades, regiments, and companies (Boatner, 1991). A corps is the largest military unit. It is made up of two or three divisions under the direction of a Major General. A division is composed of three to five brigades. Each division is led by a Major General or Senior Brigade General. A brigade consists of three to six regiments. Either a Brigadier General or a senior Colonel commands it. A regiment is typically composed of 100 to 800 men. The commanding officer of the regiment is normally a Colonel. When the Civil War began, a regiment was at full strength with about 1,000 men. After the first two years of fighting, many of the regiments consisted of less than 500 members. As additional men were later added, they were assigned to new regiments rather than being allocated to the older depleted units (Ibid.).

Finally, a regiment could be broken down into the military's smallest record keeping unit called a company. Infantry regiments were usually composed of ten companies. In contrast, heavy artillery regiments often had twelve. Each company was assigned a letter in alphabetic order. (i.e. Company A, B, C, etc.) For some unknown reason, the letter J was never used in the process of assigning alphabetical titles (Boatner, 612). In the Union Army, the normal company at the time it was created was at full maximum strength with 101 officers and men. The minimum strength of a new company was 83 total members. Each of these units was allowed to recruit between 64 and 82 privates. This provided sufficient room in the company for all of the other ranks. This rank allocation process represents an early managerial control over human resources for each company. Payroll costs were standardized through the use of specified numbers of men from each of the various ranks. The monthly salary for each rank was stated in the regulations. A Company normally included one captain, one first lieutenant, one second lieutenant, one first sergeant,

four sergeants, eight corporals, two musicians, and one wagoner. Its members early in the war elected the officers of the company. This practice was later replaced in 1862 by a system of examinations in an effort to eliminate incompetent officers.

THE POSITION OF THE COMPANY CLERK

Record keeping in the U.S. Army began, at its most basic level, with the company clerk (Kautz, 1865). The company or accounting clerk was a position filled by a man who was either a non-commissioned officer or soldier who was known to have good penmanship and a capacity for keeping good reports and records. This basically meant that privates (soldiers) or corporals and sergeants (non-commissioned officers) were allowed to hold the position of company clerk. Either the commanding officer of the company (i.e. captain) or the first sergeant normally supervised him. The company clerk did not receive any extra pay for the job but was excused from most other duties within the unit. However, during times of active service, the clerk needed to be prepared at all times for service in the field. The Accounting Clerk position represented the heart of cost control for the Army at its most basic level.

COST ACCOUNTING PRINCIPLES UTILIZED

The next segment of this paper reviews several areas in which control of costs was critical. These

costs related to two broad areas. The U.S. Army felt that it was critical to maintain significant controls over costs of both "men and materials" (Case, 1865). Beginning at the company level, reports of all types were required which often involved a significant amount of standard costing. The Army knew that in order to control costs in many areas that a standard cost for payroll and materials of all types would be necessary. For example, the Army even set a standard cost for the laundress or washerwoman (Regulations, 1861). Four washerwomen were allowed for each company and they were paid a standard allowance set by the government based on either a per item piece rate or a monthly fee (Ibid.). The use of standard costing techniques and specified allowances for most all assets were key features of the accounting system used by the Union Army. The following examples illustrate the dependence of the U.S. Army on accurate cost control and measurement. They include areas of significant costs such as payroll, clothing allowances, travel expenses,



and other items relating to "men and materials". Accurate record keeping and cost control by the Union Army provided it with a significant advantage over the Confederacy during the war. Battles could only be won if proper amounts of “men and materials” were available where and when needed.

REPORT 1 - TABLE OF PAY FORAGE, &C. OF THE U.S. ARMY

The first report in the appendix reflects the standard cost system used by the Army related to the soldier's payroll (Regulations, 348-353). The first few pages of this document list the officer's pay per month, number of rations per day for subsistence, forage allowed for the horses maintained, and the number of servants allowed. The officers who were allowed extra rations per day often used servants. It is interesting to note that in most situations the rations allowed per day would not provide three meals for the soldier and each of the servants. The soldiers of lower rank who were not officers were not given any additional food allowance. They received the normal meals prepared in the camps, but they received no extra money in which to buy fresh fruits or vegetables or luxuries such as salt and other spices. The standard pay per month varied tremendously from a high of $270 for Lieutenant Generals to $13 for a private. The Corporals rate of $20 per month and the Sergeants pay of $34 monthly explain the constant desire of soldiers to work for a promotion. They could nearly double their monthly pay with a single advancement in rank. The troops were to be paid "in such a manner that arrears shall at no time exceed two months" (Regulations, 341). This two month maximum time period was very typical during the war. This forced the soldier to stay on a budget knowing that the next payday was not for eight weeks. An estimate of total payroll for the next two months in the form of an expected wage budget was also required of each accounting clerk (Regulations, 345). This was sent to the office of the Paymaster General in order to better estimate future payroll costs.

The accounting and record keeping positions in the Army received an excellent wage when compared to the typical soldier. For example, a quartermaster earned $80 per month. These men controlled and safeguarded inventory and also prepared a variety of related reports. The paymaster of a regiment also received an $80 salary per month. This was about six times the amount received by a typical private. This exceptionally high wage standard shows the importance placed on these duties by the military.

Accounting salaries were particularly large when compared to other individuals who provided very essential services. For example, female nurses who fought to keep the men alive following a battle were paid 40 cents per day ($12 month) and received only one meal ration per day (Regulations, 353). Also, surgeons for the first ten years of military service received the same $80 monthly salary of the paymaster and quartermaster (Regulations, 349). Finally, professors at the military academy received only $70 per month (Ibid.). It appears that the Army considered its accounting personnel to be among the most valuable.

REPORT 2 - STATEMENT OF COST OF CLOTHING, CAMP, AND

GARRISION EQUIPAGE Budgeting and standard costing were also important in the allocation of clothing to each member of the U.S. Army. Standards were utilized in many cost areas including allocations of hay or straw for bedding and clothing allowances that were based on rank and area of service. The Army used many standard allowances in order to maintain control over all types of physical assets. Uniforms and other types of garments were major costs for both the Union and the Confederacy.

Report 2 in the appendix is the reference form used in the determination of whether a soldier was over or under spent related to clothing (Kautz, 18-21). Records were kept in the Company Clothing Book to determine if issues of clothing to non-commissioned officers (sergeants and corporals) and privates were more or less than their clothing allowance. This second report in the appendix was the reference guide used in this costing process. For example, hats cost about $1.65, coats were between $5.30-$7.30, and trousers ranged from $2.50-$3.75. A woolen blanket's standard rate was $3.25 while a pair of flannel drawers cost 90 cents. When a soldier was issued clothing, his personal account was charged for the cost listed in this table. Regular military personnel received a clothing allowance as shown in the second part of Report 2. For example, a corporal in the cavalry received a clothing allowance of $55.38 in his first year of service. This dropped to only $31.07 in the second year. The total clothing allowance for a five-year enlistment in the



Army was approximately $200. The figures in this table were based on the assumption that some articles of clothing would not have to be replaced each year. For example, two caps and coats were allowed the first year of service but only one each the second year (Regulations, 170). The Army allowed the soldiers an equal number of the more basic types of clothing each year such as four pair of stockings and three flannel shirts. Volunteers accounted for the majority of the total membership of the Union Army during the Civil War. The troops who were volunteers vs. regular military (draft) received a monthly clothing allowance. This figure was fixed by law at a generous $3.50 per month or $42.00 per year (Kautz, 21). Each soldier’s account was compiled to compare clothing drawn with the appropriate clothing allowance based on time served. When a soldier left military service, the personal account showed either “due the U.S. for clothing overdrawn” or “due the soldier for clothing not drawn” (Kautz, 22-23). In this final statement, the calculation of the net amount due or owed by the soldier was determined. This process was completed in order to insure that only the standard allowance for clothing was received by soldiers based on their area of service and rank. Maintaining controls over clothing inventories was a major military cost concern given the huge amounts of uniforms and other items needed to supply the troops. Clothing had to be limited to a standard amount each year in order to discourage soldiers from selling items, keeping the cash, and later requesting additional clothing. The Army imposed fines of up to $300 on soldiers who sold their clothing and civilians who bought these items based upon the Act of January 11, 1812 (Kautz, 24). Clothing inventories were performed on a regular basis, which required the soldiers to "produce their clothing and account for its absence"(Ibid.). The cost accounting practices related to clothing and uniforms were among the most detailed and specific in the U.S. Army Regulations.

REPORT 3 - INVOICE FOR EXTRA DUTY PAY

Report 3 in the appendix is an actual Civil War accounting report purchased at an estate sale by the author. This is one of the many types of invoices used by the Army. This document relates to the payment of extra duty pay to a soldier named Thomas Norbury. Thomas worked as a clerk in the regimental quartermaster’s office during May and June of 1863. This report shows the tendency to prepare payroll every two months.

The normal pay for a soldier (private) was about $13 per month (Regulations, 352). This invoice shows that the job of clerk at the regimental level was very financially rewarding. The rate of pay, according to the invoice, was $125 per month in 1863. This was ten times what the typical private earned each month. This clearly shows that the Army considered the position of the unit accounting clerk to be very important and set the rate of pay accordingly.

A final note concerning this document relates to its date of July 1, 1863. This was the first day of the battle of Gettysburg. On July 1, the cavalry of Union General Buford met Confederate General A.P. Hill in the beginning of one of the major battles of the war. During this terrible battle, both the Union and the Confederacy made a serious attempt at accurate record keeping even under these very worst of conditions. This single battle resulted in tremendous financial and human loss for both sides.

REPORT 4 - TRAVEL MILEAGE VOUCHER

The next document (Appendix Report 4) represents the payment of travel expenses to an officer. Similar to benefits that business executives receive today, the officers in the Union Army were paid a mileage allowance for travel to the camp where they were to be assigned (Regulations, 344). Capt. David M. Meredith traveled from Columbus, Ohio to a Union camp located near Manchester, Tennessee. It was typical to reimburse officers, but not enlisted men, for travel from their hometown to the place of their assignment. In this situation, Meredith's travel was 540 miles for which a six cent a mile reimbursement was paid to the Captain. This is another example where standard costing was used to calculate expenses. The Regulations also mention that the number of miles should be based on the "shortest mail route or by the shortest practical route if no mail route exists" (Ibid.) This represented still an additional control over total operating costs.



The bottom of the document represents a receipt for the funds received by Capt. Meredith. The Quartermaster, A. J. MacKay, paid him for his travel on July 20. Notice the statement on the bottom, which reads that he, "had not been furnished with public transportation, nor received money in lieu thereof, for any part of the route". The Army was very careful not to let the men "double dip" expenses.

REPORT 5 - REQUISITION OF HAY FOR SOLDIER’S BEDDING

This final report (Appendix Report 5) brings to the reader's attention the crude conditions that the soldiers endured during this difficult period in our history. This document represents a requisition for hay to be used as bedding in the U.S. General Hospital located at Hilton Head, South Carolina on March 7, 1862. An interesting note appears on the right side of the requisition and reads, "There being no straw on hand, hay is required for instead". Anyone familiar with hay and straw would realize that hay, with its various sharp and picky components, would be used as bedding only as a last resort.

The use of standard allowances is clearly evident in this report. It shows that each soldier was allowed twelve pounds of hay or straw per month to be used as bedding. The soldiers in the lower ranks had no cots or other types of beds. The document states that the bedding was needed for, "non-commissioned officers, musicians, and privates". In most cases, officers had some type of cot that was used in their sleeping quarters. This requisition includes 12 pounds of hay for each of the 45 soldiers involved for a grand total of 540 pounds of hay. The accounting clerks and quartermasters used these figures each month in preparing the budget for the many types of supplies that were needed.

Standard allowances were also used in determining the amount of bedding and food required by horses and mules. One hundred pounds of straw was allowed for each horse used in government service (Regulations, 166). Forage, consisting of hay, oats, corn, or barley, was set at a standard allowance of fourteen pounds of hay and twelve pounds of oats, corn, or barley per day per horse (Ibid.). The allowance for mules was fourteen pounds of hay and nine pounds of any of the other three grains. Depending on the rank of the officer, the regulations allowed them to maintain more than one horse. For example, during wartime Major Generals were allowed to keep seven horses or mules while a Captain in the Cavalry was allowed three (Ibid.). There were, however, strict rules against the drawing of additional rations of forage and then selling them to others.

The last statement on the document shows that Capt. H.A. Hascall who was the quartermaster at that time provided the 540 pounds of hay. The certifications in the lower middle of the document state that, "straw (or hay) has not been drawn for any part of the time charged". Each military report contained language where the preparer certifies that the information on the report was true and accurate and that no costs were being duplicated. This theme of preventing costs to be billed and paid more than once is common throughout all of the reports prepared by the U.S. Army.

A FINAL STATIONERY EXAMPLE

A final example of how standard allowances were used in order to control costs involves the ordering of stationery by the Quartermaster's department. The typical regiment was allowed to order stationery on a quarterly basis (Regulations, 167). An officer in charge of the regiment was allowed to order a maximum of 10 quires of writing paper per quarter. A quire consisted of only 24 or 25 sheets (one twentieth of a ream), which meant that only about 250 pages of paper were available for a three-month period. This same officer of a regiment was also allowed only 6 ounces of sealing wax and 2 pieces (rolls) of office tape. This system was meant to control even the smallest of supply costs for each military unit. Each officer was allowed an office table that included a standard assortment of inventory. These were items needed when various letters and reports had to be prepared. For example, one inkstand, one stamp, one paper folder, one sand box, and one wafer box were items allowed on each officer's table. Also, the regulations stated that officers might request as many lead pencils as may be required as long as it did not exceed four per year (Ibid.). This was, indeed, a very conservative standard costing and allowance system when even pencils were very limited in supply.



SUMMARY This paper has attempted to review the importance of cost accounting principles to the U.S. Army during the Civil War. The typical business today takes for granted how many of the costing methods were developed over a period of many years. Research into military accounting methods during the Civil War has been very limited. The purpose of this paper is to better document the fact that even 135 years ago cost accounting principles were critical. The Army realized that the war could not be won without proper records related to each asset. It is clear that the military did carefully observe and control all costs related to "men and materials". These two assets were critical in winning of the war. Without the correct number of men and related supplies and materials in place, a battle could not be won. It is amazing that these quartermasters and accounting clerks were able to maintain such a complete set of records. The documents included in the Appendix show that the Army was very concerned with adequate record keeping. In particular, any position that required a person to prepare accurate, complete, and timely reports carried with it a premium rate of pay. Cost accounting principles have evolved over a period of many years. Early in our history, it was clear that the government was very cost conscious. The U.S. Army regulations and related reports show that a significant amount of time and money was devoted to this endeavor. In an effort to show the significance of early military record keeping, this paper is dedicated to the early quartermasters and accounting clerks who risked their lives in order to maintain accurate records for the Army during a very difficult time in our history. Without these detailed controls over the costs of “men and materials”, the war could have either lasted much longer or may have even resulted in a different outcome.



REFERENCES

Boatner, M.M. 1991. The Civil War Dictionary, New York, NY: Vintage Books: 610-613. Case, T.S. 1865. The Quartermaster's Guide, Saint Louis, MO: P.M. Pinkard Co.: 11-17. Kautz, A.V. 1865. The Company Clerk, Philadelphia, PA: J.B. Lippincott & Co.: 9-10. U.S. War Department, Revised Regulations for the Army of the United States 1861, Philadelphia, PA: JGL

Brown, Printer: 24.



CPA ELDERCARE ASSURANCE: AN AGENDA FOR ACADEMIC AND MARKET RESEARCH

Walker, Edward R.

The University of Texas-Pan American [email protected]

ABSTRACT

ElderCare Assurance is being suggested as a means for CPA firms to attract elderly clients. Since this is a non-traditional form of assurance service that has never before been offered, it is unclear what the attitudes of CPA firms, elderly people, and providers of services to the elderly will be. This paper provides a suggested research agenda to measure these attitudes and gather information that can be used to assist CPA firms in marketing these services as well as providing feedback on their effectiveness to firms and to the AICPA.

INTRODUCTION

ElderCare Assurance is a new form of assurance service that the AICPA is suggesting for CPA firms. The AICPA Special Committee on ElderCare Assurance Services has defined ElderCare Assurance as “a service designed to provide assurance to family members that care goals are achieved for elderly family members no longer able to be totally independent. . . . [t]he CPA [will serve] as the coordinator and assurer of quality of services based on the goals set by the customer” (AICPA, 1994).

The target for these services is the elderly person who needs help managing his or her financial affairs and/or obtaining health or other types of services. CPA ElderCare Assurance Services are classified into three categories: consulting services, where plans are formulated for the care of the individual and the delivery of services; direct services, where the CPA coordinates his efforts with those of other professionals such as attorneys and stockbrokers to provide hands-on assistance; and assurance services, where the CPA reports on the extent to which care-giving goals are being met. This includes periodic reporting on both financial transactions and the effectiveness and efficiency of care providers. In providing these services, the CPA firm must make every effort to preserve the appearance of independence and when preparing reports of financial transactions must conform to the SSARS relating to personal financial statements (Kaplan and Kaplan, 1998).

Given the increasing age of the population in the United States, it would appear that ElderCare Assurance would be an ideal way for a CPA firm to maintain or expand its client base. A limited study commissioned by the AICPA Special Committee on Assurance Services found that 89% of higher income Americans would be likely to use such services if necessary. The results also revealed that the presence of a specially accredited CPA would make more than half of these individuals more likely to use elder care assurance services (AICPA, 1996). The results of this study must be interpreted with caution, however, because the sample size was small and the annual income of the respondents was greater than $80,000. Because the demographic characteristics and needs of the elderly may vary from region to region of the country, it is not possible to assume that the same mix of ElderCare Assurance will apply equally to all groups of people. Likewise, not every CPA firm will have the need or desire to offer a full range of these services. Extensive research is necessary to determine the extent to which ElderCare Assurance services are offered by CPA firms as well the extent to which they are used by the elderly. The purpose of this paper is to present a proposed agenda for research on ElderCare Assurance. It will discuss the types of research questions that should be addressed, the population groups that should be studied, and the methodological issues that should be considered in carrying out this research.



PERCEPTIONS OF CPA FIRMS TOWARD ELDERCARE ASSURANCE

As previously mentioned, not every CPA firm has the desire or need to offer ElderCare Assurance. A firm may have a client base comprised primarily of corporations and would not profit from offering ElderCare Assurance. Also, the principals of a firm may not have a desire to work with elderly clients or a desire to gain the necessary knowledge of the laws and regulations related to care for the elderly. Research directed at CPA firms should focus upon individual differences between CPA firms. Variables that should be addressed include overall firm size, number of principals in the firm, age of firm principals, composition of client base, per-capita income in an area, percentage of population 40 years and above, and number of CPA firms in a particular area. Presented below is a list of potential research questions and related variables, along with types of statistical tests and potential sources of data. Hypotheses derived (stated in the alternative form) from these research questions are shown in italics.

Table 1 Research Questions Related to CPA Firms’ Intent to Offer Elder Care Assurance

Research Question/Hypotheses Variables Type of Statistical Test Source of

Data Are CPA firms that primarily

service individual clients more

likely to offer ElderCare

Assurance than CPA firms that

service corporations?

CPA firms that primarily service individual clients are more likely to offer ElderCare Assurance than CPA firms that primarily service corporate clients.

Intent to

offer

ElderCare

Assurance

?

( DV);

Composition of client base

t-test, probably non-parametric

Questionnaire to CPA firms.

Are larger CPA firms more likely to offer ElderCare Assurance than smaller CPA firms? Larger CPA firms are more likely to offer ElderCare Assurance than are smaller CPA firms.

Intent to offer ElderCare Assurance? ( DV); Number of principals; number of staff

Stepwise regression of all IV’s against DV

Questionnaire to CPA firms

Are CPA firms with older principals more likely to offer ElderCare Assurance than those firms with younger principals?

CPA firms with older principals are more likely to offer ElderCare Assurance than those firms

with younger principals.

Intent to offer ElderCare Assurance? ( DV); Average age of CPA firm principals


Questionnaire to CPA firms

Are CPA firms in areas with higher per-capita income more likely to offer ElderCare Assurance than those firms

Intent to offer ElderCare


Questionnaire to CPA firms;



with lower per-capita income. CPA firms in areas with higher per-capita income are more likely to offer ElderCare Assurance than those firms in areas with lower per-capita income.

Assurance? ( DV); Per-capita Income

Census data

Are CPA firms in areas with a greater number of residents 40 years and older more likely to offer ElderCare Assurance than those firms in areas with younger residents? CPA firms in areas with higher percentages of residents 40 years and older are more likely to offer ElderCare Assurance than those firms in areas with lower percentages of residents 40 years and older.

Intent to offer ElderCare Assurance? ( DV); Percentage of residents 40 years old and greater

t-test, probably nonparametric

Questionnaire to CPA firms; Census data

The above variables could also be combined into a logistic regression equation in the following manner: ElderCare Assurance) = Client Base + Firm Size + Principal Age + Per-Capita Income + Population Age + e Where:

ElderCare Assurance = CPA firm’s intent to offer ElderCare Assurance (Dichotomous variable)

Client Base = Percentage of individual clients in firm Firm Size = Number of professionals in firm

Principal Age = Average age of firm principals Per-Capita Income = Average per-capita income

Population Age = Percentage of residents 40 years and older e = Error term

Since the dependent variable is dichotomous, it would be necessary to use logistic regression to

analyze the data. A stepwise technique could be employed to measure the effect of each variable (Demaris, 1992). As an alternative to a dichotomous dependent variable, the types of services offered as a part of ElderCare Assurance could be listed and the respondent indicate the likelihood of his or her CPA firm offering these services with a 5-point scale (1=very unlikely; 5=very likely). If this approach were used to operationalize the dependent variable, OLS regression could be employed. This research should be repeated after two years and after five years to determine the direction in attitude toward ElderCare Assurance. Additionally questions that address the efficacy of these services should be added. These types of questions can gauge the success of these services as well as the desirability of including them as a part of a CPA’s functions.

PERCEPTIONS OF THE ELDERLY CLIENT TOWARD ELDERCARE ASSURANCE

Not every elderly person will avail himself of the full extent of ElderCare Assurance. Some will not require them due to the ability to self-care and manage their resources; others will not have the assets necessary or sufficient for such services. The study commissioned by the AICPA found that only 38% would be “extremely” or “very” interested in ElderCare Assurance as a part of their personal financial planning. Of the services offered, home health care and assisted living are the ones in which the most interest was expressed. The study further found that 52% of the respondents would be more likely to use ElderCare Assurance Services if a specially accredited CPA were involved (AICPA, 1996). Research directed at users of these services should focus on demographic characteristics of the elderly client, such as age, income and geographic area of the country. Other variables that should be investigated are type of living arrangement, proximity of immediate family or significant others, state of



health, and previous use of CPA services. Research of this nature could serve as a marketing tool to aid in a CPA firm’s decision to offer Elder Care Assurance.

Table 2 Research Questions Related to Elderly People’s Use of Elder Care Assurance

Research Question/Hypotheses Variables Type of

Statistical Test

Source of Data

Are older individuals more likely to use CPA ElderCare Assurance? Older individuals are more likely to use CPA Elder Care Assurance.

Use of ElderCare Assurance (DV), Age

t-test or correlation

Survey of elderly citizens

Are individuals with higher incomes more likely to use CPA ElderCare Assurance? Individuals with higher incomes are more likely to use CPA Elder Care Assurance.

Use of ElderCare Assurance (DV), Income

t-test or correlation


Are individuals who have used the services of a CPA for financial planning in the past more likely to use CPA ElderCare Assurance? Individuals who have used CPA services in the past are more likely to use CPA Elder Care Assurance.

Use of ElderCare Assurance (DV), Use of CPA

t-test, possibly non-parametric


Are individuals with no immediate family in close proximity more likely to use CPA ElderCare

Assurance? Individuals with no immediate family in close proximity are more likely to use CPA Elder Care Assurance.

Use of ElderCare Assurance (DV), Family



Are individuals with health problems more likely to use CPA ElderCare Assurance Individuals with health problems are more likely to use CPA Elder Care Assurance.

Use of ElderCare Assurance (DV), Health



Are individuals living in retirement communities or assisted living facilities more likely to use CPA ElderCare Assurance. Individuals living outside their own home are more likely to use CPA Elder Care Assurance.

Use of ElderCare Assurance (DV), Living



The above variables could be combined to form a multiple regression equation that would be

analyzed using logistic regression or OLS depending upon the manner in which the dependent variable is operationalized:

Use of Elder Care Assurance = Age + Income + Use of CPA + Family + Health + Living + e

Where:

Use of Elder Care Assurance =

Subject’s use of Elder Care Assurance

Age = Age of Subject Income = Income Level of Subject

Use of CPA = CPA Use for other Matters (1=Yes; 0=No) Family = Presence of Support System (1=Yes; 0=No) Health = State of Health Living = Type of Housing



After Elder Care Assurance has been offered for at least two years, additional studies should be conducted to determine if the relationships present in earlier studies still hold true. Additionally, the attitudes of the elderly toward the effectiveness of these services should be investigated; results of these studies could help the CPA firm to better market its services and/or to improve their delivery to clients.

PERCEPTIONS OF CARE PROVIDERS TOWARD ELDERCARE ASSURANCE

Having a CPA as coordinator of services to elderly clients will likely be a new experience for some care providers. Because some of these providers may perceive the CPA as a person who questions their judgement and/or ability, resentment may occur. This may be especially true when a CPA asks to review goals and care records prepared by a medical professional such as a home-health nurse or a medical social worker. Also for large agencies that may be burdened with much paperwork, dealing with requests for information from a CPA coordinator may prove frustrating. Studies focused on care providers and their attitudes toward ElderCare Assurance should investigate the relationship between these attitudes and the nature of the organization providing services. Potential research questions along with hypotheses (stated in the alternative form) are presented below.

Table 3 Research Questions Related to Care Providers Attitudes toward Elder Care Assurance

Research Question/Hypotheses Variables Type of

Statistical Test

Source of Data

Will providers of non-medical services to the elderly be more receptive toward CPA Elder Care Assurance than providers of medical services? Providers of non-medical services will be more receptive toward CPA ElderCare Assurance than providers of medical services will be.

Attitudes toward CPA ElderCare Assurance Services (DV); Type of Agency

t-test, nonparametric

Survey of care providers

Will private, for-profit providers of services to the elderly be more receptive toward CPA Elder Care Assurance than non-profit governmental agencies? Private, for-profit, providers of services to the elderly will be more receptive toward CPA Elder Care Assurance than governmental, non-profit agencies will be.

Attitudes toward CPA ElderCare Assurance Services (DV); Type of Agency

t-test, nonparametric

Survey of care providers

Subsequent studies in future years should investigate whether these attitudes have changed as well as opinions of these service providers regarding ways in which Elder Care Assurance could be improved. This could help the CPA offer these services more effectively.

CONCLUSION

Research on CPA ElderCare Assurance can be used not only for academic purposes but to provide

feedback to firms that have begun offering these services to clients, firms that are contemplating offering these services, and to the profession as a whole. By analyzing the results of research studies such as those suggested above, a CPA firm can learn how to offer the optimal mix of ElderCare Assurance as well as how best to market these services to an aging population and work well with agencies that provide care to the elderly.



REFERENCES

AICPA (1994). Special Committee on Assurance Services. AICPA Special Committee on Assurance Services (1996). Americans’ Attitudes Toward and Interest in

“Elder Care Assurance”. Demaris (1992). Logit Modeling: Practical Applications. Newbury Park: Sage Publications. Kaplan & Kaplan (1998). CPA ElderCare: A Practitioner’s Resource Guide. Roberto & Yardley (1999). “Helping Clients Grow Old Gracefully.” Journal of Accountancy, Volume

187, Number 4, April 1999, 43-54.



DETERMINANTS OF SHORT-TERM AND LONG-TERM CEO PAY

Ramaswamy, Vinita M. University of St. Thomas, TX

[email protected]

Fernandez, Ramon University of St. Thomas, TX

[email protected]

Ueng, C. Joe University of St. Thomas, TX

[email protected]

ABSTRACT

After much controversy and heated debate, the FASB issued SFAS No. 123, “Accounting for Stock-Based Compensation” nearly three years ago. The standard requires companies to either recognize or disclose the fair value of the stock options they grant to employees, starting December 15, 1995. The initial disclosures have become available this year, and some of the compensation numbers reported are extraordinary. The high levels of executive compensation have led stockholders and analysts to question the economic factors that determine CEO compensation. This paper investigates the relationship between CEO stock options and compensation expense and corporate financial performance. The executive’s pay is measured using three variables: (1) Basic compensation, which includes salaries and bonuses earned during 1996; (2) Total direct compensation, which includes salaries, bonuses, and gains from the exercise of stock options; (3) Present value of the option grants made during the fiscal year. The first two variables measure the short-term CEO compensation while the third variable measures the long-term CEO compensation. Results indicate a strong relationship between financial performance and executive pay. In all three cases, sales is the most significant factor in determining compensation. Earnings and the efficiency of the CEO in managing working capital also explain current compensation, while other factors like stock price, P/E ratio, and leverage show greater significance for future performance.

INTRODUCTION

In recent years, CEO compensation has seen tremendous increases. The average compensation for chief executives of major companies was $ 4.37 million in 1995. Roughly, 25% of the pay came from salary - the rest was from annual bonuses and stock options. The average stock option package was valued at $ 1.52 million. This represented a 45% increase over 1994 bonuses. A survey by a consulting firm found that the CEOs of some of the biggest corporations saw their compensation increase 23% in 1995, even as thousands of workers were being laid off. Recently released IRS data shows that between 1980 and 1995, total executive pay rose 182%, while corporate revenues rose 129%. The Wall Street Journal reports that modern day CEOs have become celebrities partly due to their expensive pay packages.

The extravagant numbers reported above have made the stockholders aware that the chief executives of large companies are much more highly paid than their counterparts in other countries. Two questions are raised as a result: 1. Is executive compensation really aligned with company performance? 2. Should companies be granting stock options to their chief executives, at the same time showing zero



compensation expense in their income statements (a practice allowed by APB Opinion No. 30)? This practice is further compounded by the fact that companies can take tax deductions for the stock options, thus reducing their income tax liability.

The non-recognition of the expense attributable to employee stock options has led to a wide debate, the result of which has been SFAS No. 123, “ Accounting for Stock-Based Compensation.” Under the new standard, companies can either recognize the fair value of stock options awarded on their income statements, or continue to account for their stock compensation plans under current rules (APBO 30), but with additional footnote disclosures regarding their fair value. If disclosure is chosen, extensive disclosures, including proforma net income and earnings per share are required. The fair value is essentially the difference between the current market price of the stock and the present value of the option exercise price, discounted at a risk-free rate over the life of the option, adjusted for the volatility of the stock. Recognition is effective for transactions entered into during fiscal years beginning after December 15, 1995.

A majority of the companies have chosen footnote disclosure. The first disclosures of the fair value of stock options granted appears on financial statements for fiscal year 1996. The footnote disclosures include earnings a company would have reported after deducting stock option compensation expense - and some of the numbers reported are remarkable. In a survey done by the Wall Street Journal, reductions in reported earnings due to stock options range from a staggering 296% for Netscape to a smaller 8% for MCI Communications (see Table 1). A insidious side effect not discernible in the income statement is that companies have resorted to enormous stock repurchases to cover the stock options. For Intel, stock repurchases absorbed 60% of net income. Given these facts, the economic factors fueling compensation packages become extremely important.

TABLE 1

REDUCTION IN REPORTED EARNINGS DUE TO STOCK OPTIONS

Company Name Reduction Earnings (%) Netscape -296% Reynolds Metal -18.34% Uncoal -14.30% MCI Communications -8.10% Pepsico -6.90% Westinghouse Electric -129%

The purpose of this paper is to combine the regularly reported CEO compensation with the newly

disclosed share options to construct a broader measure of executive pay in order to examine the legitimacy of executive compensation and the factors that determine the levels of such pay. Prior studies have researched the determinants of salaries and bonuses, but this study includes stock options, which are of particular importance because of their magnitude and the fact they are not normally charged against earnings.

BACKGROUND AND MOTIVATION

Many prior studies have examined the extent to which companies use accounting earnings to

compensate managers. Healy (1985) documents that most bonus schemes define a variant of reported earnings for use in the computation of the amount allocated to bonus pools. Antle and Smith (1985), Lambert and Larcker (1987), and Sloan (1993) show that there is a significant statistical association between top-executive cash compensation and reported earnings. These studies also show that stock price performance is a determinant of CEO cash compensation, though to a lesser extent than earnings. In a related study, Kumar et.al (1993) finds that models, which include working capital from operations in addition to earnings, have a higher ability to explain executive compensation than models based on earnings alone. Dechow et.al (1994) finds that adjusted pre-tax income and restructuring charges together possess more explanatory power than pre-tax income alone in the association of performance measures with top management cash compensation. Natarajan (1996) shows that earnings and cash flow measures



together have a better association with cash compensation paid to CEOs than aggregate earnings alone. The preceding research has used CEO cash compensation as the dependent variable. In their

studies, researchers have assumed that cash compensation is likely to capture much of the variation in total compensation. Due to FASB 123, the fair value of stock options granted to CEO’s has become available for the first time, revealing that the option values granted to top executives are not always proportional to their cash compensation. Table 2 shows that the fair value of stock options deviates widely among the sample of corporations presented. The correlation coefficient between cash compensation and the fair value of option gains is a very low .23.

TABLE 2

SAMPLE OF CEO COMPENSATION ($ in THOUSANDS)

COMPANY NAME INDUSTRY BASIC PAY OPTION GAINS PV OF GRANTS Air Products Basic Materials $1,211.10 $560.60 $887 Monsanto Basic Materials 2920 1492.7 24468 Armco Basic Materials 559.2 0 559.2 Amoco Energy 1886.2 956.3 1860.1 PanEnergy Energy 1215 222.1 711.5 Enron Energy 2610.9 4409.4 11696.3 Allied Signal Industrial 4800 7005 n/a Briggs &Stratton Industrial 499.2 87.7 652.1 Delta Airlines Cyclical 1007.6 1243.8 2365.9 Kodak Cyclical 3986.9 1495.5 1947.7 Anhauser Busch Noncyclical 2473 6105.2 2664.1 Coca-Cola Noncyclical 5213.3 9009.4 n/a AT&T Technology 2436.3 1303.9 n/a Compaq Technology 4250 23546.1 14748.4 Microsoft Technology 562.6 0 n/a

In contrast to the focus on cash compensation, this paper combines cash compensation with the

fair value of stock options to obtain a broader measure of executive pay. The relationship between total compensation and certain measures of corporate financial performance is investigated in order to examine the economic factors driving such tremendous increases in pay. This paper also contributes to the extant literature by examining the determinants of future pay potential, represented by the present value of option grants.

RESEARCH DESIGN AND EMPIRICAL MODELS

The main variable of interest is CEO compensation. Such pay is usually a combination of salaries, bonuses and perks, gains from the current exercise of stock options and option grants for future exercise. SEC rules for proxy statements require disclosure of the compensation of the chief executive officer plus four or more other highly compensated executives. The term “salary” refers to base salary earned during the year, even if deferred or paid in common or restricted common stock. “Bonus” data reflect annual bonuses earned in cash for commendable financial performance. “Option gains” indicate gains from the exercise of stock options and/or stock appreciation rights. “Present value of option grants” is a new disclosure required under SFAS No. 123. It is calculated using option pricing models with the following inputs: stock price at grant date, exercise price of the option, term of option, risk-free rate of return on the grant date, expected dividend yield and expected volatility of the stock.

Using the information required by the SEC, the following three variables are defined to represent CEO compensation: 1. Basic compensation (BC): This includes salaries and bonuses earned by the CEO during a fiscal year.

Any payment not related to salary or annual bonus (for example, directors’ fees, insurance premiums) reported as cash compensation is excluded.

2. Total direct compensation (TDC): is defined as the sum of salary/bonus, option gains, and other long-term incentive compensation.



3. Option grants (PO): characterizes the compensation potential for future performance. The present value of option grants is used as a proxy for future compensation.

There is a wide variation in the three types of compensation between companies across industries and within the same industry (See Table 2). This paper explores potential reasons for the magnitude and direction of the variation, based on firm specific factors.

Corporate performance, as measured by bottom-line earnings, normally is expected to be significantly associated with CEO compensation. However, certain components of earnings may be better able to explain CEO compensation for several reasons. First, the various components of earnings, namely, cash flows from operations, current accruals, and non-current accruals are differentially informative about underlying managerial actions. It also may be easier for the manager to manipulate some components of earnings than others. Second, the components of earnings are available to the shareholders at the end of each accounting period. The logical shareholder would prefer to use the more detailed information provided by the components of earnings, rather than just an overall measure. Further, anecdotal evidence (Mintz and Lazere, 1997) suggests that working capital measures are important in measuring managerial performance. To better explain the cross-sectional variations in compensation, other firm specific characteristics are used to test whether they possess explanatory power over and above earnings and components of earnings. 1. Sales: The primary source of income for corporations is revenue from sales. Major strategic decisions

as to the sales mix, sales price and geographic regions have to be made to maximize sales revenue. Decisions are made at the planning stage, requiring the input of the top executives. Therefore, sales should play an important factor in determining compensation. Sales is also used as a proxy for the size of a corporation. Large corporations may be willing to pay more for their CEO’s performance, and may have more resources to pay larger salaries and bonuses.

2. Earnings: The major focal point of investors and other users of financial statements is bottom-line earnings. There is a large body of research indicating that stock prices respond to earnings numbers. Managers are under tremendous pressure to report high earnings every quarter and every year. Compensation packages are linked to company performance measured in terms of earnings and stock prices. The higher the earnings of a corporation, the larger is the compensation received by the managers.

3. Return on Assets: Ratio analysis can provide indications of underlying conditions that may not be apparent from inspection of the individual components of the financial statement. An overall measure of profitability is the return on assets ratio. A high ratio may attest to commendable financial performance, and therefore lead to higher compensation.

Apart from earnings and its components, executives are also evaluated on their ability to manage cash and working capital (Natarajan, 1996). Recovering cash from working capital (inventories and receivables) can signal positive financial performance, and therefore shareholder value. The following measures are used to link working capital management to CEO compensation: 4. Cash Conversion Efficiency: Cash flow from operations divided by sales. Measures how well

companies transform revenues into cash flows. High cash conversion efficiency is related to high corporate performance, and therefore, high rewards.

5. Days of Working Capital: Receivables plus inventory less payables divided by sales, divided by 365 days. This ratio denotes the ability of a corporation to turn its working capital into revenues. Fewer days of working capital reflect high efficiency, and therefore high rewards.

Other firm specific characteristics which might account for variations in CEO pay include: 6. Changes in Stock Price: Agency theory suggests that managerial compensation should be tied to a

specified gauge of financial performance. One such target used in compensation packages is the stock price of a corporation. The stock market responds to exceptional performance with increases in stock prices. High levels of performance should lead to higher compensation.

7. Price Earnings Ratio: The price earnings ratio reflects the investors’ assessment of the company’s future earnings and growth potential. Consistently high prospects of growth and earnings should be compensated with high levels of pay.

8. Leverage: Apart from working capital management, long-term financial management is also an indicator of good fiscal performance. An optimal combination of debt and equity is necessary for long-term growth and stability. Leverage, as measured by the debt/equity ratio, plays an important role



in managerial performance. The variables used in the regression model and the hypothesized direction of the relationships between the dependent and independent variables are shown in Table 3.

TABLE 3 VARIABLES USED IN THE REGRESSION

DEPENDENT VARIABLE MEASUREMENT HYPOTHESIZED DIRECTION 1. Basic Salaries and Bonuses Compensation (BC) Given to CEOs in 1996 2. Total Direct Salaries, Bonuses, and Compensation (TDC) Option Gains in 1996 3. Present Value of Options (PO) Present Value of Stock Options Granted in 1996 INDEPENDENT VARIABLES:

1. Sales Net Sales in 1996 + 2. Earnings Net Income in 1996 + 3. Return on Assets Net Income/Avg. Assets + 4. Cash Conversion Efficiency Cash Flow from Operations/ Sales + 5. Days Working Capital (Receivables + Inventory - Payables)/

Sales/ 365 -

6. Changes in Stock Price (Dec. 1996) - + Stock Price Stock Price Jan. 1996) - 7. Price Earnings Stock Price/EPS + 8. Leverage Debt/Equity -

Executive pay and the economic characteristics of the firm are then combined in three sets of

regressions. In each case, a variation of executive pay is the dependent variable. The hypothesized determinants of executive pay are the independent variables. BC = β0 + β1 Sales + β2 Earn + β3 ROA + β4 CCE + β5 DWC + β6 CSP

+ β7 PE + β8 DE + ε (1) TDC = β0 + β1 Sales + β2 Earn + β3 ROA + β4 CCE + β5 DWC + β6 CSP

+ β7 PE + β8 DE + ε (2) PO = β0 + β1 Sales + β2 Earn + β3 ROA + β4 CCE + β5 DWC + β6 CSP

+ β7 PE + β8 DE + ε (3) Where: BC = Salary plus bonuses (basic compensation) TDC = Total direct compensation (basic compensation plus stock option gains) PO = Present value of stock option grants Sales = Sales of the firm for the current year Earn = Net income for the current year ROA = Return on assets CCE = Cash conversion efficiency



DWC = Days in working capital CSP = Change in price of common stock during the year PE = Price earnings ratio DE = Leverage as measured by the debt-equity ratio.

The regression models are run to assess the effect of firm specific characteristics on the compensation received by executive management. BC and TDC represent rewards for past performance, while PO represents potential compensation for future performance.

SAMPLE SELECTION

CEO compensation data for this study were collected from the Wall Street Journal survey for the year 1996. The WSJ survey provided information about cash compensation, as well as stock option gains and the present value of option grants. Initially, 348 firms were selected for the study. Firms were deleted because: a. Data for the present value of option grants were not available. The main focus of this paper is to

combine cash compensation and option grants to obtain an extensive measure of compensation. The option values, required by SFAS 123, is necessary for extending this analysis beyond direct cash compensation.

b. Data necessary for the multiple regression model were not available. The final sample consists of 263 firms across eight industry classifications. The industry composition is dominated by cyclical firms and Technology companies. Energy companies have the smallest representation, followed by Basic Materials. A large number of financial companies also provided option data in their financial statements. Most of the companies chose footnote disclosure, rather than inclusion in their financial statements.

TABLE 4

INDUSTRY CLASSIFICATION INDUSTRY N0. OF FIRMS

Energy 20 Basic Materials 22 Industrial 44 Cyclical 51 Non-cyclical 47 Technology 53 Financial 31 Utilities 14 Total 263

Average basic compensation for the companies in the sample is $ 2.1 million, with a maximum of $ 6 million and a minimum of $ 562,000. The compensation varies widely between companies, with a standard deviation of $ 1.4 million. Total direct compensation shows an average of $ 4.5 million, with a median figure of $ 2.6 million, and a standard deviation of $ 5.5 million. The present value of option grants has a maximum value of $ 17 million and a minimum of $ 0.

TABLE 5 DESCRIPTIVE STATISTICS OF THE SAMPLE

DESCRIPTION MEAN MEDIAN STD. DEV. MAXIMUM MINIMUM 1. Basic Compensation 2115.52 1681.35 1452.11 6300 562.6 2. Total Direct Compensation($000s)

4554.68 2613.2 5559.23 27620.6 562.6

3. Present Value of Stock Options ($000s) 3031.2 1407.1 4293.14 17286.9 0



4. Net Sales 24,743 11,364 31,225 131,543 2,364 5. Earnings per share 1.53 1.12 2.44 6.82 -3.91 6. ROA .06 .07 .0506 .22 -.01 7. CCE .15 .14 .097 .43 .02 8. DWC 103.81 29.29 225.22 1029.7 -14.62 9. CPE 52.55 46 21.183 89.44 16.19 10. PE Ratio 19.2 15.6 14.347 58.6 1.36 11. Leverage .67 .51 .63 3.12 .01

The average net sales of these companies is $ 24 billion, with sales ranging from $ 131 billion to $ 2.3 billion. Earnings per share average $1.53, with a high of $6.82 and a low of $-3.91. The highest ROA is 22% with a mean of 6% and median of 7%. Cash conversion efficiency has a mean of 15% and a median of 14%. Maximum CCE is 43% and minimum is 2%. Days working capital (DWC) has a mean of 104 and a median of 29. The common stock price change during 1996 averages $53, with a high of $89 and a low of $16. PE ratio has a maximum of 59 and a minimum of 1.36, with a standard deviation of 14.3. Leverage ranges from 312% to 1%, with a mean of 67%. As with the CEO compensation, there seems to be a wide range of performance levels.

RESULTS AND CONCLUSIONS

The first set of regressions uses Basic Compensation (BC) as the dependent variable. The firm specific factors are able to explain 57% of the variation in salaries and bonuses (the regression has an R2 of 57%, with an F value significant at the .07 level). The predominant independent variable is Sales, which is significant at the .001 level (See Table 6).

TABLE 6 REGRESSION RESULTS

DEPENDENT VARIABLE BASIC TOTAL DIRECT PRESENT VALUE COMPENSATION COMPENSATION OF OPTION GRANTS ADJUSTED R-SQ. 57% 68% 51% F-VALUE 0.07 0.003 0.1 INDEPENDENT VARIABLES: [P-VALUES] SALES 3.1126 [.001] 21.54 [0.001] 7.32 [0.01] EARNINGS 23.58 [0.01] 48.29 [0.01] 264.58 [0.42] RETURN ON ASSETS 19.83 [0.80] 157.77 [0.48] 94.14 [0.67] CASH CONVERSION EFFICIENCY 2749.71 [0.20] 16.527 [0.01] 29.73 [0.75] DAYS WORKING CAPITAL -1.87 [0.01] -9.501 [0.01] -0.924 [0.81] CHANGES IN STOCK PRICE 13.147 [0.53] 25.64 [0.48] 48.29 [0.05] PRICE EARNINGS RATIO 20.64 [0.41] 86.23 [0.05] 81.49 [0.05] LEVERAGE -39.95 [0.10] -76.56 [0.05] -21.93 [0.05]

Bottom-line earnings (EARN), growth potential of the company (PE) and the efficiency of the CEO in managing working capital (DWC) also showed significance at the .01 level. Leverage (DE) was



significant at the .10 level. These results indicate that sales productivity, earnings performance and short-term/long-term financial management and stability play an important role in determining the cash compensation of CEOs. Next, the dependent variable TDC (salaries, bonuses and stock option gains) is regressed against the economic factors hypothesized to influence compensation. The results are robust, with an R2 of 68%, where the F-value was significant at the .003 level. Once again, Sales is the most crucial factor, showing a significance of .0001. Earnings and short term capital management (DWC and CCE) are significant at the .01 level. Finally, leverage (DE) and growth potential (PE) are also significant at the .05 level. Overall, the results of the first two regressions imply that the size of the firm (as a proxy for Sales), the competence of the CEO in managing short-term and long-term financing (CCE,DWC, and DE), as well as the perception of the stock market as to the growth potential of the firm (PE) seem to be the chief factors in determining the levels of compensation received by the top executives.

The final regression uses the present value of options granted (PO) as the dependent variable. As discussed earlier, this variable represents the potential compensation for future performance. The regression has an R2 of 51%, with an F-value significant at the .10 level. Once again, Sales is the most significant factor, with a significance level of .01. None of the short term variables, such as earnings, DWC, CCE or ROA shows any significance. Future growth potential (PE), change in stock price during the year (CSP) and leverage (DE), which represent long-term stability and financial management, are significant at the .05 level. Long-term growth and stability seem to be the critical factors in explaining future compensation.

In conclusion, Sales is the most substantial factor in determining current as well as future levels of compensation. The predominance of Sales could mean two things. As a proxy for size and, by extension, complexity, larger corporations could be paying more to their CEOs because of the sheer size of the companies that need to be managed. The emphasis on Sales could also explain some of the unacceptable practices used by companies to boost their sales figures without an actual transfer of ownership (for example, some companies ship products to their warehouses and book the shipping as sales). Current compensation is explained by a company’s earnings performance and the efficiency of the CEO in managing working capital, while long term factors like stock price, growth and financial stability show greater significance for future compensation levels.



REFERENCES Antle, Rick, and Abbie J. Smith. 1985. Measuring executive compensation: Methods and an application. Journal of Accounting Research 23, Spring, 296-325. Dechow, Patricia, Mark Huson, and Richard G. Sloan. 1994. The effect of restructuring charges on executives’ cash compensation. The Accounting Review 69, January, 138-156. Healy,Paul, 1985. The effect of bonus schemes on accounting decisions. Journal of Accounting and Economics 7, 85-107. Kumar,Krishina R, Dimitrios C. Ghicas, and Victor C. Pastena. 1993. Earnings, cash flows and executive compensation: An explanatory analysis. Managerial Finance 19(2), 55-75. Lambert, Richard and David Larcker. 1987. An analysis of the use of accounting and market measures of performance in executive compensation contracts. Journal of Accounting Research 25 (Supplement): 85-125. Mintz,S.L., and Cathy Lazere. 1997. Inside the corporate cash machine. CFO June 1997: 54-68. Natarajan,Ramachandran. 1996. Stewardship value of earnings components: Additional evidence on the determinants of executive compensation. The Accounting Review 71 (January): 1-22. New York Times. 1997. Executive pay increases at a much faster rate than corporate revenues. September 2, 1997. Sloan,Richard G. 1993. Accounting earnings and top executive compensation. Journal of Accounting and Economics 16 (January/April/July): 55-100. Wall Street Journal. 1997. CEOs are stars now, but why? And would Alfred Sloan approve? September 3, 1997. Wall Street Journal. 1997. Coming clean on company stock options. June 26, 1997. Wall Street Journal. 1997. Executive pay survey. April 10, 1997.



DETERMINING FACTORS IN THE STUDENT DECISIONS TO CHANGE MAJORS IN COLLEGES

OF BUSINESS

Finch, Beth Southern University, Baton Rouge

[email protected]

Moss, Gisele Lamar University [email protected]

ABSTRACT

The number of degrees granted by colleges of business has been in a steady decline since the early

1990s (AACSB, 1999). Accounting programs have traditionally been the largest among the alternatives in business, but the number of business students selecting majors in Accounting has also followed a downward pattern (CPA, 1994). Administrators and faculty are attempting to find out why students are turning away from business majors and accounting programs, in particular. This research project was designed to evaluate the factors that enter into a business student’s decision to change majors.

In order to examine a maximum number of variables, two university populations were used. Southeastern Louisiana University, with a predominantly majority race student population and Southern University, Baton Rouge, with a predominantly African-American student population. Surveys were conducted in Business Policy, Advanced Accounting and Managerial Accounting classes. These classes were selected to encompass the maximum number of junior and senior business and accounting majors.

One hundred and sixty-one surveys were completed and analyzed. The two most significant majors in the survey were management and accounting (41.6 percent and 29.8 percent respectively). Other majors included economics, finance, marketing and business administration. Of these, 55.3 percent had changed their major at least once in their college career. The mean number of times that participants had changed their major was 1.35. The maximum number of changes by one student was four.

As hypothesized, the major that was most frequently changed was accounting, with 21.2 percent of the participants indicating that they left an accounting major for another. Engineering was the second most often indicated (10.6 percent) as major area that was left for a business major with general studies and nursing tied for third place (9.4 percent). The most frequently cited reason for switching majors was “didn’t enjoy the old major” (45 percent). “Better opportunities” was cited 16.3 percent.

Ninety-four percent indicated that they were now satisfied with their major, but many indicated that there were a few things that they would do differently. Fifty percent said they would study more or be more diligent about classwork. Twenty-one percent said that they would have changed their beginning major and nineteen percent said that they would have scheduled things better. Other statistical testing reveals correlation between race and university as well as changing majors. These results and others are more fully explored in the body of the paper.

This information should be useful to all individuals that are involved in advising students in their selection of majors. An appropriate selection of major early in a student’s academic career may save a lot of time and effort for the student. Knowing that students make well-planned decisions in their degree programs will also benefit departments and universities as well.



DISCLOSURE OF ETHICAL ISSUES: PHARMACEUTICAL COMPANIES UNDER

SCRUTINY

Evelyn C. Hume University of Texas-Pan American

Aileen Smith

Steven F. Austin State University

Violet Rogers Steven F. Austin State University

INTRODUCTION AND REVIEW OF LITERATURE

In recent years, the trend among publicly traded corporations has been toward the use of annual report as an opportunity for conveying information beyond that contained in the balance sheet, income statement, and statement of cash flows. Companies are required to comply with a plethora of regulations requiring social responsibility and good environmental stewardship. The degree to which companies must report on their levels of compliance in the annual reports, however, is limited. Nevertheless, a growing number of companies voluntarily include a discussion of their ethical and/or environmental practices in their reports to shareholders. Schiff and May (1991) report that during the years 1985-1990, almost one half of the 25 largest industrial companies in the Fortune 500 included some information on the companies’ ethical policies and practices. Investors and society continue to increase pressure on corporation to exhibit accountability for social and environmental actions. In response, many companies now include statements in their annual reports which relate to social awareness and concern for the planet. Companies have begun to recognize that ethical responsibility is good business. Many investors show their regard for the environment and social issues by incorporating those concerns into their investment decisions. This interest in corporate social responsibility is evidenced by the number of mutual funds which bill themselves as “socially responsible.” Brooks (1989) notes an increase in corporate awareness of the need to shift some attention from short-term profit maximization toward corporate responsibility. In fact, Anderson and Frankle (1980) show that companies that report on ethical issues outperform those that do not disclose such information. Epstein, McEwen, and Spindle (1994) surveyed investors to determine their levels of preference for ethical practices compared to their levels of desire for profits. They found that a majority of the respondents preferred ethical behavior at the risk of profitability. Their study further found that a large majority (72%) supported ethics reporting, and an even larger number (82%) would like for companies to include information specifically on environmental issues. Gamble, Hsu, Kite, and Radtke (1995) investigated the quality of environmental disclosure in 10K and annual reports in 12 industries over a period of five years (1986-1991.) Their study showed that, overall, the quality of disclosure was low. However, the quality of disclosure was higher in the later years of the study than in the earlier years, indicating an upward trend in environmental reporting. Ethical disclosures may be in the form of communications presented in the CEO letter or other public relations sections of the annual report, accounting related footnotes to the financial statements, or comments contained in the Management’s Discussion and Analysis. Rogers (1996) conducted a study in which she investigated the change in the level of ethical and environmental reporting by Oil and Gas Companies over time. She compared the degree of reporting on social responsibility issues in 1993 to 1984. The study made a separate examination of financial statement disclosure of ethical and environmental issues and those disclosed in other sections of the annual reports.



Rogers found that both financial and non financial environmental disclosures increased from 1984 to 1993. Also, non-financial disclosure increased over the same time span. However, for the Oil and Gas industry, disclosure of ethical issues did not increase in the financial statement section of the annual reports. This study examines ethical and environmental reporting practices of pharmaceutical companies. The pharmaceutical industry is of interest because of hazardous wastes generated in the production of their products. Another concern expressed by some groups relates to the testing methods used by the industry. This study investigates the types of social responsibility disclosure contained in the annual reports of publicly traded pharmaceutical companies. Social responsibility issues may be related to ethical or environmental concerns.

DATA AND ANALYSIS

Annual reports for this study were obtained by writing to the public relations officer of the 12 Companies classified by Fortune 500 as Pharmaceutical companies. The letters were mailed out in mid-1999 requesting annual reports for the two most recent years, 1997 and 1998. Nine companies responded by sending annual reports for both years. Following Rogers (1996), reports of social responsibility issues were identified and categorized as to ethical or environmental. Social responsibility statements in the annual reports were further classified grouped by type. Statements include those relating to environmental matters such as the clean up toxic wastes, the current policies for disposal of hazardous materials, the minimization of the use of toxic substances, expenditures for pollution control, and natural resource conservation. Statements on social issues are those related to health and safety policies, drug testing policies, disaster relief efforts, and education. Annual reports from a cross section of industries were reviewed to identify types of ethical and environmental statements that one might expect to find in annual reports. A word count of the statements on ethical issues and environmental issues was made. A matrix was developed to track whether the statements were a part of the financial report or from other sections of the annual report. The examination of the annual reports was made twice, once by a graduate assistant and again by one of the major researchers. The word count for each company was combined for an overall measure of reporting by the industry. A comparison of the two years and the percent change is provided in tabular form. The sign in parentheses indicates whether the change is an increase (+) or a decrease (-). No percentage change is calculated for the type of statement if the number for either year is zero. Table 1 reports the total number of words used in each type of ethical disclosure in the financial portion of the annual reports by year and the percent change. The two types of social responsibility statements contained in the financial reports are “Emphasizes employee health and safety” and those related to retirement plans and benefits. The number of words devoted to the discussion of health and safety of employees increased by 13.6 percent. The discussion of retirement plans and post retirement benefits increased by 91.7 percent.

Table 1 Ethical Statements from Financial Reports Sections of the Annual Report

Type of Ethical Statements 1997 1998 Change Seeks to preserve the environments 0 0 Recognizes that employees are important 0 0 Portrays the company as a good corporate citizen 0 0 Emphasizes employee health and safety 103 117 (+)

13.6% Devoted to improving standards of living in communities 0 0 Devoted to improving quality of life 0 0 Values human diversity 0 0 Supports education by working with local schools 0 0 Retirement plans and post retirement benefits 786 1,507 (+) 91.7%



Table 2 reports the total number of words used in each type of environmental disclosure in the financial portion of the annual reports by year and the percent change. The reports of environmental issues and the environmental responses showed the greatest increases in words from 1987 to 1988 (206.9 percent and 106.3 percent respectively.) Discussions on environmental audits compliance costs fell to zero in 1998, as did comments on compliance costs.

Table 2

Environmental Statements from Financial Reports Sections of the Annual Report

Type of Environmental Statement 1997 1998

Change Reports environmental issues 130 399 (+) 206.9% Environmental response 608 1,254 (+) 106.3% Environmental assessment/audit and remedial action 269 0 (-) Discusses environmental compliance costs 90 0 (-) Accounting treatment of environmental costs 0 0 Evolvement in environmental leadership 0 0 Encourages recycling 0 0 Has a formal risk management program 0 0 The total number of words used in each type of ethical disclosure in the non financial portion of the annual reports is presented in Table 3 by year and percent change. The reporting on seven types of disclosure increase in 1998 over 1997, with the largest percentage increase being in the areas of employee health and safety. The reporting fell to zero on two items.

Table 3 Ethical Statements from Non Financial Reports Sections of the Annual Report

Type of Ethical Statements 1997 1998

Change Seeks to preserve the environments 14 35 (+) 150.0% Recognizes that employees are important 194 361 (+) 86.1% Portrays the company as a good corporate citizen 14 80 (+) 471.4% Emphasizes employee health and safety 61 674 (+) 1,004.9% Devoted to improving standards of living in communities 22 99 (+) 350.0% Values human diversity 88 136 (+) 54.5% Supports education by working with local schools 89 12 (-) 86.5% Donations for worldwide efforts 0 72 (+) Sponsors of cultural exhibition/events 49 0 (-) The total number of words used in each type of ethical disclosure in the non financial portion of the annual reports is presented in Table 3 by year and percent change. Non financial reporting increased on “Environmental assessment/audit and remedial action” by 66.7 percent. The number of words used in reporting on all other types of environmental topics fell or remained at zero from 1997 to 1998.



Table 4

Environmental Statements from Non Financial Reports Sections of the Annual Report Type of Environmental Statement 1997 1998

Change Environmental tasks 106 53 (-) 50.0% Environmental assessment/audit and remedial action 21 35 (+) 66.7% Discusses environmental compliance costs 0 0 Accounting treatment of environmental costs 0 0 Evolvement in environmental leadership 51 0 (-)

Encourages recycling 14 0 (-) Has a formal risk management program 0 0

CONCLUSION The research shows that pharmaceutical companies have added a new dimension to their annual reports. These reports to stockholders are used by some companies to convey that their goals have moved beyond the sole objective of maximizing of shareholder wealth and now include corporate responsibility. While the greatest amount of increase is in ethical reporting in the non financial section of the annual report, increases are also observed in ethical reporting in the financial sections. Reporting on environmental issues can be found in both areas of the annual report.



REFERENCES

Anderson J. and A. Frankle (1980) “Voluntary Social Reporting: An Iso Beta Portfolio Analysis,” The Accounting Review, 55 (July), 467-479.

Brooks, L.J. (1989), “Corporate Ethical Performance: Trends, Forecasts and Outlooks,” Journal of

Business Ethics, 8, 31-38. Epstein, J.J., R.A. McEwen and R.M. Spindle. (1994) “Shareholder Preferences Concerning Corporate

Ethical Performance,” Journal of Business Ethics, 13, 447-453. Rogers, V. (1996). “ Ethical Statements Contained Within Annual Reports: An analysis of the Oil and Gas

Industry,” Journal of Accounting and Finance Research, Summer, 39-48. Schiff, J.B. and C. B. May. (1991). “Are management Reports on Financial Statement Responsibility Useful?” Management Accounting, September, 41-46.



DOES CULTURE OR PERSONALITY TRAIT INFLUENCE CAREER CHOICES, A STUDY OF

VENEZUELA, UNITED KINGDOM AND UNITED STATES PROFESSIONAL ACCOUNTANTS

Laribee, Stephen

Eastern Illinois University [email protected]

ABSTRACT

This paper presents the findings of a research study of the personality traits of professional accountants from two disparate Spanish and English speaking cultures. This study is specifically concerned with the relationship between Myers-Briggs Type Indicator (MBTI) personality characteristics and individuals who have chosen accounting as their professional career. The MBTI is not a measure of skills or abilities. It looks at four personality preferences that everybody supposedly uses at different times. These preferences are not a measure of excellence; rather, they are an indication of the type of environment in which we feel most comfortable and work best. The theoretical background to the measure of personality in this study is derived from the theoretical work of Carl Jung. Jung believed he was describing mental processes common to the entire human species. To the extent that he was correct, type differences should be consistent across cultures.

INTRODUCTION

Professional accountants seem to have strong stereotypes associated with them. Researchers who have studied this issue (Arayana, Meir & Bar-Ilan, 1978; Bedeian, Mossholder, Touliatos & Barkman, 1986; DeCoster & Rhode, 1971; Granleese & Barrett, 1990; Imada, Fletcher & Dalessio, 1980) have found the following stereotypic descriptors being applied to accountants: conforming, conservative, stable, restrained, unsociable, conscientious, sober, introverted, uncreative, poorly developed sense of aesthetics, precise, exact, detailed, perfectionist, likes certainty, practical, persevering and ambitious. The question this study will explore is: personality traits of professional accountants play an important role beyond the existence of an accounting stereotype and do they remain constant between Spanish and English speaking cultures.

METHODOLOGY The test instrument used in this study is the widely used Myers-Briggs Type Indicator (MBTI). Based upon Carl Jung’s theory of psychological types, it is an effort to determine how individuals seek out, perceive, and evaluate information. Jung’s psychological type theory proposed that starting in childhood, one develops a preference to using certain mental abilities and continues throughout life to the point that certain functions and attitudes will become more developed and thus dominate. Jung believed he was describing mental processes common to the entire human species. To the extent that he was correct, type differences should be consistent across cultures.

The MBTI is not a measure of skills or abilities but centers about four contrasting pairs of psychological preferences: Extraversion versus Introversion, Sensing versus Intuition, Thinking versus Feeling, and Judging versus Perceiving. These four sets of preferences combine to form 16 distinct personality types. These preferences have been applied to the work environment by using the following distinctions (Myers and McCaulley, 1985).

1. Extraversion (E) and Introversion (I): E-type persons have interests flowing mainly to the outer world of actions, objects and persons. They work interactively with a variety of people. I-



type persons, on the other hand, have interest flowing mainly to the inner world of solitude and ideas. They like work that allows some privacy and time for concentration.

2. Sensing (S) and Intuition (N): S-type persons prefer to perceive the immediate, real, practical facts of experience and life. They enjoy work that requires attention to detail and careful observation. N-type persons, though, prefer the possibilities, relationships, and meanings of experiences. They like work that provides a succession of new problems to be solved.

3. Thinking (T) and Feeling (F): T-type persons prefer making judgments or decisions objectively, and impersonally, and considering causes of events and where decisions may lead. They enjoy work that requires logical order, especially with ideas or numbers. F-type persons, however, would rather make judgments or decisions subjectively and personally, weighing values of choices and how they matter to others. F-type persons prefer work that provides service to people and a harmonious and appreciative work environment.

4. Judging (J) and Perceiving (P): J-type persons most want to live in a decisive, planned, and orderly way, aiming to regulate and control events. They like work that imposes a need for system and order. But P-type persons prefer living in a spontaneous, flexible way, aiming to understand life and adapt to it. They like work where understanding situations is more important than managing them.

All of us, of course, possess elements of each personality type, but normally prefer one of each contrasting psychological preferences to the other. At the same time, we neither ignore nor eliminate the other preference; it is simply submissive to the stronger, preferred type.

Scarbrough (1993) research found that there is a strong relationship between Personality Type and accountant’s career satisfaction. The Personality Type of United States professional accountants has been studied in some detail by Jacoby (1981); Kreiser, KcKeon, & Post (1990); and Otte (1983). For the purpose of this study, their data have been combined for a base group of United States accountants. Shackleton (1980) studied the Personality Type of United Kingdom professional accountants. All the previous studies were done on English speaking accountants, as the MBTI was English only. It is now available in Spanish, which allows us to give it to a group of Venezuela professional accountants.

DATA ANALYSIS

The data were analyzed using the CAPT Selection Ratio Type Table PC Program (Granade, Hatfield, Smith, & Beasley, 1987). This allowed us to see if there were any significantly differences in Personality Type between professional accountants from the United States, United Kingdom, and Venezuela. Table 1 shows the percentage of each group’s preferences for the difference type components. There were no significance differences between the accountants from the United States and the United Kingdom in their preference. This was not unexpected as they both have a similar culture. The following is an analysis of each set of type component. The English-speaking accountants seem to somewhat fit the stereotype that they are Introverts as a slight majority have the Introversions preferences. Within the MBTI community, there is disagreement as to what percentage of the world’s population have these preferences, but the latest research suggests that the United States population is about 50 percent. Most people may think that accountants are Introverts because Extraverts tend to talk more and louder, but there is far more to Extraversion and Introversion than talkativeness. Professional accountants, by training and their code of ethics, must be careful what they say because of the confidential data they work with. The Venezuela accountants are significantly (p<.01) more Extroverted (68.6%). This may be a result of their culture, as there seems to be a strong bias toward Extraverts in their country. The second dimension of personality type is about the kind of information people notice. Sensors are people who trust what can be measured or documented and focus their attention on what is real and concrete. They are especially good at figures and remembering a great many facts. One can see that Sensors would be comfortable in the accounting world. Intuitives would rather trust their inspirations and hunches. They focus on implications and inferences. They work best at interpreting facts and seeing the consequences. They would be comfortable in the auditing or fraud investigation area. The English-speaking accountants are very similar to the United States population where the Intuitives are in the minority at 35%. The accountant with the Intuitive preference (5.9%) in Venezuela appears to be few in number and significantly different (p<.001) than found in the United States. The Venezuela professional



accountant does more bookkeeping and less auditing or fraud investigation for their clients as compared to the United State professional accountant. The Venezuela accountant with the Sensing preference would be more comfortable with the work of his profession.

TABLE 1

Percentage of Professional Accountants by MBTI Type Components

United States

N=913

United

Kingdom N=91

Venezuela

N=51

E (Extroversion) I (Introversion)

46.3 53.7

41.8 58.2

68.6** 31.4**

S (Sensing) N (Intuition)

60.7 39.3

65.9 34.1

94.1*** 5.9***

T (Thinking) F (Feeling)

74.3 25.7

65.9 34.1

100.0*** 0.0***

J (Judging) P (Perceptive)

74.0 26.0

68.1 31.9

88.2* 11.8*

*p<.05 **p<.01 ***p<.001

The third dimension of Personality Type concerns the way in which we make decisions and come to conclusions. Thinkers are objective and analytical in their decision-making. They are motivated by a desire for achievement and accomplishment. Because Thinkers prefer decisions that make sense logically, they should feel at home in the field of accounting. Feelers, on the other hand, make decisions based upon what is important to them and others. Their priorities are different than Thinkers because of their empathetic and compassion. Unlike the Thinkers, they are motivated by a desire to be appreciated. In the United States about two thirds of men prefer Thinking and two thirds of the women prefer Feeling. Socialization may have some influence on this preference. The Venezuela accountants all preferred Thinking even though there were 21 women in this group. This is a very significance (p<.001) difference between the two cultures. The last dimension of Personality Type concerns whether the accountants prefer to live in a more structured way (making decisions) or in a more spontaneous way (taking in information). The people who prefer Judging like their lives structured and matters settled. They experience tension until closure is reached and are constantly drawn toward making a decision. They are comfortable in a business environment where setting and meeting deadlines are important. Perceiver’s behavior is just the opposite of the Judgers. They experience tension when they are forced to make a decision; they avoid closure and prefer to keep their options open. One can see that the Perceiver may not be comfortable in the accountant’s world. Many of the accountants have the Judging preference with the Venezuela having significance (p<.05) more. In the United States population, about 60 percent are Judgers and 40 percent are Perceivers.



The above four separate dimensions of Personality Type, each bi-polar, will give 16 discrete Personality Types possible as shown in Table 2. You will note that the United State accountants are represented in all 16 types, but not equally. Again, we found that there are no significance differences between the United State and the United Kingdom accountants. The Venezuela accountants were represented in only six of the indices, but as a group they only had significance differences in two types, ESTJ (56.9%, p<.001) and INFP (7.8%, p<.05).

TABLE 2

Percentage of Professional Accountants by MBTI Types

United States

N=913

United

Kingdom N=91

Venezuela

N=51

ISTJ ESTJ INTJ ENTJ ENTP ISFJ ESFJ INTP ISTP ENFP ENFJ INFP ESTP INFJ ISFP ESFP STJ

24.1 16.9

8.8 8.2 5.8 5.7 4.4 4.2 3.8 3.7 3.7 2.6 2.5 2.3 2.2 1.1

41.0

25.3 13.2

4.4 5.5 4.4 9.9 6.6 4.4 4.4 5.5 2.2 6.6 4.4 1.1 2.2 0.0

38.5

25.5 56.9***

2.0 3.9 0.0 0.0 0.0 3.9 0.0 0.0 0.0 0.0

7.8* 0.0 0.0 0.0

82.4***

*p<.05 ***p<.001

What is of interest is that two types, ISTJ and ESTJ, represent the largest group of accountants from all three countries. The United States population is thought to have about 6% ISTJs and 13% ESTJs. For the accountants, ISTJ types are consistent as a percentage for all three countries. The percentages of ESTJs are similar between the United States and the United Kingdom, but significantly higher with the Venezuela accountants (56.9%, p<.001). The accountants with the Sensing, Thinking and Judging (STJ) preference represent about 40% of English speaking accountants, but 82% of the Venezuela accountants which is significantly higher (p<.001).

DISCUSSION

This study set out to determine if personality traits of professional accountants play an important role in who chooses this career and if so, do the traits remain constant between cultures. The studies on English and Spanish speaking professional accountants found that all Personality Type can be found, but



there is one distinct Personality Type. The accountant with the Sensing-Thinking-Judging (SJT) type is the most common type in both

cultures. In the United States, studies of CPA firms show that this is the Personality Type most likely to succeed in career advancement. Jacoby (1981) studied three national (Big Eight) CPA firms and found that 56% of the audit partners were STJs, whereas Otte (1983) studied twenty-four local CPA firms and discovered that 53% of the partners were STJs. The Venezuela CPAs were overwhelming STJs at 82%.

There may be a practical reason that the STJ type appears to be the dominant type in the accounting profession. The STJ accountants are very practical, results-oriented, precise and accurate in their work. They are good at remembering important facts and figures and can cite evidence to support their views. They like work that follows established procedures, where they can make decisions and are given a great deal of control and responsibilities. This description seems to fit the accounting stereotype.

Although the Venezuela professional accountants had significant differences to the English-speaking accountant, it was only because more of them had the dominant STJ Personality Type. This supports Carl Jung’s theory that the professional accountant’s Personality Type should be consistent across cultures. It appears that Personality Type is an important factor in individuals choosing the career of a professional accountant.



REFERENCES

Arayana, Barak, A. & Amernic (1981). “A Test of Holland’s Theory in a Population of Accountants.” Journal of Vocational Behavior, Volume Nineteen, 1981, 15-24. Bedeian, Mossholder, & Touliatos (1986). “The Accountants Stereotype: An Update for Vocational Counselors.” Career Development Quarterly, Volume Thirty-Five, Number Two, 1986. DeCoster, & Rhode (1971). “The Accountant’s Stereotype: Real or Imagined, Deserved or Unwarranted?” Accounting Review, Volume Forty-Six, 1971, 651-664. Granade, Hatfield, Smith, & Beasley (1987). The Selection Ratio Type Table PC Program. Gainesville, FL: Center for Applications of Psychological Type, 1987. Granleese and Barrett (1990). “The Social and Personality Characteristics of the Irish Chartered Accountant.” Personality and Individual Differences, Volume Eleven, Number Nine, 1990. Imada, Fletcher & Dalessio (1980). “Individual Correlates on an Occupational Stereotype: A

Reexamination of the Stereotype of Accountants.” Journal of Applied Psychology, Volume Sixty-Five, 1980, 436-439.

Jacoby (1981). “Psychological Types and Career Success in the Accounting Profession.” Research in Psychological Type, Volume Four, 1981, 24-27. Kreiser, McKeon, & Post (1990). “A Personality Profile of CPAs in Pubic Practice.” Ohio CPA Journal, Volume Forty-Nine, Winter 1990, 29-34. Myers and McCaulley (1985). Manual: A Guide to the Development and use of the Myers-Briggs Type Indicator, Consulting Psychologists Press, 1985. Otte (1983). Psychological Typology of the Local Firm Certified Public Accountant, Unpublished Doctoral Dissertation, Western Michigan University, Kalamazoo, Michigan, 1983. Scarbrough (1993). “Psychological Types and Job Satisfaction of Accountants.” Journal of Psychological Type, Volume Twenty-Five, 1993, 3-10. Shackleton (1980). “The Accountant Stereotype: Myth or Reality?” Accountancy, November 1980, 122- 123.



ELDERCARE ASSURANCE SERVICES: SHOULD A CPA FIRM IMPLEMENT THEM?

Walker, Edward R.

The University of Texas-Pan American [email protected]

ABSTRACT

ElderCare Assurance Services are designed to provide assurance that an elderly person’s financial and medical affairs are being properly managed. The CPA serves as a coordinator of services and provides assurance that care goals are being met. For some CPA firms, these services represent an opportunity to attract new clients. This paper presents a SWOT analysis that a CPA firm might consider when making the decision whether to offer ElderCare Assurance Services.

INTRODUCTION

ElderCare Assurance is a new form of assurance service that the AICPA is suggesting that CPA firms consider implementing. The AICPA Special Committee on ElderCare Assurance Services defined ElderCare as “a service designed to provide assurance to family members that care goals are achieved for elderly family members no longer able to be totally independent. . . . [t] he CPA [will serve] as the coordinator and assurer of quality of services based on the goals set by the customer” (AICPA, 1994).

The target for these services is the elderly person who needs help managing his or her financial affairs and/or obtaining health or other types of services. CPA Elder Care Assurance Services are classified into three categories: consulting services, where plans are formulated for the care of the individual and the delivery of services; direct services, where the CPA coordinates his efforts with those of other professionals such as attorneys and stockbrokers to provide hands-on assistance; and assurance services, where the CPA reports on the extent to which care-giving goals are being met. This includes periodic reporting on both financial transactions and the effectiveness and efficiency of care providers. In providing these services, the CPA firm must make every effort to preserve the appearance of independence and when preparing reports of financial transactions must conform to the SSARS relating to personal financial statements (Kaplan & Kaplan, 1998).

Given the increasing age of the population in the United States, it would appear that ElderCare Assurance would be an ideal way for a CPA firm to maintain or expand its client base. A limited study commissioned by the AICPA Special Committee on Assurance Services found that 89% of higher income Americans would be likely to use such services if necessary. The results also revealed that the presence of a specially accredited CPA would make more than half of these individuals more likely to use Elder Care Assurance Services (AICPA, 1996). The results of this study must be interpreted with caution, however, because the sample size was small and the annual income of the respondents was greater than $80,000.

In arriving at a decision to provide Elder Care Assurance Services, a CPA firm should use strategic planning to insure that all aspects of the decision have been adequately considered. A technique that is frequently used in this type of planning is a SWOT analysis, a description of strengths, weaknesses, opportunities, and threats that exist in an organization’s environment. Strengths and weaknesses are internal to the firm. A strength is a characteristic that gives a firm market advantage; a weakness is a characteristic that puts the firm at a disadvantage. Opportunities and threats exist in the external environment; these must be considered in conjunction with firm strengths and weaknesses (King & Cleland, 1989). Because a CPA firm has not only independence and objectivity as objectives, but profitability and market penetration as well, it is appropriate to use a SWOT analysis as a technique to aid in the decision to implement ElderCare Assurance. This paper presents an analysis of strengths, weaknesses, opportunities, and threats that a CPA firm should assess when deciding the extent to which ElderCare Assurance should be offered.



STRENGTHS Because a CPA firm has personnel who are experienced in financial management, it would be

fairly easy for a firm to begin offering extensive financial management services for elderly clients. For a CPA firm that has emphasized individual tax preparation and other assurance services, such as compilation and review, an existing client base could be maintained or even expanded to include more clients requiring personal financial planning. Such financial planning has become increasingly important due to the growing trend toward companies providing fewer post-retirement benefits and forcing individuals to assume more responsibility for managing their financial affairs (Roberto & Yardley, 1999). Offering these services could be conducive to optimal financial planning for clients both during their years of employment and in the years after retirement and eventually could evolve into asset management as the need arises.

Another strength is the reputation that public accounting profession has for integrity and objectivity. This reputation puts CPA firms in an ideal position to act as impartial professionals providing assurance that providers of services render these services in a desirable manner (Roberto & Yardley, 1999). The results of the above-mentioned AICPA study revealed that 52% of the participants would be more likely to use ElderCare Assurance services if a specially accredited CPA were involved (AICPA, 1996).

WEAKNESSES Some CPA firms may not fully understand the entire range of issues involved with the care of the elderly. Before offering ElderCare Assurance services, it is necessary for a CPA firm to be knowledgeable in a number of areas and also be able to work as a part of an interdisciplinary team with other professionals such as social workers, attorneys, and health-care providers. First, the CPA must have a general knowledge of the aging process and the network of services that are available to support the elderly. Additionally, he must also develop a thorough working knowledge of laws related to social security, Medicare, Medicaid and other public programs designed for the elderly. The CPA should also develop an understanding of regulations relating to nursing homes and other care facilities. Finally, he should understand elder abuse, specifically in the area of misuse of an elderly person’s financial resources. Some of these issues are complex and require considerable time and effort to fully comprehend. Even when working as a part of an interdisciplinary team, a CPA must still have a knowledge of these areas that is sufficient to allow him to attest to the quality of care that a client is receiving. These laws are in a constant state of change; therefore CPA firms offering Elder Care Assurance Services must be diligent in monitoring for these changes. Failure to do so could subject the CPA firm to give inaccurate advice and possible litigation by clients. The CPA firm should also make certain that their liability insurance covers Elder Care Assurance Services (Kaplan & Kaplan, 1998). In some CPA firms, there may be principals who do not wish to work with the needs of the elderly. The culture of a CPA firm depends largely on the personalities of its principals, some of whom prefer working with corporate clients and the accounting and auditing services associated with these clients. The CPA firm that provides Elder Care Assurance Services will have to have an interest in these issues and at least some principals who are able to relate well to elderly clients, some of whom may be experiencing loss of sight and/or hearing, and/or the caregivers of these clients. In most cases, when dealing with an elderly person, it is necessary to speak more slowly and explain issues more carefully to facilitate the client’s understanding (Kaplan & Kaplan, 1998).

Some CPA firms may not have the staff available to devote to this type of service. In a small CPA firm, it may be common for a few staff accountants to perform a wide variety of duties ranging from simple bank reconciliation to complex income tax returns. These firms typically have one or two principals that are responsible for reviewing the work of these staff accountants and attesting to its correctness. For CPA firms such as these, it could be very difficult to offer Elder Care Assurance Services, because of the time required to gain the necessary knowledge and develop the relationships with other professionals that are necessary for Elder Care Assurance Services to succeed. In some instances, it might be necessary to hire another staff accountant to handle these types of services; in the short run, this could result in a drain on firm profitability.

Elder Care Assurance Services may not be profitable for some firms that are dependent on services chargeable at high hourly rates to increase profit margins. Because most elderly clients are living on fixed incomes that will have to conserve their resources for a period of many years, the fees that can be



charged to these clients for Elder Care Assurance Services will likely also have to be fixed. Even if the CPA budgets a specific amount of time for a client, contentious issues relating to some aspect of a client’s care, such as questionable payments to a care provider, will require that additional non-chargeable time be spent resolving these issues. Delays such as these could create the need for overtime to complete all the jobs that a firm is working on. The end result could be an overall reduction in firm profitability. Some Elder Care Assurance Services may create independence issues. As with other forms of assurance, the CPA is bound by the Code of Professional Conduct to maintain an attitude of independence. This may be difficult when a CPA is involved in Elder Care Assurance Services, because he or she will become familiar with service providers in many areas and will likely develop personal preferences. Care must be taken not to allow these preferences to be made apparent in recommending services to clients or their caregivers. The safest approach to this is to refer the client to a professional with expertise in that area (such as a social worker) and/or provide a comprehensive list of care providers for the service that they are seeking.

OPPORTUNITIES

Elder Care Assurance Services can help the accounting profession adapt to a changing marketplace. Several factors are contributing to the ongoing change in the accounting profession. The increasing use of personal computers by small businesses has led to a decline in the need for management services such as preparation of payroll and general ledgers. Additionally, the advent of tax preparation software and electronic tax return filing has reduced some need for routine income tax preparation services. Finally, the population of the United States is aging. In 1994, one-eighth of the population was 65 years and over; by 2030, it is estimated that one-fifth of the population will be in that group. This fact, combined with the increased life span of people, implies that there is a growing market for Elder Care Assurance Services. Offering these services may give a CPA firm the opportunity to retain existing clients and expand their client base to include more elderly clients and/or caregivers for these clients. Elder Care Assurance Services may have the potential to improve care given to an elderly client. It is possible that if care providers are required to document the care goals for a client and are made aware that the client’s progress is being monitored and reported to family members by an outside party, it may force these providers to be more diligent in providing care. In the long run, the elderly client could benefit from more attention to his medical and social needs; ultimately this has the potential of keeping him or her healthy. For the CPA, this translates into an improved reputation for providing ElderCare Assurance and the potential for more clients of all types.

THREATS

While the CPA appears to be the ideal professional to coordinate and oversee ElderCare

Assurance, there are still environmental threats that must be addressed. To begin with, similar services are offered on both a formal and informal basis by other sources. The rates that are charged by these organizations and/or individuals may be lower than rates charged by a CPA firm for Elder Care Assurance Services.

Trust departments of many banks hold the assets of an individual in trust and disburse payments to care providers. In such a situation, the only contact with the client’s CPA occurs when the income tax returns for the client and the trust must be filed. For a trust department, the necessity of providing periodic reports of transactions to a CPA for assurance reporting may be greeted with resentment and for the client may actually be a duplication of services. When such a situation arises, it may be necessary to coordinate activities to eliminate the between the CPA firm and the trustee.

There are many financial planners who are not CPA’s and therefore cannot formally attest to either financial or non-financial matters. These individuals or organizations may be able to give advice on certain areas of financial management, but it is doubtful that they have either the breadth or depth knowledge to provide assurance on Elder Care Assurance Services. However, to many elderly people, the lack of formal assurance will be of less importance than the cost to them. Addressing this threat will require some skillful and tactful marketing on the part of the CPA to convince the client of the importance of the assurance service without implying any type of enhanced outcome.

Another potential threat lies in the potential for reduced fees as an elderly client’s assets dwindle.



The longer a person lives, the greater is the potential for assets to be reduced to the point where adjustments have to be made to expenses. A CPA firm could be faced with reductions in revenue in the long run if this occurs. Charging reasonable fees throughout the client’s engagement and continually marketing the services of the CPA firm to maintain or increase its client base may mitigate the potential dangers from such a threat.

The CPA firm must also deal with the possibility that some care providers may not readily accept the CPA as a provider of assurance services for the elderly. There may be a perception that the client is questioning the capabilities of the care provider, and this could create friction and a lack of cooperation. This type of problem can best be addressed by fully explaining the concept of ElderCare Assurance Services to care providers and emphasize that it is focused primarily on the overall care needs of the elderly client. Finally, there may be a mistrust of the CPA firm as a coordinator of assurance services. In the AICPA study, 28% of the respondents indicated that they would be less likely to use Elder Care Assurance Services if a CPA firm were involved. Further, the study indicated that only 19% of the respondents felt that a CPA would provide these services in a “very compassionate” manner (AICPA, 1996). Mistrust of the CPA firm may also come from family members who fear that the client’s assets are being exploited. Resolving these issues may be difficult; however, they emphasize the importance of having a long-standing relationship with a CPA that the client and his family are comfortable with and also maintaining independence in both fact and appearance. As in any fiduciary relationship, the CPA firm should not engage in financial transactions with the client and, if the situation arises, should emphasize that no bequests of client assets should be made to the CPA (Kaplan & Kaplan, 1998). The following table presents a summary of the strengths, weaknesses, opportunities, and threats discussed above.

Table 1 SWOT Analysis for Elder Care Assurance Services

Strengths (Internal) Opportunities (External)

Personnel experienced in financial management Gives CPA’s a means of staying viable in a changing marketplace

Reputation of CPA for integrity and objectivity May result in improved care for the elderly and an enhanced reputation for the coordinating CPA

Weaknesses (Internal) Threats (External) CPA’s lack of knowledge of laws relating to ElderCare

Competition from other sources

Principals who do not wish to work with elderly clients

Eventual reduction in fees as clients’ assets dwindle

Lack of available staff to perform these types of services

Lack of acceptance by care providers

Not profitable for firms who focus on chargeable hours

Mistrust of CPA by client and/or family members.

Some independence issues may be encountered

CONCLUSION

Providing ElderCare Assurance services is not something that every CPA firm should feel compelled to do. Before making a long-range commitment to offer these types of services, a firm must assess its overall mission, its competitive position within the local market, the composition of its existing client base, and the expertise and availability of its professional staff. The CPA firms ideally suited to provide these services seem to be the firms that have a genuine interest in offering ElderCare Assurance, an existing client base of individuals 40 or older with whom it has started financial planning, and CPA firms in areas with a high percentage of higher-income retirees. CPA firms that have traditionally focused on services to corporate clients such as audits and/or due diligence should consider carefully the benefits versus the costs of adding ElderCare Assurance to their existing services. Since ElderCare Assurance is being offered for the first time, it is not certain how successful it



will be. Therefore it will be necessary to do future research studies on the extent to which it is being offered by CPA firms as well as on how much it is being used by the elderly. It is possible that the SWOT analysis here will require revision after determining the extent to which ElderCare Assurance penetrates the market for financial services and affects the CPA profession.



REFERENCES

AICPA (1994). Special Committee on Assurance Services. AICPA Special Committee on Assurance Services (1996). Americans’ Attitudes Toward and Interest in

“Elder Care Assurance”. Kaplan & Kaplan (1998). CPA ElderCare: A Practitioner’s Resource Guide. Roberto & Yardley (1999). “Helping Clients Grow Old Gracefully.” Journal of Accountancy, Volume

187, Number 4, April 1999, 43-54. King & Cleland (1983). “Strategic Strength-Weakness Assessment.” Journal of Business Research,

Volume 11, Number 4, 475-487.



E-MAIL: ACCOUNTING STUDENTS HAVE A LOW-COST INTERNATIONAL EDUCATION

EXPERIENCE -- A REPORT ON AN EXPLORATORY PROJECT

Edwards, Wendell E., PhD, CPA

Texas A&M University-Commerce [email protected]

ABSTRACT

This paper gives the efforts and results of an exploratory study project to utilize the e-mail technology to enable managerial accounting students from a USA campus and a class from a Mexico campus to have a personal international experience. There has been an ongoing interest and effort to internationalize the Business and Accounting curriculum. There has been a critical concern to provide low-cost opportunities for Accounting students to have knowledge of and respect for persons from a different culture. With the "global village" concept of the economy and career fields, professionals must be prepared to work with professionals from a different culture. This project matched a student from one culture (USA) with a student from a different culture (Mexico) for the purpose of learning to communicate when the language, the culture, and the technology might be a challenge. The problems, benefits, and recommendations of the study are shared.

INTRODUCTION

There has been an ongoing interest and attempt to internationalize the Business and Accounting curriculum and provide low-cost opportunities for Accounting students to have educational and cultural appreciation experiences with persons from another country. The need for students to have an appreciation and respect for persons from a different culture and to be able to work with them has been heralded many times in the past and is now almost accepted without question. Most students do not have the financial resources to take advantage of extended stay opportunities to actually experience a different culture. Faculty members and students look for the next best alternative for international education experiences for financially disadvantaged students. There is a movement to encourage students to take advantage of opportunities to have an international education experience. This need for the international experience is shared by faculty members in countries around the world. Universities, even with limited resources, have tried to facilitate exchange and partnership programs for faculty and students. The use of e-mail as a low cost alternative for on-site international experiences has been considered.

PREVIOUS RESEARCH AND REPORTS

A search of previous research and publications (ERIC, 1999) relating to the use of e-mail in accounting education and related topics produced no previous research nor publications. There were studies indicating some use of e-mail to enhance the classroom experiences of students in other academic fields. The following is the result of that research.



Table I

Search of the Eric Ovid Web Database for Publications

Search Topic(s) Thru

all

years

1999

Jan –

Jun

1998 1997 1996 1995 1994 +

Earlier

E-Mail 1784 40 5321 487 .20 060 187

E-Mail and Education 1533 39 451 424 295 164 152

E-Mail and Business

Education

15 0 3 4 4 2 2

E-Mail and

Accounting

91 0 37 25 11 12 5

E-Mail and

Accounting Education

0 0 0 0 0 0 0

E-Mail and

International

182 6 60 49 26 20 21

E-Mail and

International

Education

29 2 9 13 2 2 1

E-Mail and

International Business

Education

1 0 1 0 0 0 0

It was thought that e-mail had enough promise to help accounting students that at least an exploratory study of its uses should be undertaken (Reiss, no date). It was noted there had been no publications on the use of e-mail in Accounting Education. Texas A&M University-Commerce (TAMU-C) had previously arranged for the Department Heads in the College of Business and other University officials to go to the Instituto Technologico y de Estudios Superiores de Monterrey (ITESM) in Mexico City. During this visit several "Monterrey Tech" Accounting faculty members were visited and there was discussion of ways to try to have international experiences for the faculty as well as the students. It was an encouraging and challenging time together. It was agreed that the two Departments of Accounting would explore different ways to bring this exchange and cultural interaction into reality. Professor Wendell Edwards (TAMU-C) and Soraya Cruz (ITESM) started e-mail exchanges attempting to design and develop a beginning program whereby one student at ITESM and one student at



TAMU-Commerce would be paired together as partners in an e-mail project as a part of the Managerial Accounting course. Since the semester had already started, the course requirements and procedures had been given to the students. Experience revealed to us that the late start was a serious problem. All of the problems and "opportunities" had not been anticipated. The students were administered a questionnaire in English for the TAMU-Commerce students and in Spanish for the ITESM students (Edwards, 1998). The questionnaire obtained information about the interests of the students, e-mail utilization, training in a language other than their first language, previous travel, and interest in international educational experiences. The following are selected results that support the effort to try to use e-mail to help Accounting students to have at least some exposure to international influences.

Table II It is Important to Gain an Appreciation of the International Influence in Their Lives

Yes No

TAMU-Commerce Students 71% 29%

ITESM Students 100% 0%

It is seen in Table II that 100 percent of the ITESM students and 71 percent of the TAMU-Commerce students think that it is important that they gain an appreciation of the international influence on their lives.

Table III International Projects Need to be Inserted into the Curriculum

Yes No

No Valid

Answer

TAMU-Commerce Students 61% 34% 5%

ITESM Students 88% 12% 0%

Table III shows that 88 percent of the ITESM students and 61 percent of the TAMU-Commerce students saw the need for international projects in the curriculum. This reports students being aware of the need for international projects, which does not automatically translate into the desire to participate in these projects.



Table IV Expect to Work With Someone from a Different Culture During Future Career

Yes No



Table IV shows that 100 percent of the ITESM and 79 percent of the TAMU-Commerce students expect to work with someone from a different culture during their future career. It is good that the students acknowledge the need to work with people of different cultures. It is more likely that they will be more willing to take advantage of opportunities to improve their ability to work in that expected environment.

Table V Students Think an E-Mail Project Could Start To Help Them Understand People of a Different Culture

Yes No

TAMU-Commerce Students 84% 16% ITESM Students 100% 0%

Table V shows that 100 percent of the ITESM and 84 percent of the TAMU-Commerce students think an e-mail project could start to help them understand people of a different culture

Table VI Students Think This E-Mail Project Has The Potential To Benefit In Preparing For Their Future Career

Yes No



Table VI shows that 100 percent of the ITESM and 76 percent of the TAMU-Commerce students think this project has the potential to benefit in preparing for their future career. (The students had received the preliminary plans for the e-mail project at the time of the questionnaire but had not started the e-mail messages of the project. There was a prevailing positive feeling toward the project.)

Table VII Students Are Interested In Spending Time Communicating With Someone From Another Country

Yes No



Table VII shows that 100 percent of the ITESM students and 76 percent of the TAMU-Commerce



students were interested in spending time communicating with someone in another country. This was a positive indicator of a willingness to invest some time and energy into the project. The e-mail project participation was not required. During the following weeks students were given topics on which to send e-mail messages to their partner in the other country. Gaining the ability to use e-mail, to use e-mail internationally, to describe or explain something about themselves to a person in another culture, to have different measures (kilometers vs. miles for example, Fahrenheit, vs. Celsius) to have different holidays, to have different academic classifications, etc. became real issues. There were general topics dealing with the economy, politics, fun or recreation, and career opportunities. The TAMU-Commerce students had to prepare an end of the project evaluation report where they reported on the problems, benefits, and their recommendations. The following is a generalization of their written reports.

PROBLEMS

1. The agreement between the two faculty members to do the e-mail was not finalized until the semester was started. All of the requirements and procedures were not in place until several weeks into the semester. 2. The course syllabus and grade requirements had already been publicized before the e-mail project was introduced. The students had a preliminary mindset on what they would need to do during the semester. Then when the opportunity to earn part of their grade by exchanging e-mail messages with students in another country was offered, some students did not want to participate. This “no impact on their grade” encouraged a low commitment to the project. 3. Many of the students submitted erroneous e-mail addresses to the professors. These addresses were given to the student e-mail partners. When the e-mail messages were “returned” for incorrect addresses, the students were disappointed and the professors and administrative assistants had to try to facilitate the matching of the correct e-mail addresses between the partners. This resulted in delays and loss of enthusiasm for the project. 4. Some of the students did not have a high commitment to the project. Those students whose grades were not affected by late responses or nonresponses caused much frustration to their partners. 5. Very few of the TAMU-Commerce students could speak or read Spanish. Some of the messages needed someone to help translate. This was okay, but for the students at the time of the receipt of the Spanish message, it was a really serious problem.

BENEFITS

Student Views: The benefits of the International e-mail project as expressed by the students were extremely important. The TAMU-Commerce students were required to prepare and submit a written evaluation at the end of the project. One student in her evaluation said the following:

I feel that the execution of this international e-mail project will prove to be very beneficial for various reasons. Initially this assignment builds computer skills and e-mail experience. For those students who are not necessarily computer oriented, and have somewhat of a "cyber-phobia", completion of this project will be a great way to gain knowledge and security in working with computers. Also this assignment gives students the opportunity for "cultural exchange". Students can communicate with their Mexican e-mail partners and share information about a host of different concepts including lifestyles, educational and social issues, economic issues, etc. (Student Report, 1998).

Faculty Views: The e-mail project has the potential to challenge students to overcome many barriers to effective communication and learning. The problems with technology, language differences, people, and culture differences provided the opportunity to do some problem solving in a real sense for their benefit. Most of the students want the problems to be worked out in advance of beginning the project.



Several of the students expressed a good level of satisfaction of overcoming their lack of understanding of the technology for their use and their weakness in understanding the Spanish language.

RECOMMENDATIONS

1. To enable the professors to agree on the objectives and procedures of an e-mail project, it is recommended that definite teaching assignments be made at least three or four months prior to the start of the semester. The professors would develop and set forth the requirements and procedures. Then on the first day of class the participating students would receive a complete set of written instructions. 2. The students would agree to participate only by sending an e-mail message to their professor. The professor would send an acknowledgement back to the student, verifying the validity of the e-mail address. The professor would then prepare a list of participating students and their e-mail addresses to be matched with their partner. 3. Choose some initial topics for the e-mail project that would be easy and interesting to the students. Then some of the later topics would be more academically challenging and hopefully bring out some of the differences in the cultures. 4. Each students' grade should be mutually affected by the partner students' timely and complete responsiveness to the requirements of the project and their partner's inquiries. If one student is not affected there is not as much commitment in a time crunch. 5. Most students strongly recommended continuing the project in the future. All students who received and sent the scheduled messages strongly encouraged its future use.

CONCLUSION On the basis of the responses of the students in this exploratory e-mail project, it is recommended that there be some refinements in the program and it continued in future because of the potential benefits to the students! The written end-of-project evaluations submitted by the A&M-Commerce students can not be easily tabulated. The overwhelming majority who received at least one response strongly encourage continuation of the project. It is the low-cost opportunity for international intercultural interaction between students. It does involve a large amount of extra work on the part of the faculty member and/or administrative assistant.



REFERENCES

Educational Resource Information Center Processing and Reference Facility. ERIC OvidWeb. [Electronic Database 1966 to September 1999]. Available: http://multimedia.tamu-commerce.edu/library/tel.htm Edwards, W. (1998). [Survey of TAMU-Commerce Students and ITESM Students Administered Prior to Project]. Unpublished raw data. “International E-Mail Project Evaluation Report.” (1998) [Student report on Personal Experience With E-Mail Project]. December 1998. Reiss, D., Selfe, D., & Young, A., (Editors). Electronic Communication Across the Curriculum. National Council of Teachers of English, Urbana, IL (no date cited).



ENVIRONMENTAL INFLUENCES OF ACCOUNTING

SYSTEMS IN LATIN AMERICA vs U.S.A.

Aghimien, Peter Indiana University South Bend

[email protected]

ABSTRACT The accounting procedures used in the United States, adapted from Anglo Saxon accounting, are very detailed and strict, are strongly influenced by the accounting profession as well as other regulatory bodies, and tend to be less conservative and more transparent than the accounting systems of other countries. On the other hand, the accounting systems of Latin American countries have been influenced by the Roman concepts of law and are more conservative and secretive. The reasons for the differences in the accounting systems of these two regions originates from the many environmental factors that influence them such as sociocultural factors, political systems, economics, and legal systems. The changing environmental factors of today and of the future will continue to shape the accounting systems of all countries to meet the needs of business. As business expands into the global environment, the industrialized countries of the world one day may share a unified system of accounting in order to enhance the comparability of financial statements. Accounting to record business transactions dates way back to 3600 BC, although double entry accounting was not developed until somewhere between the 13th and 15th centuries. Accounting began to adapt to entirely new needs of business with the onset of the Industrial revolution in the 1900=s which gave birth to the technology of mass production and the use of fixed assets. Accounting today continues to adapt in even new ways with the emergence of mergers, acquisitions, multinational corporations, and world trade. There are many obvious differences between the United States and Latin America including the imbalance of size, wealth, and the level of development of these two regions of the Western Hemisphere. For example, U.S. GNP is approximately 10 times that of Brazil, 22 times that of Argentina, 110 times that of Venezuela, and 4 times that of the region as a whole. The currency used in Latin America is not only different from that used in the United States, but also from that used country to country within Latin America. Even the terminology used in the financial statements is different as well as the amounts of information disclosed and the procedures used to arrive at the final figures (rules of valuation, recognition, realization). The United States continues to be a world model for accounting while Latin America struggles for political and economic stability as it strives to be a player in the global markets. As change continues in the economy and politics of Latin America, the accounting systems will continue to evolve as well. The environmental influences of the past have developed the accounting systems of the United States and Latin America. The influences of today and tomorrow will continue to shape those systems.



FACTORS IMPEDING THE HARMONIZATION OF INTERNATIONAL ACCOUNTING STANDARDS

Ramage, Judy Christian Brothers University

[email protected]

Stromberg, Peter Christian Brothers University

[email protected]

Lawrence, Howard Christian Brothers University

[email protected]

ABSTRACT

Because of increased international financial accounting activity there is an increasing need for accountants to provide useful and comparable information across international borders. Unfortunately, the creation of this additional information is impeded by a variety of educational, socio-cultural, legal, political, and economic factors. Specific examples of these factors include differences in taxation methods, legal systems and language. More general obstacles to harmonization include the magnitude of accounting differences, lack of strong professional accountancy bodies, nationalism and the audit function. Perhaps the single biggest factor impeding harmonization is the reluctance of individual nations to surrender their control over accounting and disclosure practices to any supra-national agency.

A number of bodies are working toward harmonized accounting standards. These include The International Federation of Accountants (IFAC), The International Accounting Standards Committee (IASC), and The International Organization of Securities Commissions (IOSCO). In addition, the European Union and the United Nations has accepted the standards of the IASC for official reporting of the Union.

This paper will examine the benefits and problems of international accounting standards and discuss the major impediments to the use of these standards.

INTRODUCTION Financial reporting seeks to provide accounting information that is useful in projecting cash flows and economic information about specific business enterprises. Two primary qualities that make accounting information useful for decision making are relevance and reliability. Relevance pertains to the ability of information to make a difference in a decision. This enables users to have predictive values as well as feedback value. Reliability pertains to the quality of information and seeks to assure that information is reasonably free from error and bias. Comparability and consistency are two other factors that contribute to good accounting information. These refer to the conformity of accounting policy and procedures from period to period. The different users of accounting data make the preparation of financial statements even more difficult. At one end of the spectrum is the investor who only casually looks at the annual financial report and never analyzes the statements. At the opposite end is the chartered financial analyst (CFA), who, like the CPA, wants specific information prepared according to some recognized standard. With such diverse users, accounting information can not be specifically directed to any one group. Standards are developed to find median that will be acceptable and useful for as many users as possible.



Clearly, there are many groups that have a vested interest in the setting of these standards. For example, political parties have a vested interest for tax policy purposes. Private sector and professional bodies need standards as a source of business information. Regional bodies use standards in their legal systems, and special interest groups influence standards to enhance the economic environment.

WHAT ARE STANDARDS? Standards are formal agreements that define the contractual, functional, and technical requirements of a product, service, process, or system. Every facet of the business profession has its own set of standards. In layman's terms, these standards are guidelines for professionals to abide by. Accounting standards are developed, after due process, to resolve measurement, valuation and reporting problems arising from business transactions and events. The accounting institutions of the United States follow the most detailed and comprehensive standards of any country in the world. Established by the Financial Accounting Standards Board (FASB) and other predecessor bodies, these accounting standards, play an important role in today's global economy. Most countries have their own set of accounting principles and policy processes and these principles reflect the economic and social environment of the individual nation or region. From country to country, standards are different because the laws and customs are different and this makes it difficult to reach a level playing field on the standardization of financial institution regulation, audit requirements, ethical standards, and tax and customs policies. Establishing standards is a balancing act and there must be an opportunity for the interest of all to be represented on both the national and international level. With the growth of the global marketplace, a harmonization of relevant and reliable financial information has become increasingly urgent. These standards would provide a basis for underdeveloped countries to follow as their accounting profession emerges. Multinational companies would have a better understanding of their accounting and reporting responsibilities. But the urgent need for globalized standards does not make development any easier. The accounting profession has found that this process is a lengthy one and the task will not be completed soon. In the center of this debate lies the International Accounting Standards Committee (ISAC). Other key figures include the International Organization of Securities Commission (IOSCO), the European Economic Community (EEC), the International Federation of Accountants Committee (IFAC), the American Institute of Certified Public Accountants (AICPA), the Institute of Management Accountants (IMA), and the Financial Accounting Standards Board (FASB). These groups, along with standards committees from other nations, will ultimately determine if a common accounting language for the world will be developed.

THE INTERNATIONAL ACCOUNTING STANDARDS COMMITTEE The London based International Accounting Standards Committee (IASC), was established in 1973. The purpose of the IASC is to reduce the diversity of practice in financial reporting among the countries and to achieve some level of harmonization of principles. The committee has worked vigorously in developing international standards of accounting and disclosures that meet the needs of international capital markets and the international business community. The objectives of the IASC as stated in its Constitution are:

1. To formulate and publish, in the public interest, accounting standards to be observed in the presentation of financial statements and to promote their worldwide acceptance and observance, and

2. To work generally for the improvement and harmonization of regulations, accounting standards, and procedures relating to the presentation of financial statements. (IASC Constitution, 1999)

Accounting bodies from nine countries formed the IASC. Currently, the IASC consists of over 100 professional accounting institutions from over 75 countries. The IASC Board is composed of representatives from 13 countries and up to four other organizations with an interest in financial reporting



appointed by the Board itself. This means that there can be a maximum of 17 Board Members. As of November 1999, there were 16 members. The members are from public accounting, industry, academia, and the investment community. The International Federation of Accountants (IFAC) appoints the 13 countries to be represented. At least nine of these countries must be from the most significant countries in terms of the status and development of the accountancy profession or that are of significant importance to international commerce and trade. As a member of the International Accounting Standards Committee, each member agrees to work for the improvement and harmonization of regulations, accounting standards, and procedures. What should emerge is a fine mixture of the best standards used in practice with omission of those tried and found wanting. With experts in accounting and financial reporting from all parts of the world, the development of these standards will be a true international due process. The IASC is a standard setting body, unlike the IFAC, who coordinates the professional activities of accountancy bodies worldwide. IFAC recognizes ISAC as the sole body with authority in establishing international accounting standards. The IASC does not provide educational courses because it feels this role is better suited to academic institutions and commercial organizations. The standards developed are aimed at businesses involved in multinational trading and capital investments. While the standards do apply to government business enterprises, they are not directed toward financial reporting for non-business activities of national, regional, and local governments. Many of the standards are similar to those issued by the FASB. However, to accommodate the diverse interests of its constituencies, many IASC standards permit conflicting treatments in standards (Cascini, 1993, p. 56). In an effort to reduce these alternatives, the IASC developed the Comparability of Financial Statements project. The objective of the project is to eliminate most of the free choices of accounting treatments for like transactions and events. While the project seeks to have one treatment for each event many in the accounting community believe that, realistically, this can not be done. The comparability project issues two alternative treatments for each standard with the benchmark being the preferred alternative. The allowed alternative is acceptable only if footnotes are provided showing financial information prepared under the preferred accounting treatment. The more consistency that exists in the presentation of the numbers, the easier it will be for users of financial statements to compare one company with another. Compliance with international accounting standards varies from country to country. In developing countries, where domestic accounting standards do not exist, the consensus has been to adopt IASs as their guidelines for financial reporting. Developed countries generally feel uneasy about the new standards. The standards established thus far are general in nature to industry-specific and region-specific topics. Highly developed countries feel that emerging issues are neglected by the IASC. The reason for this is the committee wants to be diverse and not directed at any one industry or group of countries. The committee provides service to many industries and issues are dealt with in many different ways from which interpretations emerge. Issues regarding highly developed countries are irrelevant to the underdeveloped nations, and vice versa. This conflict is an area of concern to the committee and it is working to achieve a common ground for all nations. Accounting standards have traditionally been national in characteristic and origin and developed either by government regulators or by accounting bodies. Because the IASC is not a governing body and has no legal power, compliance with international accounting standards is voluntary. Accordingly, national laws and standards take precedent over international standards. It is through the influence of local accounting institutions, as well as committees such as the IOSCO, the EEC, and FASB, that the IASC gets its support. This influence is not insignificant. Groups such as the United Nations, the Organization for European Corporation and Development, the International Federation of Accountants, and several national stock exchanges recognize the work of the committee. Because international market forces are not enough to change national accounting standards, the active support of all these national bodies is vital to success. The movement toward harmonization is being taken by countries whose need for requiring (or prohibiting) a given accounting practice is becoming more important in the global economy. However, the IASC feels that the search for common accounting standards must not obscure the need for accounting standards that reflect the different business and economic circumstances that exist in different countries (International Accounting Standards Committee, 1992, p. 1). A major event occurred in 1993 when the IOSCO and the IASC agreed on the necessary



components of 40 core standards that would comprise a comprehensive body of principles for enterprises. (Core Standards, 1999). In 1998, the IASC completed all 40 of the standards. With that completion many countries, companies, professional organizations and world trade organizations have come out in support of the IASC.

REASONS FOR HARMONIZATION The emergence of several powerful forces have provided the opportunity and increased the need for sound and credible accounting data. These forces include increased cross-border financing, emergence of multinational companies, heightened willingness to cooperate cross-borders in an effort to enhance natural, regional, and global economic strength, awareness by security regulators around the world of the necessity for comparable and credible financial information, and a vehicle, the IASC, to drive these standards closer together to uniformity. The rapid growth of the globalization of markets has created pressures for international accounting standards and disclosures. It is not, as some would think, the existence of international accounting standards that has made globalization possible. Nevertheless, harmonization of accounting standards will assist in the growth of the world economy. The restructuring of the Eastern Bloc into a free-market economy, and relaxing of the socialist system have opened up a market containing approximately 400 million people to foreign investment opportunities. Development of the European Community will allow the growth of international trade. More and more countries are changing from a socialist to a market economy and trade barriers are being dissolved with agreements such as the North American Free Trade Agreement (NAFTA). These barriers restricted trading in the past but the doors of opportunity are now opening, awaiting the arrival of capitalism. Developing accounting standards that meet the financial reporting needs of developing and newly industrialized nations and assisting with the implementation of those standards will be economically beneficial to the new global market. The increase in competition for capital in the international markets has also made the accounting world realize the need for uniformity in financial reporting. The rapid growth in international capital markets, cross-border mergers and acquisitions, and generally heightened level of international commerce has created pressure for harmonization of accounting standards far beyond those contemplated at the formation of IASC (Wallace, 1989,). In order to achieve the objectives of free trade and economy in the global marketplace, harmonization must exist. Yet another reason for harmonization is that the use of different accounting treatments around the world leads to wide variations in the reporting of net income, shareholders' equity, net assets and the carrying amounts of individual assets and liabilities even when dealing with the same set of economic circumstances. Global investors are now faced with financial statements prepared under multiple accounting bases. Financial information that is not comparable and difficult to read places these investors at a disadvantage. Lack of confidence in the accuracy of published data, along with problems that occur in having to publish statements in different parts of the world, will be a hindrance to investors in international markets. Improved financial market information will reduce the risk in investment decisions and financial-based management decisions. Harmonization of accounting standards will create comparable data on which to base decisions and to enhance the credibility of those data for use across borders. The long-term impact of unified accounting standards will allow investors the capability to understand the financial statements of companies in any nation. Many developing countries are adopting international standards as their nation's accounting standards. This reduces the expense of creating and maintaining domestic accounting standards. Multinational companies are currently faced with the extra expense of creating financial statements to conform to different national accounting requirements. Once international standards are set, it will eliminate the need for multinational companies to produce and maintain multiple sets of records. Money and time spent could therefore be better directed toward other projects. All international transactions could be handled more efficiently with a minimum of exchange costs. A common language would eliminate the need for the accounting profession to be well versed with the many different standards available in cross-border capitalization. Consider also that the rapid increase in technology provides information at a much faster pace than before. Communication lines from one side of the world are able to send financial information to the other side in minutes. This information needs to be reliable and relevant. A uniform set of standards will provide increasingly perfect information. Financial reports prepared in accordance with international



accounting standards by one country could more easily be interpreted by another. International accounting standards will assist world leaders by providing standardized information to worldwide economic policy-makers. All financial information, regardless of the country, will be reported in a manner that is apparent to all. The allocation and management of world resources would be better handled. Countries would benefit by the efficient use of each other's raw materials, technology, and human resources. This will also assist in improving government accountability. For example, businesses sold to the private sectors by the government can be efficiently evaluated. The differences in accounting standards are not the only factors that contribute to different financial results between countries. Accounting principles represents a culture's attitude towards its own government and towards meeting its tax demands. The taxation system has the most influence on how and why an accounting system is established. In some countries, accounting standards are established by law rather than by the private sector. In those cases, accounting institutions are able to influence the process by lobbying. As will be seen in the third paper prepared for this class, cultural differences are an important factor in the differences that exist in accounting standards. For instance, in Germany and Japan the banks rather than the equity markets are the primary source for financing and so more focus is placed on the creditors than the investors. On the other hand, businesses in the United States look primarily to the public debt and equity markets. In this case, the investors have more influence. With such diverse systems of accounting in the world, increased cross-borders transactions foster a need for a common language in financial reporting.

OTHER MEANS OF ACHIEVING HARMONIZATION There are other opportunities available in the effort to achieve international accounting uniformity. One is through the issuance of certificates by the national stock exchanges to their domestic registrants. If these certificates, whose financial statements have met its nation's review processes, are recognized by other national stock exchanges, then harmonization has been achieved with a reduction of repetitive financial statements. Another road to accounting accordance as many highly developed countries have found, is through research of the different accounting practices that exists. The outcome of these surveys can serve as recommendations on how to conform different practices. Harmonization can be achieved at different levels. Total harmonization exists when all countries accept and enforce the same accounting and disclosure standards, however this level of standardization is not the goal of the IASC. The IASC is currently allowing alternative accounting treatments to similar events. This process, known as alternative harmonization, can consist of minimum, partial, and optimal harmonization. Minimum harmonization occurs when member countries adopt minimum floor limits that can not be less restrictive than those issued by the IASC. In partial harmonization, the emphasis is on improving national standards. Financial papers prepared on the basis of a country's standards would be accepted by securities regulators in other countries. Optimal harmonization allows a country to adopt standards different from the global standards. A foreign country investing cross-borders where optimal harmonization exists would have the option to select which standards to follow, the national standards of the domestic country or the national standards of the invested country.

THE ROLE OF THE ACCOUNTANT

Barret (1993) believes that accountants involved in international capital markets and their regulation recognize that harmonized accounting and auditing standards are necessary for efficient operations and that there should be an accounting framework that accommodates the uniqueness of each country. To begin this framework, a standardization of reporting requirements by national securities regulators must be achieved. As the competition for capital in international markets intensifies, the role of the accountant becomes more important. To do the job correctly, accountants need a level playing field and many accountants believe that International standards provide that level field. Accounting has become the first truly international profession and accountants must take the lead in harmonizing international standards. Many accounting firms realize the need for a standardized accounting system for the global economy. Leading firms in the United States such as Price Waterhouse



Coopers, Arthur Anderson & Co, and Deloitte & Touche have established local accounting offices worldwide. These firms have developed surveys of the different accounting standards that exist throughout the world but so far have not exerted their considerable influence on achieving harmonization. Perhaps when they understand the savings to be achieved and the improvement in the quality of their services they will take the leadership role needed.

THE REGULATOR'S ROLE One of the most common problems encountered by multinational corporations is the vast difference in registering securities for public trading in countries outside the borders of the country of origin. The United States requires foreign registrants to reconcile certain data in conformity with U.S. GAAP. For this reason, foreign investors are hesitant to venture into the American capital markets. On the other hand, the London and Netherlands' stock exchange allows foreign companies to register for trading if their financial statements are in accordance with international accounting standards. On May 11, 1999, the European Commission stated that it is considering giving companies the option of raising capital throughout the European Union using financial statements prepared on the basis of a single set of financial statements. The Commission went on to say that the IASC was probably the best means to accomplish this. (European Commission Announcement, 1999) Perhaps one approach to internationalism would be to find standards acceptable to each local regulator. A solution would be to allow the preparation of basic financial data under local standards with a reconciliation of key data to international standards for those who want to use international capital markets. Security regulators, as one of IASC's users, must be satisfied with the integrity of the data reported.

MAJOR ISSUES OF NON-CONFORMITY There are a number of major issues of non-conformity. The treatment of goodwill, for example, varies from nation to nation. Goodwill refers to the excess of purchase price over fair value of net assets acquired. In the United States, goodwill has historically been amortized over a period not to exceed 40 years. The United Kingdom immediately writes off goodwill against reserve. Capitalization of goodwill is an option in Germany. However, if capitalized, the goodwill must be amortized over a four-year period, unless it is amortized systematically over the benefiting years. Japan immediately expenses goodwill, but a company may capitalize and amortize it over a five-year period. The proposed international standard would allow amortization of goodwill over a period not to exceed 20 years, with five years proposed for all but unusual situations. The impact for the United States would be a decrease in earnings due to a smaller time frame for amortization. In countries where goodwill is written-off to reserves there is no effect on earnings. How a nation treats consolidation must be considered when reviewing financial statements. In the U.K. dissimilar operations do not have to be consolidated, regardless of the percentage of ownership. The Japanese consolidate only significant subsidiaries (10% or more). German law imposed a size test for consolidation. This test is based on three items: consolidated balance sheet totals, sales to third parties, and average number of employees of the group in Germany. Without a common language, the effect of these differences can not easily be determined. Germany at least has now begun to accept IASC standards to reduce its problem of comparability. The treatment of research and development is another nonconformity issue that the IASC must confront. Research and development is expensed in the U.S. as well as in Germany. While in the U.K. research is expensed and certain development expenditures are deferred. Japan capitalizes research for new products and amortizes it over a five-year period. The proposed IASC standard will allow some development costs to be capitalized. This is true only if the company could prove there was a market for the products to which the development spending related, and costs could be recovered. Other areas of disagreement relate to financial statement presentations. Which assets and liabilities should be included on the companies' balance sheet? How should assets and liabilities be valued? Issues that have caused disclosure problems include the treatment of taxation in corporate reports, cash flow statements, interim financial reporting, and the computation and reporting of earnings per share. Thus far, these topics are not addressed under current IASC standards. The level of participation of the Third World countries is a concern of the committee members.



These countries lack the funding or the knowledge to participate as members of the IASC. A concession must be made to incorporate these issues by the IASC in order to formulate an all-inclusive set of standards. It has taken the IASC over 20 years to develop 39 international accounting standards. This is only the beginning of a long journey down the road to financial information uniformity. A harmonization of accounting policy would provide a level playing field for those investing capital in foreign markets. The one question we should ask is: "Does one size fit all?" The continued works of the IASC will answer this question.



REFERENCES Barrett, G. (1993, February). Is accounting becoming the first truly international profession?

Austrailian Accountancy, pp. 16-18.

Cairns, D. (1993, July). The IASC - 20 more years of vision and commitment? Accountancy, pp. 72-74. Cascini, K. T. (1993, Winter/Spring). Playing by different rules; varying nations' accounting

standards can make profit evaluation difficult. Business Forum, pp. 55-56.

Core Standards (1999). IASC Current Projects. http://www.org.uk/frame/cen3_5.htm. European Commission Announcement. (1999). About IASC.

http://www.org.uk/frame/cen1_6_22.htm.

IASC's Constitution (1999). IASC Structure. http://www.iasc.org.uk/frame/cen4_1.htm. International Standards Committee (1992, October). IASC insight (The newsletter of the

International Accounting Standards Committee.) London, England: International Accounting Standards Committee.

Wallace, R. S. O. (1990, June). Survival strategies of global organizations: the case of the international accounting standards committee. Accounting Horizons, pp. 1-22.

Webber, C. M. (1992, October). Harmonization of international accounting standards. The National Public Accountant, pp. 40-42.



FIGHTING POVERTY THROUGH NEGATIVE INCOME TAXATION: THE SUGGESTIONS OF A

COMPUTATIONAL MODEL

Neill, Jon Western Michigan University

[email protected]

ABSTRACT Economists from both sides of the political spectrum have advocated for a negative income tax. Interestingly, the negative income tax was never considered as an alternative during the most recent overhaul of the U.S. welfare system. This paper uses a computational model to gauge how effective a negative income tax would be in raising the incomes of the poor.

INTRODUCTION

To some, the amount of redistribution that the U.S. political system supports is surprisingly modest. By various measures, income inequality is significantly greater in the U.S. than in any other OECD country (Smeeding (1997). Moreover, inequality seems to have been increasing. Nonetheless, the U.S. welfare system remains very much on the defensive. In his first presidential campaign, President Clinton promised “to end welfare as we know it,” and much of the rhetoric from the recent debate over welfare reform is reminiscent of that surrounding the welfare crisis which faced the nation when Nixon took office in 1969. However, the response of these two presidents to a similar crisis has been markedly different, in fact, the reverse of what might be expected given their party affiliations. Clinton’s response was to sign the Personal Responsibility and Work Opportunity Reconciliation Act, an act which some view as harsh and punitive. In contrast, Nixon proposed, as his first domestic policy initiative, the Family Assistance Program (FAP), a negative income tax. This was a bold, even radical, reaction to the problem, a program that would have increased the number of families receiving cash payments from the state by millions. Apparently it was much too bold since Congress declined to pass President Nixon’s bill. While it may not be too surprising that this bill was defeated, it is certainly interesting that negative income taxation was never mentioned as a possible solution to the current welfare crisis. In 1968, James Tobin and Paul Samuelson were joined by over 1200 economists in signing an endorsement of a negative income tax (Moynihan (1973)). One has to wonder how many economists would sign such an endorsement today (see Hum-Simpson (1993) vs. Anderson-Block (1993)). It seems as if both the public and the economics profession have lost faith, or at the very least, interest, in the potential of the NIT to reduce poverty. The purpose of this paper is to determine how much of an impact a negative income could be expected to have on the economic status of low income households. Our analysis is based on a computational model that is, for the most part, the model used by Atkinson (1995) in his analysis of the optimal income tax. What we find is that a negative income tax would not necessarily have a significant effect on poverty. It seems that concern about the work disincentive of such a scheme is well placed. It may be that modest real income transfers through so-called socialized consumption, in-kind transfers, and subsidies are the best that a democratic political system can do.

THE THEORETICAL MODEL

The form of the negative income tax that we will confine our attention to is the linear income tax. Let Li denote household i’s endowment of those input-goods which are sold by households to generate income. Let w denote the vector of their prices. With a linear income tax of rate t, the household’s disposable income will be yi + t( y* - yi ) where yi = w(Li - li) + ui; li is the vector of the household’s



consumption of those goods sold to generate income and and ui is the household’s unearned income. The level of government spending on goods and services would determine y*. Here we are thinking of government spending on goods and services that do not have a direct effect on household welfare. Specifically, if G denotes this spending, then the government’s budget constraint is

t Σ (yi - y*) = G This implies that t y* = t ya - ga where ya and ga denote average income and per-capita government spending respectively.

Thus, the household’s budget constraint becomes: 1) (1 - t)(wLi + ui) + tya - ga = p x + (1 - t)wlI where x is the vector of goods that the household uses income to purchase and p is the vector of their prices. So, household i’s income is a function of wealth and the after-tax wage

yi = yi((1-t)(wLi + ui) + tya - ga,(1-t)w) Let ya(t) be the solution to

ya = Σ yi((1-t)(wLi + ui) + tya - ga,(1-t)w)/n Throughout, average income is assumed to a continuous function of each of its arguments. Average income is also a function of ga, which for notational convenience, is suppressed. Substituting ya(t) into each household’s income function gives us household income as a function of

Ei(t) = (1-t)(wLi + ui) + tya(t) - ga and the after tax wage:

yi(t) = yi ( Ei(t),(1-t)w ) + ui A work disincentive is said to be created by the negative income tax when ∂ya/∂t < 0.

Using the above model, it can be shown that despite a work disincentive, a majority of households would support a linear income tax if per capita government spending (ga) is sufficiently low. However, the level of government spending is a determinant of the tax rate that a household finds optimal. And if government spending is high enough, a majority of voters would choose a proportional income tax over a linear income tax (Neill (1999). Of course, this theoretic model does not offer any insight into the tax rate that voters would support. Nor can it be used to gauge the effect of a linear income tax on the incomes and consumptions of low income households. To this end, we will use a computational model to identify the tax rate that the median voter would support. Using this rate, we will calculate the effect of the linear income tax on average income, and the earned incomes and consumptions of benchmark low income households. Subsequently, we will compare the effect of existing transfer programs on earned income and consumption to the effect of the linear income tax.

A COMPUTATIONAL MODEL

We will suppose that housholds have Cobb-Douglas utility functions, one of the functional forms used by Atkinson. As is well-known, if household i has such a utility function, its demand for leisure will be

li = βi{(1 - t)(wiLi + ui) + t ya - ga}/(1 - t)wI

where βi is the exponent of leisure. Subtracting this amount from the household’s stock of leisure Li, multiplying that difference by the wage, adding unearned income, and summing yields 2) yi(t) = yi(0) - βi (t ya(t) - ga)/(1 - t) for the household’s income function where yi(0) denotes the household’s income when t = ga = 0. Thus, average income will be 3) ya(t) = {(1 - t) ya(0) + β ga}/(1 - t + βt), β = Σ βi/n

Using 2) and 3), we can determine the LIT rate that the household finds optimal. Specifically, when βi= β the household’s most preferred tax rate will satisfy



1 - yi(0)/ya(0) + {t(1 - β)β(ga/ya(0)) - βt}/(1 - t + βt)2 = 0 Since the expression on the left-hand side of this equality decreases as t increases when β and ga/ya are less than one, the solution must decrease as yi(0) increases. Therefore, the median of the set of optimal tax rates is the rate that is optimal for the household with the median income when there is no LIT. So, by setting β and ym(0)/ya(0), the tax rate of the median voter can be approximated. Meaningful values for ym/ya are easy to come by. Census date on household income in the U.S. gave us ratios of .8564, .8408, .8126, .8005, and .7583 for 1975, 1980, 1985, 1990, and 1995 respectively. Family income yielded somewhat higher ratios: .8825, .8769, .8419, .8289, and .7908. In view of these numbers, we decided to use three values for ym/ya: .9, .85, and .8. Our interest in a ratio of .9 derives from the fact that an agent’s decision to support a particular LIT rate would presumably be dependent on his lifetime income, and there is some evidence that the distribution of lifetime incomes is less skewed than that of annual income (see, for example, Davies et al. (1984)). Giving β a reasonable value is perhaps more problematic. Note that it can be set either on the basis of estimates of wage elasticities or estimates of the marginal propensity to earn. However, estimates of both these magnitudes fall in a wide range. For example, the wage elasticities from the studies based on U.S. nonexperimental data surveyed by Pencavel (1986) range from -.29 to .14, while the estimates from the U.S. negative income tax experiments range from -.12 to .21, with the average of the eight estimates equal to .02625. Similarly, the estimates of the marginal propensity to earn range from -.7 to .08 and -.29 to .02 respectively. The averages for these two groups of studies were .2017 and .1025. Estimates of the wage elasticity of the labor supply of women usually produce substantially higher values, and the range of estimates is even wider than that for men. The studies surveyed by Killingsworth and Heckman (1986) range from about -.9 to 14.79, though most estimates lie between -.4 and 1

Under the assumption of a Cobb-Douglas utility function, the labor supplied by the household is equal to

lis = (1 - β)Li - β(ui + t ya - ga)/(1 - t)w

Thus, the elasticity of labor supply with respect to the wage would be

ε = {β(ui + t ya - ga)}/{(1-t)wlis}

implying that β = {ε(1-t)wli

s}/{ui + t ya - ga} Suppose that the federal income tax schedule is approximated using the flat-rate tax. Then for each household with an income exceeding the deductible, t ya - ga = t D. In 1994, a family of four paid federal income tax only on income in excess of $15,400. The federal income tax paid by such a family with an income of $43,133, average income that year, was $4,159. So, setting D equal to $15,400, the tax rate was about 15%. Using these figures, data on earned and unearned income, and estimates of wage elasticities, we can set the value of β. The data from the 1995 Current Population Survey on personal income by source indicates that the ratio of average earned to average unearned income was 3.33. In 1990, this ratio was slightly lower, but still greater than 3 (3.09) . Consequently, with the ratio of earned to unearned income equal to 3 and a wage elasticity between .03 and .21, the value of β for a household with average income would lie between .065 and .45. Since this range is comparable to the range of marginal propensity to earn estimates, and in our model, the marginal propensity to earn equals - β, we will determine the median LIT rate using three values for β: .5, .3, .1. Our estimates of the median value of t are found in Table 1. Estimates were made with ga set to zero, and with ga set to 20% of average income. This level of government spending was chosen due to the fact that in 1994, government spending on goods and services in the national income and product accounts was 20.6% of personal income. In 1993, this percentage was equal to 21.4%.

Table 1. LIT Rates of the Median Voter

ga = 0 ga = $8,627

ym/ya = .9 .85 .8 ym/ya = .9 .85 .8



β = .5 .17 .24 .29 .2 .255 .315 .3 .23 .31 .37 .255 .335 .4

.1 .4 .48 .54 .445 .51 .57

Critical Value of β = .445 .705 1

As can be seen, the LIT rate preferred by the median voter is quite sensitive to the values of ym/ya and β. However, in only two cases do we obtain a value greater than .5, the tax rate of the FAP. Thus, a linear income tax rate in the neighborhood of .5 requires a relatively low wage elasticity. And higher, but still credible wage elasticities reduce the tax rate significantly, to the point where the redistributive potential of the tax would have to be questioned. In the following section the effect of the rates in Table 1 on the incomes and consumptions of poor households are estimated on the basis of equations 2) and 3), and data from the Current Population Survey.

COMPARING THE LIT TO EXISTING TRANSFER PROGRAMS We now want to compare the transfers that, on the basis of our model, could possibly be effected through a linear income tax with the cash and in-kind transfers that were being made in the U.S. in 1994. Mean household income in the U.S. in 1994 was $43,133. Using 3) and the LIT rates in Table 1 we can determine the annual income that the LIT would guarantee. These guarantees, along with the average income that the corresponding tax rate generates, are found in Table 2. Again, the income guarantee very much depends on the values of β and ym/ya, as well as the level of government consumption. In the absence of government consumption, even high wage elasticities imply a relatively generous guaranteed income. Of course, it is also true that in this case, the tax has a profound effect on average income, an effect which may very well be underestimated since without unearned income, the wage has no effect on the household’s demand for leisure when its preferences are Cobb-Douglas. When government consumption is introduced to the model, the median tax rate rises, but the guaranteed income falls and the tax has considerably less impact on average income. Moreover, with β equal to .5 and a median income that is 90% of average income, the median voter prefers a proportional income tax to a linear income tax. Table 1 shows the minimum value of β at which the proportional tax is preferred by the median voter to a linear income tax for each of the three values of ym/ya we are using. This critical value is .445 when this ratio is .9, and slightly more than .7 when ym/ya is .85. Coleman and Pencavel estimated the wage elasticity of labor supplied by white makes with some college education to be .164. Their estimate of wage elasticity for white male high school graduates was .065. Zabel’s study (1993) of the labor supply of married women produced estimates of wage elasticity between .554 and .078; the average of his five estimates is .247. His estimates of the elasticity of labor supply with respect to non-labor income ranged from -.108 to -.322 with the average equal to -.158. We might add that Browning (1993) used considerably larger values for elasticity in his study of the marginal cost of redistribution (.3, .4, and .5). So, with the ratio of median to average income greater than .85, plausible wage elasticities imply that majority rule would not lead to a guaranteed income vis-a-vis significant government consumption. For comparison, Table 3 contains data on U.S. transfer programs in 1994. The guaranteed incomes found in Table 2 are often substantially greater than the cash benefits from existing transfer programs. At the same time, there are cases where the guarantee is significantly less than these cash benefits. For example, the average monthly AFDC payment per family was $378 or $4536 annually while the average monthly SSI payment added up to an annual income

Table 2. Income Guaranteed by the LIT

ga = 0



β ym/ya = .9 .85 .8

Guaranteed Income 6,709 8,940 10,387

.5 Average Income 39,467 37,251 35,818

% Decrease in AI 8.5 13.64 16.96


.3 Average Income 39,586 38,010 36,672

% Decrease in AI 8.22 11.88 14.98


.1 Average Income 40,437 39,488 38,602

% Decrease in AI 6.25 8.45 10.5

ga = $8,627

Guaranteed Income 0 2,025 3,995

.5 Average Income 43,133 41,774 40,071

%Decrease in AI 0 3.15 7.1


.3 Average Income 42,190 41,040 39,540

% Decrease in AI 2.19 4.86 8.33




.1 Average Income 40,984 40,661 39,855

% Decrease in AI 4.98 5.73 7.6

of $4212. Considering that unemployment insurance benefits typically run out after 26 weeks, the average annual UI benefit amounted to just about what the average AFDC recipient received. So, with government consumption, the income guaranteed by the LIT exceeds these amounts in 5 of 9 cases. The comparison of the LIT guarantee with OASDI is considerably less favorable to the linear income tax. In 1994 OASDI paid $697 a month to retired workers and slightly less to disabled workers ($661) for an annual payment of $8364. This amount exceeds the LIT guarantee in 6 of 9 cases. Coincidentally, the income guaranteed by FAP is close to the median of our nine values. The bill debated in Congress in 1970 set the guaranteed income (family of four) at $1,600; in 1994 dollars this guarantee would be $5,741. However, when in-kind transfers are factored in, the LIT appears likely to be even less of an improvement on the existing system of transfers. Certainly the most important of these transfers are food stamps and Medicaid. In 1994, a family’s annual allotment of food stamps was determined by the formula S = $4,500 - .3 yc

where yc is the family’s “counted income” ( Counted income is computed from family income by subtracting the deductions to which the family is entitled. See Where Your Money Goes: The 1994-95 Green Book .) In all that follows we will allow only two deductions, the standard deduction of $131 per month and the 20% of earned income that families can deduct to cover job related expenses. Thus, the family receiving the average AFDC payment would receive $3,611 of food stamps annually. Including the average Medicaid benefit, the average AFDC recipient’s consumption was $11,314. Families also receiving the average school lunch and energy assistance benefit consumed goods and services amounting to $11,915 while the consumption of those who were eligible for housing assistance amounted to $16,802. Obviously these transfers compare very favorably to the incomes that the LIT would guarantee vis-a-vis government consumption at its current level.

Table 3. Annual Average Benefits

U.S. Transfer Programs and Social Insurance: 1994

AFDC OASI SSI UI EITC* MEDICAID

$ 4,536 8,364 4,212 4,732 2,528 3,167

MEDICARE Food Stamps Housing School Lun. Energy Asst.

$ 4,740 828 4,887 317 284 *Maximum credit. Source: 1996 Statistical Abstract of the United States. It also appears that with significant government consumption, the LIT may not increase the consumption of the working poor by significantly more than does existing programs, most notibly the earned income tax credit (EITC) and the food stamp program. Using 2) and 3) we obtain the following expression for the household’s after-tax income:



4) yd

i(t) = (1 - t) yi(0) + (1 - β)(tya(t) - ga) Using this specification and the income equation generated by linear approximations of the EITC and food programs, we can compare the disposable incomes of working poor households with the LIT to those with existing programs. Our benchmark households will be households earning $5,500, $11,000, and $15,000. $11,000 is the earned income at which the EITC begins to decline and is slightly more than what an individual working 40 hours a week, 52 weeks of the year at $5 an hour would earn. $5,500 is half that and therefore corresponds to the income of a low wage worker working half-time. $15,000 is (about) the poverty threshold for a family of four. In 1994, a household with an earned income of $11,000 received the maximum EITC, $2,528, and a zero credit once its income reached $25,296 or greater. In linear form, the EITC schedule for a household with two children is therefore T(y) = .23 y, y ≤ $11,000 = $4,475 -.177 y, $11,000 < y ≤ $25,296 = 0 otherwise where y is earned income. If we assume that our household’s counted income is 80% of its earned income minus the standard food stamp deduction, its food stamp allotment is F(y) = $4,500, y ≤ $1,965

= $4,972 - .24 y, $1,965 < y < $20,712 = 0 otherwise

Assuming that households with our benchmark incomes pay no income taxes, we obtain the following equations for household consumption c = .99 y + $4,972, $1,965 < y ≤ $11,000 = .583 y + $9,447, $11,000 < y < $20,712 Under the assumption that the household has Cobb-Douglas preferences with the exponents of foodstuffs sufficiently large that the household’s food stamp allotment is equivalent to a cash transfer, the household’s income will be given by yi = yi(0) - βi $4,972/.99, $1,965 < y ≤ $11,000

= yi(0) - βi $9,447/.583, $11,000 < y ≤ $20,712

while its consumption will be c = .99 yi(0) + (1 - β) $4,972, $1,965 < y ≤ $11,000 = .583 yi(0) + (1 - β) $9.447, $11,000 < y ≤ $20,712 Table 4 contains the earned and disposable incomes of households with our benchmark incomes with the LIT when ym/ya = .85 and β = .1 and .3 and earned income and consumption under the EITC and the food stamp program. The LIT incomes are calculated using the median tax rates and guaranteed incomes when average government consumption is $8,627. Note that a family of four whose income was $15,000 or less paid no federal income tax in 1994. We are implicitly assuming that these households were also exempt from state and local income taxes. As can be seen, when β is .1 the LIT would decrease the earned incomes of the working poor more than the EITC and food stamp program. But the LIT increases the consumption of these households, considerably so when the household’s earned income in the absence of transfers is very low. On the other hand, when β is .3, the results are almost the reverse of what they are when β is set at .1. Though the household whose income is $5,500 without transfers will earn more income under the EITC and food stamp program than under the LIT, households with higher incomes choose to earn less. In all three instances,



household consumption is significantly greater under the EITC and food stamp program. In fact, when β = .3 the LIT leads to a decrease in the disposable incomes of some of the working poor. Of course, these results may be quite sensitive to changes in the form of the household’s income function. But it should be borne in mind that when preferences are Cobb-Douglas, the household’s supply of labor is independent of the wage. Thus, a smaller reduction in earned income when there is a wage effect is counter-intuitive. Nonetheless, some of the tax rates and guaranteed incomes in Tables 1 and 2 were used to determine the effect of the LIT on the earned income of low income households with CES utility functions. As expected, the LIT has an even greater, negative effect on earned income. For instance, when the wage elasticity is set equal to .1, a household that earns $10,920 when there is no LIT will decrease its earnings by about 40% (to $6,476) in response to an LIT with a rate of 33.5% and a guaranteed income of $5,121. At a result, its disposable income will fall to $9,428, roughly 14%. It is certainly worth noting that even if a negative income tax has a much smaller effect on the earned income of a household with an income below the poverty line than indicated by our model, most of the rates and guaranteed incomes from Tables 1 and 2 imply very modest increases in the disposable incomes of low income households. A number of studies aimed at determining the effect of existing transfer programs in the U.S. on poverty and inequality have concluded that it has been profound (see Tables 9 and 10 in Danziger, Haveman, and Plotnick (1981)). Danziger, Haveman, and Plotnick (1981) argue that income transfer programs have reduced poverty by 75% and income inequality by 19%. They also argue that the reduction in labor supply attributable to such programs is only 4.8%, which is

Table 4. Incomes and Consumptions:

The LIT vs. the EITC and Food Stamps

Initial Income $5,500 11,000 15,000

β =.1, ym/ya = .85

Earned Income w. the LIT $3,029 8,529 12,529 Disp. Income w. the LIT $13,594 16,289 18,249 Earned Income w. the EITC and FS $4,998 9,380 13,380 Consumption w. the EITC and FS 9,920 14,915 17,247

β =.3, ym/ya = .85 Earned Income w. the LIT $3,190 8,690 12,690 Disp. Income w. the LIT $7,243 10,900 13,560 Earned Income w. the EITC and FS $3,993 6,139 10,139 Consumption w. the EITC and FS 8,925 12,364 14,696 ___________________________________________________________________________________ comparable to the percentage decreases generated by our computational model. Still, only the rates and guaranteed incomes generated with β equal to .1 result in large increases in disposable income for households with earned incomes in the $11,000 to $15,000 range. Using the tax rate and guaranteed income when β = .3 and ym/ya = .85, we find that if earned income decreases by 5% due to the LIT, a household earning $11,000 without the LIT would have a disposable income of $12,070. The household whose income is initially $15,000 would end up with less disposable income, $14,597. The contents of Table 4 raise serious questions about the ability of the linear income tax to



increase the consumption of the poor. The weak wage effect in our model, and the exclusion of other transfer programs in making these comparisons can only further mitigate against any claim that a linear income tax would be a significant improvement on existing anti-poverty programs.

CONCLUSION

Economists have frequently argued that a negative income tax would be an improvement on the motley of programs that have been used to redistribute income. For example, Blinder and Rosen (1985) argue that “both apriori reasoning and empirical evidence support the idea that an NIT is a better way to redistribute income than our current welfare system.” But though an NIT was given serious consideration by high ranking members of the Johnson administration, and though Nixon’s Family Assistance Plan came very close to being enacted, it seems that the NIT has fallen out of favor with both politicos and economists. One explanation for its present status could be its work disincentive; FAP drew a great deal of criticism and invective for guaranteeing an income to the indolent and malingering. However, our analysis shows that despite the work disincentive from negative income taxation, a majority of households would support such a program. Moreover, our computational model indicates that a linear income tax rate in the 40 to 50% range could be politically viable. On the other hand, our computations lead to other, less happy conclusions. First, a linear income tax could have a very large depressing effect on income. Even with government consumption, decreases in average income between 5 and 8% obtained, decreases that are much larger than the effect that existing transfers are believed to have on income. Danziger, Haveman, and Plotnick (1981) estimate that the work disincentive of existing income transfer programs have caused a 3.5% in earnings. Second, the NIT rate that may emerge from the political process could be so low that replacing existing welfare programs with the LIT would result in a decrease in the real incomes of many poor households. It should be kept in mind that some economists support negative income taxation as a replacement for all existing transfer programs. Our model shows that there is no guarantee that such a substitution would increase the consumption of goods and services by low income households. Third, while a majority of households may prefer a linear income tax when government spending on goods and services is low, they may not when government spending is high. To us, the lesson to be taken from this study is that the negative income tax may not be the panacea for poverty that it sometimes has been thought to be. In fact, if existing transfers are equivalent to a negative income tax, replacing these transfers with a linear income tax could be detrimental to the poor. Thus, our analysis stands as a caveat against ambitious, direct transfer schemes. If poverty is defined as a state wherein a household is consuming “insufficient” quantities of goods other than leisure, our computations suggest that a linear income tax may be relatively ineffective in reducing poverty, that existing programs may have as much, if not more of a salutary effect on the consumption of low income households. What this study underscores then is that skepticism and suspicion of the wisdom of fighting poverty through negative income taxation may not be misplaced. Perhaps the hodge-podge of conditional cash payments, socialized consumption, in-kind transfers, and subsidies is not such a misguided endeavor after all. If existing poverty programs are not adequate, it is not at all clear that a program which provides for generous cash payments will be a viable alternative. It may very well be that whatever can be achieved on this front through cash transfers has already been achieved.



REFERENCES

Atkinson (1995). Public Economics in Action: The Basic Income/Flat Tax Proposal, Clarendon Press, Oxford, 1995.

Anderson & Block (1993). “Comment on hum and Simpson.” Journal of Labor Economics, Volume Eleven, January 1993, 348-363. Ballard (1988). “The marginal Efficiency Cost of Redistribution.” American Economic Review, Volume

Seventy-Eight, December 1988, 1019-1033. Blinder & Rosen (1985). “Notches.” American Economic Review, Volume Seventy-Five, September 1985, 736-747. Browning (1993). “The Marginal Cost of Redistribution.” Public Finance Quarterly, Volume Twenty-One, January 1993, 3-32. Browning (1973). “Alternative Programs for Income Redistribution: The NIT and the NWT.” American Economic Review, Volume Sixty-Three, March 1973,38-49. Browning & Johnson (1984). “The Trade-Off between Equality and Efficiency,” Journal of Political

Economy, Volume ninety-two, April 1984, 175-203. Coleman & Pencavel (1993). “Changes in Work Hours of Male Employees.” Industrial and Labor Relations Review, Volume Forty-Six, January 1993, 262-283. Danziger, Haveman, & Plotnick (1981). “How Income Transfers Affect Work, Savings and the Income Distribution.” Journal of Economic Literature, Volume Nineteen, September 1981, 975-1028. Davies, St.-Hilaire, & Whalley (1984). “Some Calculations of Lifetime Tax Incidence.” American

Economic Review, Volume Seventy-Four, September 1984, 633-649. Hum & Simpson (1993). “Economic Response to a Guaranteed Annual Income: Experience from Canada and the United States.” Journal of Labor Economics, Volume Eleven, January 1993, 263-296. Killingsworth & Heckman (1986). “Female Labor Supply: A Survey.” Handbook of Labor Economics, Volume One, North Holland, New York, 1986. Moynihan (1973). The Politics of a Guaranteed Income: The Nixon Administration and the Family Assistance Plan, Vintage, New York, 1973. Neill (1999). “Welfare Reform in the 90’s: Whatever Happened to the Negative Income Tax?” Working Paper, Department of Economics, Western Michigan University, Kalamazoo, Michigan, 1999. Pencavel (1986). “Labor Supply of Men: A Survey.” Handbook of Labor Economics, Volume One, North

Holland, New York, 1986. Smeeding (1997). “The International Evidence on Income Distribution in Modern Economies.” Poverty

and Inequality, W.E. Upjohn Institute for Employment Research, Kalamazoo, Michigan, 1997. U.S. House of Representatives Committee on Ways and Means (1994). Where Your Money Goes: The

1994-95 Green Book, Brassey, Washington, 1994. Zabel (1993). “The Relationship between Hours of Work and Labor Force Participation.” Journal of Labor

Economics, Volume Eleven, April 1993, 387-411.



GENDER DISCRIMINATION IN THE RECRUITMENT OF ENTRY-LEVEL

ACCOUNTANTS

Hardin, J. Russell Pittsburg State University

[email protected]

Reding, Kurt F. Pittsburg State University

[email protected]

Stocks, Morris H. University of Mississippi [email protected]

ABSTRACT

This study examines whether there is gender bias in the recruitment of entry-level accountants by public accounting firms. The effects of student gender, recruiter gender, and firm size were used as independent variables. A sample of recruiters from large and small accounting firms was asked to rate the employability of a hypothetical student graduating with a major in accounting. The recruiters were also asked to indicate the approximate salary they would offer this hypothetical recruit. The overall results show that, after controlling for recruiter age, females and males are recruited equally and are offered similar starting salaries. The results also show that recruiters from large firms rate both males and females higher than small firms and offer larger starting salaries. An examination of a two-way interaction between student gender and recruiter gender, however, returned an unexpected result. Female recruiters rate males somewhat higher than females and offer significantly higher salaries to males compared to females.



PERFORMANCE MEASURES IN HOSPITALS

Smith, Melissa Ann Stephen F. Austin State University

Marsh, Treba Lilley

Stephen F. Austin State University [email protected]

ABSTRACT

Delivering cost efficient high quality health care is essential to a facility's success in today's competitive market. As the operating environment changes and the role of accounting and external disclosure grows, the methods of evaluations also need to change. There are three aims that the hospital accounting system should accomplish in today's health care environment. The accounting system should accomplish: (1) cost efficiency without a negative impact on the quality of service or delivery, (2) provide relevant and timely information in order to allow management to maximize their resources and (3) assist in quality improvements. These objectives can be met through activity based accounting which measures the cost and performance of activities and resources. Resources are assigned to activities and, subsequently, activities are assigned to cost objects, based on their use. However, performance is impacted by more variables than simply cost. Performance measurement systems use the data stored in accounting systems to evaluate the activities performed by the organization. In addition, performance measurement systems are used to support decisions about budgeting, performance goals, employee mix and customer service. By tracking both financial and operational measures, performance measurement solutions should provide a more balanced measure of real performance.



HOW MUCH IS AN ACCOUNTING PUBLICATION WORTH?

Todd L. Sayre

University of San Francisco [email protected]

Frederick W. Rankin

Washington University

James R. Hasselback Florida State University

[email protected]

ABSTRACT

We investigate the effects of high-tier and low-tier publications on the salaries of accounting professors. We separate the effects between institutions with high and low levels of research emphasis. Our sample consists of 910 accounting professors from 126 institutions. We collected the salary information for our sample from the annual budgets of each university. The results indicate that both high-tier and low-tier institutions consider the journal quality of publications in determining faculty pay, both high-tier and low-tier institutions pay more for publications in high-tier journals. In addition, while both types of institutions pay a comparable amount for a publication in a high-tier journal, high-tier institutions pay less than low-tier institutions for publication is low-tier journals. Combining the difference in pay and publications between the faculty at high-tier and low-tier institutions explains over 1/3 of the total difference between the average salaries.

INTRODUCTION

Journal article publications play an important role in the reward structure of faculty working in academic institutions. Many studies document a positive relationship between number of publications and faculty salaries (e.g., Zivney & Bertin, 1992; DeLorme et al., 1979). A smaller number of studies investigate the impact of journal quality on faculty salaries (e.g., Tuckman & Leahey, 1975; Swidler & Goldreyer, 1998). Despite its importance, only Gomez-Mejia and Balkin (1992) address the notion that the research emphasis of institutions affects the valuation of journal article publications. In the context of agency theory, Gomez-Mejia and Balkin (1992) argue that organizational objectives should influence the emphasis that principals place on particular performance dimensions in determining pay. They hypothesize that institutions that grant doctoral degrees are more likely to reward faculty members for research productivity than are non-doctoral granting institutions. For a sample of 353 professors of management, they use surveys to collect salary information and other data. The results indicate that while both doctoral and non-doctoral granting institutions reward professors for publishing in high-tier journals equally, only the non-doctoral granting institutions reward professors for publishing in low-tier journals. Contrary to their prediction, these results imply that non-doctoral granting institutions emphasize research in rewarding their faculty more than do doctoral granting institutions. We investigate the effects of high-tier and low-tier publications on the salaries of accounting faculty in institutions with high and low levels of research emphasis. Our study improves on similar studies that investigate the relationship between publications and salary in several respects. First, earlier studies report results from very small samples, which were collected from only a handful of institutions. In contrast, our sample consists of 910 accounting professors from 126 institutions. Second, Gomez-Mejia



and Balkin (1992), the study most similar to this paper, used surveys to collect salary information and other data. Although the surveys provided for a large sample, concerns arise regarding the accuracy of the data. For example, a sampling bias would result if the professors who were proud of their publication records or salaries were more inclined to complete the survey. To avoid such problems, we collected the salary information for our sample from the annual budgets of each university.

RESEARCH METHOD

We requested the 1995 academic year budgets for the accounting departments of every public U.S. four-year academic institution listed in Hasselback’s Accounting Faculty Directory (1996). A total of 126 schools provided us with usable budgets. Candidates for our study were restricted to individuals included in the 1995 academic year budget who 1) held PhD’s or DBA’s as of 1995 according to Hasselback’s Accounting Faculty Directory (1995); and, 2) held the rank of professor, associate professor, or assistant professor in 1995 according to the budget. Department heads and deans were excluded. The final sample totaled 910 accounting professors. For each faculty member, we collected: (1) the nine-month pay for the 1995 academic year; (2) the rank achieved for the 1995 academic year (e.g., assistant professor); (3) the number of years employed in an academic accounting department after receiving the terminal degree; and, (4) information pertaining to the quantity and quality of the journal articles published through 1995. The budgets typically listed the pay for each faculty member and the number of months for which the pay applied (e.g., nine months). We clarified any uncertainties regarding the budget information by calling the appropriate institutional budget department. To insure the integrity of the budget information, one author made all the necessary calls. Many budgets did not include summer support. In addition, because our selection criterion eliminated administrators, our sample included only faculty members who potentially received no pay beyond nine months. Accordingly, the dependent variable reported in our results reflects only nine-month pay. Unless the independent variables vary systematically with summer support, our results should be unbiased. We limited rank to three categories: professor, associate professor, and assistant professor. Department heads and deans were eliminated, because faculty publications typically are not weighted in the same manner in the evaluation of overall performance for these administrative categories as they are for faculty in the other ranks. The categories denoted on departmental budgets were utilized when given or were obtained from Hasselback’s Accounting Faculty Directory (1995). We determined, again from Hasselback’s Accounting Faculty Directory (1995), the number of academic years each individual had been employed at an academic institution since receiving the terminal degree. Both rank and years of employment were collected, because each might independently impact pay. Three computerized databases were used to build the database of articles examined in this study. Pacific Research Company publishes two databases: Database of Accounting Research, which contains the listings of 47 accounting journals, and Database of Finance Research, which contains the listings of 40 finance journals. The Economic Literature Database (1996), which contains information pertaining to 300 economics, finance, accounting, real estate, and insurance journals, was utilized to collect data on articles published in 47 additional journals. A total of 134 academic journals were examined for authored papers. None of the databases give credit for notes, letters to the editor, departmental articles, or other instances where the author’s name does not appear in the listed table of contents. Full credit was given, however, for co-authored works. We separated journals into those of high and low quality. To determine the quality of the published articles, we assigned weights to the journals in our database primarily based on seven recent articles that ranked subsets of the journals in our list (i.e., Schroeder et al., 1988; Hull and Wright, 1990; Hall & Ross, 1991; Smith, 1994; Brown & Huefner, 1994; Alexander & Mabry, 1994; Jolly et al., 1995). Hull and Wright (1990) ranked 39 journals by having respondents assign a rating to each journal with respect to The Journal of Accountancy, which previously had been assigned a rating of 1. Information contained in the six remaining studies was then used to assign ratings to 27 journals not included in the Hull and Wright study. We estimated the ratings for each of these journals based on their proximity to journals previously rated in the Hull and Wright study. This procedure resulted in ratings for 66 of the journals considered in the current study. Similar to the procedure used in Morris et al. (1990), these



journals were then separated into eleven clusters, with all journals in a given cluster receiving the same rating. The resulting ratings ranged from a high of 2.25 to a low of .70. Most of the remaining journals not included in any previously cited study were assigned a weight of .70. Based on the quality ratings, we classified journals as either high-tier, those with ratings of 1.60 and higher, and low-tier. We classified each school that submitted a budget according to the institutional classification scheme specified by the Carnegie Foundation for the Advancement of Teaching (1994). We also rated each doctoral program from which our sample of faculty members received their terminal degrees. We used the six categories reported in A Classification of Institutions of Higher Education (Carnegie Foundation for the Advancement of Teaching, 1994) to classify the sample into high-tier and low-tier institutions. We classified the first three categories as high-tier institutions and the last three categories as low-tier institutions. Any institutions not included in the Carnegie classification were also considered low-tier institutions. We used the Hasselback and Reinstein (1995) rankings of accounting doctoral programs to rate the institutions from which each faculty member had received his or her terminal degree. Hasselback and Reinstein ranked 73 doctoral programs by the number of articles per accounting graduate, weighted both for co-authorship and journal quality. Rankings were based on the articles written by the 1978-1992 graduates, which had been published in 41 major accounting journals. Journal quality was determined in a manner similar to that used in the present study. The ratings of doctoral granting institutions range from a high of .53 to a low of .01. All institutions not included in the Hasselback and Reinstein study, such as a foreign school, were assigned a rating of .01.

RESULTS

Table 1, Panel A provides descriptive statistics of high-tier and low-tier institutions. The total sample consists of 910 faculty members from 126 institutions. The faculty averaged a 9-month salary of $68,355, high-tier publications of 1.63, and low-tier publications of 3.23. In addition, the average number of years since receiving a terminal degree was 13.21 and the average quality of graduate program was .18. Of the 910 accounting faculty comprising the sample, 475 worked at high-tier institutions while 435 worked at low-tier institutions. Compared to those at low-tier institutions, the accounting faculty at high-tier institutions have, on average, higher salaries ($75,160 vs. $60,924), more publications in both high-tier (2.75 vs. .40) and low-tier journals (4.19 vs. 2.19), and terminal degrees from higher quality graduate programs (QGP = .21 vs. .14). Table 1 Panel B shows the results of t-tests on these differences between the high-tier and low-tier institutions. The tests indicate that all of these differences are significant at the .01 level. The remaining variable, average years since being granted a doctorate, was higher for high-tier institutions (13.75 vs. 12.63), but the difference was only weakly significant (t-value = -2.7, p = .039). Table 1 also shows averages across professorial ranks. Not unexpectedly, average pay, number of years since receiving a doctorate, and low-tier and high-tier publications all increase when moving from the assistant the full professor rank. A chi-square test of independence indicates that the proportion of faculty at the professorial ranks of assistant, associate, and full professor were not significantly different between high-tier and low-tier institutions (Chi-square = 2.68, p = .262). Moreover, Panel B indicates that, like for the total sample, for each of the professorial ranks, t-tests for the differences in pay, quality of graduate program, and publications between high-tier and low-tier institutions are significant at the .01 level. Not surprisingly, the difference in years since receiving a doctorate is not significant for assistant and associate ranks, but is significant at the .05 level for full professors.



TABLE 1 Characteristics the Sample and Test Statistics

Panel A: Characteristics of sample7

Assistant Professor Associate Professor Institution Type1

n Pay2 QGP3 Yrs4 LoPub5 HiPub6 n Pay2 QGP3 Yrs4 LoPub5 HiPub6

Research 1 81 68847 0.23 4.69 1.12 1.27 100 72851 0.23 13.46 3.85 2.82 Research 2 19 60333 0.16 4.79 2.00 0.21 31 64377 0.17 11.03 0.38 0.65 Doctoral 1 30 62341 0.16 5.07 1.60 0.27 31 62422 0.15 13.87 3.07 0.61 High-tier 130 66101 0.21 4.79 1.36 0.89 162 69234 0.20 13.07 3.69 1.98 Doctoral 2 33 61405 0.17 4.45 0.70 0.45 27 64534 0.15 15.04 3.70 0.63 Master's 1 89 55021 0.13 5.01 0.83 0.15 120 58657 0.14 12.97 2.32 0.17 Master's 2 9 53672 0.16 5.11 0.11 0.00 12 53541 0.15 8.00 0.50 0.17 Low-tier 131 56536 0.14 4.88 0.75 0.21 159 59269 0.14 12.94 2.42 0.25 Total 261 61301 0.17 4.84 1.05 0.55 321 64298 0.17 13.01 3.06 1.12

Full Professor Total Institution

Type1 n Pay2 QGP3 Yrs4 LoPub

5 HiPub6 n Pay2 QGP3 Yrs4 LoPub5 HiPub6

Research 1 121 92066 0.25 20.95 6.71 6.21 302 79476 0.24 14.11 4.27 3.76 Research 2 18 77446 0.17 18.56 6.61 2.00 68 66706 0.17 11.28 4.03 0.88 Doctoral 1 44 76319 0.19 20.91 6.48 1.91 105 68222 0.17 14.30 4.08 1.06 High-tier 183 86841 0.23 20.70 6.65 4.76 475 75160 0.21 13.75 4.19 2.75 Doctoral 2 35 73958 0.18 20.71 5.80 2.09 95 66919 0.17 13.45 3.43 1.11 Master's 1 106 64425 0.13 18.81 2.42 0.33 315 59571 0.13 12.69 1.93 0.22 Master's 2 4 63590 0.11 19.00 2.75 0.00 25 55196 0.15 8.72 0.72 0.08 Low-tier 145 66703 0.14 19.28 3.24 0.75 435 60924 0.14 12.63 2.19 0.40 Total 328 77939 0.19 20.07 5.14 2.99 910 68355 0.18 13.21 3.23 1.63

Panel B: Statistical tests for differences between high-tier and low-tier institutions

Assistant Professors Associate Professors Full Professors All Professors Variable t-value Sig. t-value Sig. t-value Sig. t-value Sig.

Pay2 -10.58 .000 -9.96 .000 -11.69 .000 -15.52 .000 QGP3 -5.15 .000 -5.68 .000 -7.35 .000 -10.67 .000 Yrs4 .194 .846 -.191 .849 -2.12 .035 -2.7 .039 LoPub5 -3.21 .000 -3.81 .000 -5.57 .000 -7.19 .000 HiPub6 -5.26 .000 -8.52 .000 -7.32 .000 -10.37 .000 1 Source: Carnegie Foundation for the Advancement of Teaching (1994) 2 Average 9-month salary. 3 Average quality of graduate program. 4 Average number of years since being granted a doctorate. 5 Average number of publications in the low-tier journals. 6 Average number of publications in the low-tier journals. 7 Professorial Rank chi-square statistic = 2.68, p = .262



Table 2 shows the results of the regressions for high-tier and low-tier institutions. The regressions for both high-tier and low-tier institutions indicate the coefficients for QGP, LOWJRLS, HIGHJNLS, and PROF are significant and that SEX, YEARS, and ASOC are not significant. The variance inflation factors indicate no serious multicollinearity among variables. Other diagnostic tests for multicollinearity, including eigenvalues, condition indices, and variance-decomposition proportions, also indicated no serious problems. The explanation for an insignificant SEX coefficient is discussed in Sayre et al. (2000). Briefly, they find that gender affects accounting faculty pay through differences in productivity and experience (e.g., publications, rank, and years worked), but not independently. Therefore, since on average males produced more and worked longer, their salaries were higher. To investigate the reason for the insignificant YEARS coefficient, we performed a stepwise regression, entering the variables in the order shown on Table 2. We found that only after adding the variables ASOC and FULL did the relationship between YEARS and PAY become insignificant. This implies that the YEARS variable only served as a proxy for promotions. However, it can be argued that YEARS should be significant even after controlling for rank since academicians receive pay increases if for no other reason than inflation. The reason may lie in the measurement of YEARS, which neglects years worked before receiving their terminal degree. Since many accounting educators began their careers ABD, YEARS variable may be obscured. Finally, the insignificant ASOC coefficient implies that a pay increase does not typically result from promotion to associate professor. While this may be true, indirect pecuniary benefits accrue to those promoted to associate since this typically means that they were granted tenure. Comparing the coefficients, the two types of institutions appear to pay about the same amount for a publication in a high-tier journal, but differ in what they pay for a publication in a low-tier journal. The coefficients for the HIGHJRNLS variable indicate that a publication in a high-tier journal results in $1,574 for a low-tier institution and $1,968 for a high-tier institution. Ninety-five percent confidence intervals for the coefficients imply that the coefficients do not significantly differ. The coefficients for the LOWJRNLS variable indicate that a publication in a low-tier journal results in $892 for a low-tier institution and $292 for a high-tier institution. The 95% confidence intervals imply that the coefficients significantly differ from each other as well as from the coefficients related to HIGHJRNLS for high-tier and low-tier institutions. These results taken together suggest that both high-tier and low-tier institutions pay more for publications in high-tier journals and that the pay is comparable; however, compared to low-tier institutions, high-tier institutions pay less for publications is low-tier journals. The coefficients indicate that as compared to a publication in a low-tier journal, high-tier institutions pay about 7 times more for a publication in a high-tier journal while low-tier institutions pay only twice as much. This difference in the amount by which high and low-tier institutions reward publications in high-tier journals combined with the average difference in publications in high-tier journals explains a large part of the difference in average pay.



TABLE 2 Regression Results

Low-tier institutions:

Unstandardized Coefficients

95% Confidence Interval for B

Model

B Standard

Error

t

Sig. Lower Bound

Upper Bound

VIF Constant 54,368 988 55.00 0.00 52,425 56,311 SEX -823 931 -0.88 0.38 -2,653 1,007 1.11 QGP 12,321 4,175 2.95 0.00 4,114 20,527 1.09 YEARS -59 66 -0.90 0.37 -188 70 2.14 LOWJRLS 892 110 8.11 0.00 676 1,108 1.12 HIGHJNLS 1,574 277 5.68 0.00 1,030 2,118 1.12 ASOC 1,596 1,058 1.51 0.13 -483 3,674 1.95 FULL 7,775 1,343 5.79 0.00 5,135 10,415 3.01

R2 = .391

High-tier institutions: Unstandardized

Coefficients 95% Confidence

Interval for B

Model

B Standard

Error

t

Sig. Lower Bound

Upper Bound

VIF Constant 61,274 1,367 44.83 0.00 58,588 63,960 SEX 883 1,317 0.67 0.50 -1,706 3,472 1.11 QGP 13,283 4,195 3.17 0.00 5,040 21,527 1.12 YEARS -67 91 -0.73 0.46 -246 112 2.64 LOWJRLS 292 110 2.65 0.01 75 509 1.28 HIGHJNLS 1,968 113 17.35 0.00 1,745 2,191 1.25 ASOC 1,002 1,434 0.70 0.48 -1,815 3,819 2.18 FULL 12,569 1,988 6.32 0.00 8,664 16,475 4.42

R2 = .628

The average number of publications in high-tier journals is 2.75 for high-tier institutions and .40 for low-tier institutions. Multiplying these averages by their coefficients yields $5,412 for high-tier institutions and $630 for low-tier institutions. The difference of $4,782 explains over 1/3 of the total $14,236 difference in average pay between high and low-tier institutions. In contrast, publications in low-tier journals add more to average pay in low-tier institutions than they add to pay in high-tier institutions. The average number of publication in low-tier journals is 4.19 for high-tier institutions and 2.19 for low-tier institutions. Multiplying these averages by their coefficients equals $1,223 for high-tier institutions and $1,953 for low-tier institutions. Finally, the independent variables explain more of the variation in salaries for high-tier institutions than they do for low-tier institutions (R2 = .628 vs. .391). This implies that high-tier institutions rely on performance measures included in our model to a greater degree than do low-tier institutions.

CONCLUSION

Although considerable research investigates the determinants of faculty pay, few consider journal quality and only one (i.e., Gomez-Mejia & Balkin, 1992) considers the research emphasis of institutions. Moreover, the previous studies base their results on very small samples collected from only a handful of institutions. One exception is Gomez-Mejia and Balkin (1992) that collected salary data and other information through surveys.



We investigate the effects of high-tier and low-tier publications on the salaries of accounting faculty in institutions with high and low levels of research emphasis. Our sample consists of 910 accounting professors from 126 institutions. We collected the salary information for our sample from the annual budgets of each university. To our knowledge no earlier study uses such a large sample of objective salary data in investigating the determinants of faculty pay. This study suggests that both high-tier and low-tier institutions consider number of publications in determining faculty pay. The results indicate that both high-tier and low-tier institutions consider the journal quality of publications in determining faculty pay, both high-tier and low-tier institutions pay more for publications in high-tier journals. In addition, while both types of institutions pay a comparable amount for a publication in a high-tier journal, high-tier institutions pay less than low-tier institutions for publication is low-tier journals. Combining the difference in pay and publications between the faculty at high-tier and low-tier institutions explains over 1/3 of the total difference between the average salaries.



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INDEPENDENCE ISSUES FOR THE 21st CENTURY: CONSIDERATION OF A CROSS-CULTURAL BIAS

Lavin, David

Florida International University [email protected]

Hillison, William

Florida State University [email protected]

ABSTRACT

The issue of independence is so important that the profession recently established the

Independence Standards Board (ISB or Board) with the mission of developing a conceptual framework for independence applicable to audits of public entities. The conceptual framework is to serve as the foundation for the development of principles-based independence standards and the Board is charged with the responsibility to create, codify, amend, and preserve independence standards for auditors of public companies.

One of the initial issues undertaken by the Board is the topic of family relations and auditor independence. Although the rules have always prohibited certain familial situations, the Board notes that "the practical problems of applying the existing rules to protect auditor independence in these situations have intensified greatly. The notion of what is 'close family' has evolved with the changing demographics of divorce and co-habitation, for example." Currently an ISB project task force is considering undertaking research and other endeavors necessary to evaluate the alternatives in establishing rules. Our purpose is to provide one aspect of independence research with regard to the changing nature of the business environment, that relating to the influx of the Hispanic culture. We provide evidence as to whether Hispanics view familial relationships differently than non-Hispanics when judging the effects of those relationships on independence. We also extend the analysis to report on how our sample perceived the effects of family relationships as compared to existing AICPA standards.

INTRODUCTION & PURPOSE

Financial statement users, such as stockholders and creditors, demand assurances that management representations are not materially misstated or biased. Independent auditors have traditionally provided that assurance for public companies under the administration of the Securities and Exchange Commission. It has been long recognized that the cornerstone of the auditing profession is independence and without independence, the auditor's assurances are of no value to users of audited financial statements. And, although the profession has changed dramatically in recent years, Bartlett (1993) states “At a time when significant challenges are being made to the societal role of the public accounting profession, independence continues to be one of the most important issues that it faces” (p. 65). The issue of independence is so important that the profession recently established the Independence Standards Board (ISB or Board) with the mission of developing a conceptual framework for independence applicable to audits of public entities. The conceptual framework is to serve as the foundation for the development of principles-based independence standards and the Board is charged with the responsibility to create, codify, amend, and preserve independence standards for auditors of public companies.

One of the initial issues undertaken by the Board is the topic of family relations and auditor independence. Although the rules have always prohibited certain familial situations, the Board notes that "the practical problems of applying the existing rules to protect auditor independence in these situations have intensified greatly. The notion of what is 'close family' has evolved with the changing demographics



of divorce and co-habitation, for example." Currently an ISB project task force is considering undertaking research and other endeavors necessary to evaluate the alternatives in establishing rules. Our purpose is to provide one aspect of independence research with regard to the changing nature of the business environment, that relating to the influx of the Hispanic culture. We provide evidence as to whether Hispanics view familial relationships differently than non-Hispanics when judging the effects of those relationships on independence. We also extend the analysis to report on how our sample perceived the effects of family relationships as compared to existing AICPA standards.

WHY CONSIDER THE HISPANIC ISSUE?

One major change in the business environment that was alluded to by the ISB results from the

impact of other cultures. Recent population estimates indicate that there are 22 million Hispanic/Latino Americans representing 8.2% of the total U.S. population. This segment of society has been growing at approximately 34% or five times the general population growth in the U.S. (Szapocznik1995, p. 6). It is predicted that sometime in the early part of the 21st century Hispanics will represent 25 percent of the U.S. population. The Hispanic enclave, in particular Cuban influx that began in Miami, has grown to become a major segment of the economy of the Southeast United States. Additionally, Hispanic influence from Mexico and Latin America, in the southwest has been documented and that influence continues to grow. Since this growth is material, independence might be perceived differently by these informed third parties when compared to non-Hispanics. Given this new sphere of influence, it is appropriate that the ISB, in fulfilling their responsibilities, consider results of research studies and any other relevant information.

BACKGROUND OF EXPECTED DIFFERENCES

Why might it be expected that differences in attitudes about family relationships be manifested

between Hispanic and non-Hispanic users of audit services? One reason is that family value structure differences have been documented in a number of studies. The research indicates that Hispanics appear to have stronger ties with their families than many other cultures. It has been noted that the Hispanic/Latino American's relationship with the family, including those family members more remote such as cousins, aunts, uncles, nieces, or nephews, appears to be stronger than that of their U.S., non Hispanic, counterpart. Szapocznik, et al. (1995) in reference to Hispanics, state that “our concept of family conforms with the existing patterns of extended family/kinship networks in the Hispanic/Latino community in which multiple generations are integral members of the family” (p. 172). Additionally, it has been noted that "...a Cuban's self-confidence, sense of security, and identity were established through family relationships" (Boswell and Curtis 1983, p. 181). The importance is illustrated by the “compradre” system where a set of compradres is selected for each child in a Hispanic family. Although similar to the tradition of godparents in other segments of U.S. society, it is taken more seriously by Hispanic/Latino citizens and usually involves a higher level of personal obligation by the compradres. The purpose of a compradre is to offer both economic and moral assistance to the family member. Since it is essential that compradres live close to the family member, they are often relatives such as cousins, aunts, or uncles. The importance of the centrality of the family in terms of feelings of loyalty, reciprocity, and familism for Hispanics has been documented as a distinct and enduring characteristic among Mexicans, Cubans, Puerto Ricans, and Central and South Americans (Rodriguez 1998). Based upon a large body of literature, it is expected that financial statement users of Hispanic/Latino descent may have different perceptions of the importance of familial relationships on independence.

As an alternative consideration, as other cultures are merged into society, it might be expected that those cultures would come to share similar perceptions of the society. There have been studies that support this conjecture. For example, Szapocznik and Kurtines note that “Cuban families were embedded in a culturally diverse context, in which parents and children were exposed to both Hispanic and mainstream values and customs. Following traditional learning curves, young people acculturated far more quickly to the mainstream, whereas parents tended to remain far more attached to their traditions” (1993, p. 402). From the ISB's perspective, it would be advantageous to find no differences in perceptions across cultures. This would increase the confidence that a parsimonious set of rules might adequately address the family related independence concerns.



THE CONCEPT OF INDEPENDENCE The requirement of auditor independence in fact is a necessary, but not sufficient condition to

assure that users have confidence in the auditor's opinion. Independence in fact relates to the auditor's mental attitude or intellectual honesty and is not directly measurable. However, to ensure confidence, the auditor must also be independent in appearance. To be independent in appearance, the auditor must be recognized or viewed by the user as impartial. The ISB is charged with the responsibility to develop rules to assure that auditors can maintain independence in fact as well as provide the appearance of independence to the financial statement users. Currently the AICPA Code of Conduct, particularly the interpretations of Rule 101, deals specifically with the appearance of independence. This literature provides explicit guidance to auditors concerning the potential effect of family relationships on independence (AICPA ET Section 101-1). In general, it is concluded that the appearance of independence is impaired when a spouse or dependent person has any direct financial or managerial position with a client. Additionally, the standards state that any close relative having a material financial interest or significant influence over the operating, financial or accounting policies of the client would impair the CPA's independence. Remote relatives' association with clients is not expected to influence users' perceptions of auditor independence, and thus these relationships are not currently prohibited by the Code of Conduct.

Only limited empirical research has been conducted as to what degree users actually view family relationships as an important factor in judging whether the CPA appears to be independent. Virtually no evidence exists whether culture, in particular Hispanic, is related to users’ perceptions of family relationships on independence. The following section describes research into that area.

DESCRIPTION OF STUDY

A sample of financial statement users and CPAs was taken from the Dade/Broward county area of

Southeast Florida. As part of a university accounting class assignment, students were individually required to identify and contact a designated number of Hispanic and non-Hispanic bank loan officers and CPAs. Students administered a pre-prepared questionnaire directly to the subjects after providing information on its general nature and purpose. Prior to administering the questionnaire, the students were coached in the use of appropriate procedures to assure conformity in responses. The following sample was obtained for each classification:

Hispanic Loan Officers 94 Non Hispanic Loan Officers 109 Hispanic CPAs 99 Non Hispanic CPAs 106 Although, the sample cannot be considered truly random, a representative mixture of subjects

appeared to be identified. Tables 1 and 2 provide additional demographic information about the subjects. The age percentages across the classifications are not significantly different. As expected due to the Florida State Board of Accountancy requirements, the CPAs have, in general, a higher level of education than the loan officers. However, most subjects in all classifications have some college education. No apparent biases were evident in the sample.

The data collection instrument began by providing a set of instructions to the subject. Several fact statements framing the audit environment followed the instructions. Questions to the subject were then posed as to whether the CPA described would be considered independent by the subject. Ten questions relating to two different scenarios resulted in 20 responses per subject concerning the issues of interest. For example, the following is a representative question:

The CPA partner's office is participating in a significant portion of the audit engagement wherein the client's financial officer is the CPA partner's non-dependent child. Is the CPA: Independent? Not Independent?

The alternative scenario and related questions indicated that the family member held a financial interest in the client rather than being a financial officer. The two forms of the scenario were asked, varying across ten family relationships explicitly identified in the AICPA Code of Conduct. Those ten family relationships were:

•Non-dependent child •Brother or sister



•Grandparent •Spouse's brother or sister •Brother or sister's spouse •Uncle or aunt •Cousin •Niece or nephew •Father or mother •Parent-in-law A forced choice dichotomous measure of independent versus not independent was used to elicit

responses. A Likert-type scale was considered for use, but rejected. The dichotomous measure was considered more appropriate since Fritzemeyer and Carmichael (1972, p. 80) argue that "there are no varying degrees of lack of independence; the auditor is either independent or he is not independent." Lavin (1976) uses this forced-choice methodology in studying different issues of user perceptions of auditor independence. Additionally, Coffey (1993) presents a series of scenarios in an exercise which requires the reader to make a dichotomous decision about the independence of a practitioner. Based on a specific scenario, the subjects were required to choose whether the auditor would be judged independent or not independent. The scenarios were based on the current AICPA standards relating to family relationships and independence and demonstrate the attitude of the AICPA concerning the expectation of a dichotomous judgment concerning independence.

For the 10 questions relating to where the client's financial officer is the CPA partner's family member, the existing AICPA Standards state that the auditor would lack the appearance of independence if the family member were any of the following:

•Non-dependent child •Brother or sister •Grandparent •Brother or sister's spouse •Father or mother •Parent-in-law For the following relationships from the same scenario the auditor would be considered to be

independent under current AICPA standards: •Spouse’s brother or sister •Uncle or aunt •Cousin •Niece or nephew The question concerning a financial interest held by a relative specified in the questionnaire

instructions that the subject was to assume that "The financial interest held by the kin is not material or is unknown to the partner...” Thus, existing AICPA Standards would consider the auditor to be independent in all 10 cases (family relationships) presented.

TESTS FOR CROSS-CULTURAL DIFFERENCES

To determine if there are differences in independence perceptions by Hispanic and non-Hispanic

users, tests on the two samples, bank loan officers and CPAs, were performed. The following null hypotheses are tested for each of the 10 family relationships: Ho1 : There are no differences of independence perceptions between Hispanic and non-Hispanic `bank

loan officers. Ho2 : There are no differences of independence perceptions between Hispanic and non-Hispanic .

A Chi-square test of independence is used to test each hypothesis. Tables 3 and 4 present the results of these tests. The left panel in both tables reports the results of Bank Loan Officers, Hispanic and non Hispanic and the classifications--Independent versus Not Independent. Contrary to expectation, there is little evidence to support rejection of Ho1. A Chi-square test statistic of 3.84 (alpha level of .05) indicates that there is only one relation deemed a significant difference at that level. Given there were 20 individual tests, this finding would not be unexpected. If a less traditional significance level of .1 is



considered, then three scenarios would indicate differences. Thus, in general, it is concluded that Hispanic and non-Hispanic loan officers do not hold different attitudes of independence for the relatives tested in this study.

A similar conclusion can be drawn from the analysis of the CPA subjects. That is, Ho2 cannot be rejected at the .05 level of significance for any scenario. This suggests that no significant differences exist in the population of Hispanic versus non-Hispanic CPAs on their attitudes concerning the effects of family on independence perceptions.

CONSENSUS WITH EXISTING AICPA STANDARDS

The next issue addressed was whether there is a consensus of perceptions that are congruent with

the current AICPA Standards. Although the division between bank loan officers and CPAs is maintained, the sample is pooled across Hispanic and Non Hispanic where previous tests suggested no systematic cross-cultural differences. The following hypotheses are tested for each of the scenarios:

Ho3 : There is no consensus of perceptions with existing AICPA Standards of independence among

bank loan officers. Ho4 : There is no consensus of perceptions with AICPA Standards of independence among CPAs.

Consensus is defined operationally as a statistically significant majority opinion. The degree of consensus can be evaluated by the frequencies of responses. The binomial test was used to test each hypothesis where it is expected:

P = Q = .5 The alternative hypothesis is accepted (e.g., a consensus does exist) if: P ≠ Q

P is the proportion of responses expected in the Independent category and Q is proportion of responses expected in the Not Independent category. If the null hypothesis is rejected, then it can be concluded that a consensus exists. The results can then be compared to existing AICPA guidance to determine consistency or lack of consistency with extant standards.

Panel A of Figure 1 provides the pooled results for the bank loan officers for each of the scenarios where, based on the prior analysis, no difference existed between Hispanic and non-Hispanic. Ho3 is rejected at an alpha level of .05 for all seven of the scenarios presented. The direction is important since it suggests that bank loan officers would consider the auditor to lack independence in every condition where a relative was a financial officer in the audited organization. Recall that the existing AICPA standards would conclude that the auditor lacked independence in six of the seven scenarios and that the bank loan officers also concluded that independence would be impaired. An “arrow” in Panel A of Figure 1 marks these scenarios. Thus, for these relationships current AICPA standards are consistent with the empirical findings. That is bank loan officers would conclude that the auditor lacks independence and the AICPA standards prohibit the situation. However, the scenario not marked with an arrow, that of the client's financial officer is the brother or sister of the CPA's spouse, is not prohibited by the AICPA yet over 60% of the bank loan officers considered this situation to impair independence.

Panel B displays those scenarios where cultural differences likely exists and the analysis is based on non-pooled data. In all three scenarios, the non-Hispanic bank loan officers would judge the auditor to lack independence. Based on current AICPA rules, the auditor would be considered independent in these cases. Thus, the standards appear not congruent with the empirical findings. For the Hispanic bank loan officers in only one scenario, where the relative is and uncle or aunt, did the loan officers judge the auditor to lack independence. Again, this scenario is allowed under current AICPA standards. In the final two scenarios where the relative is a cousin or niece/nephew, the Hispanic loan officers did not have a consensus of whether the auditor was independent or lacked independence.

Figure 3 continues the analysis of bank loan officers for the scenario that the relative holds an immaterial financial interest in the client. Analysis on the pooled sample indicates that there is a consensus that the auditor lacks independence in all ten scenarios. Ironically, for all ten scenarios current AICPA



standards would determine the auditor to be independent. Thus, the AICPA standards and the empirical evidence are not congruent.

For the CPA sample the results are more mixed as reported in Figures 2 and 4. However, Ho4 is still rejected in general. Results indicate that CPAs, themselves, would consider the familial relationships to affect perceptions of independence. In most cases the CPAs indicated that the family relationship would impair independence in the judgment of the CPA. Several exceptions are noted, however. First, where an aunt/uncle, cousin, or niece/nephew held a financial officer position in a client, CPAs held no consensus of opinion of whether the auditor would be or would not be independent. Similarly, where an uncle/aunt held an immaterial financial interest in a client, CPAs held no consensus of opinion. However, where a cousin or niece/nephew held an immaterial financial interest in a client, there was a consensus of CPAs that the auditor would be independent. These exceptions indicated that the auditor could maintain independence by the CPAs and are consistent with the current AICPA standards.

However, recall that the perceptions of the users (e.g., bank loan officers), not necessarily CPAs, are the important consideration for the profession. As noted above in all 14 conditions where the AICPA would allow the familial relationship and determine the auditor to be independent, a significant majority of the loan officers indicated that they would judge the auditor as not independent.

Although the results based on cultural difference provide optimism for the actions of the ISB, the subsequent analysis about the general attitudes towards family relationships and independence appears somewhat dismal. Based on these results, users expect more than the current AICPA rules.

SUMMARY AND LIMITATIONS

There are two aspects of independence presented here. First, it may be reassuring to note that

there appears to be consistency of opinions across two significant segments of society concerning one facet of audit-related perceptions. There was no support for a cross-cultural bias in opinions on independence. This supports the conclusion that the ISB may be able to establish pervasive standards that can attain widespread support across diverse segments of society.

The second aspect, however, is disconcerting. Results here suggest that a significant segment of users, e.g., a sample of loan officers, conclude that in many cases, family relationships with a client affect perceptions of independence. In the cases presented here, the results indicate that a significant majority of loan officers would conclude that the auditor lacked independence. In contrast, many (14 of 20) of these cases are currently permitted under current AICPA standards. This may require additional study and potentially change by ISB.

Obviously, analyses from studies such as this one are subject to numerous limitations. Some of the apparent limitations stem from potential sample bias. The focal point was Hispanic and non-Hispanic loan officers and CPAs from only one geographical area. Generalizations to other populations are subject to sampling risk.

Additionally, the instrument presented the questions in only one specified manner. Concerns of framing must be considered. Different responses may have been attained if the scenarios or questions were presented differently. In a related sense, the forced-choice, dichotomous nature of the responses may have altered the results that might be expected by using other techniques. Regardless of the limitations, we feel that the results should be considered carefully by the profession, in particular the ISB which is charged with ensuring auditor independence. We also encourage additional research on the issues.

Table 1 CPA’s & Loan Officer’s Ages

Percentages of Sample CPAs Loan Officers

Age Category Hispanic Non Hispanic Hispanic Non Hispanic 18 - 24 8.0% 6.7% 8.4% 3.7% 25 - 29 27.0 16.2 28.4 25.0 30 - 34 25.0 24.8 21.1 21.3 35 - 39 15.0 18.1 17.9 17.6 40 - 44 10.0 11.4 11.6 14.8 45 - 49 6.0 12.4 6.3 10.2 50 - > 9.0 10.5 6.3 7.4



Table 2

CPA’s & Loan Officer’s Highest Education Level Percentages of Sample

CPAs Loan Officers Education Hispanic Non Hispanic Hispanic Non Hispanic

High School 0.0% 0.0% 2.1% 1.8% Some College 1.0 0.0 19.8 18.6 Bachelors 26.0 33.6 41.7 41.6 Some Graduate 26.0 30.8 18.8 16.8 Graduate & > 47.0 35.5 17.7 21.2

Figure 1

CONCLUSIONS BY BANK LOAN OFFICERS Relative is a Financial Officer in the Client

Panel A: Combined Hispanic/Non Hispanic Sample (n = 203) (No Significant Difference Between Hispanic/Non Hispanic)

Percent Judged CPA Not Independent

Indicates agreement with current AICPA Rules and Interpretations of not allowing this situation.

In all situations Bank Loan Officers would judge that the auditor lacked independence (Sample

supports that over 50% of population would judge auditor lacks independence at .05 significance level).

0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

Brother or Sister's Spouse

Spouse's Brother or Sister

Parent-in-Law

Father or Mother

Grandparent

Brother or Sister

Non-dependent Child



Panel B: Hispanic (n = 94)/Non Hispanic Sample (n = 109) (Significant Difference Noted Between Hispanic and Non Hispanic)


In all situations, except those noted by Not Significant (NS), Loan Officers would judge that the auditor lacked independence (Sample supports that over 50% of population would judge auditor lacks independence at .05 significance level). Sample not combined because prior analysis indicates a significant difference between the groups.

Figure 2

CONCLUSIONS BY CPAs Relative is a Financial Officer in the Client

Combined Hispanic/Non Hispanic Sample (n = 205)


Indicates agreement with current AICPA Rules and Interpretations of not allowing this situation.

In all situations, except those noted by Not Significant (NS), CPAs would judge that the

NS

NS

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Neice or Nephew

Cousin

Uncle or Aunt

Hispanic

Hispanic

Hispanic

Not Hispanic

Non Hispanic

Non Hispanic Niece or Nephew

NS

NS

0 % 20% 40% 60% 80% 100%

Neice or Nephew

Cousin

Uncle or Aunt



Parent- in-Law

Father or Mother

Grandparent

Brother or Sister

Non-dependent Child

NS

NS

NS Niece or Nephew



auditor lacked independence (Sample supports that over 50% of population would judge auditor lacks independence at .05 significance level).

Figure 3

CONCLUSIONS BY BANK LOAN OFFICERS Relative Has Immaterial Financial Interest in the Client



For all relationships represented above, the current AICPA rules and interpretations would

conclude that the auditor was independent. In all situations Bank Loan Officers would judge that the auditor lacked independence (Sample

supports that over 50% of population would judge auditor lacks independence at .05 significance level).

0% 20% 40% 60% 80% 100%

Neice or Nephew

Cousin

Uncle or Aunt



Parent-in-Law

Father or Mother

Grandparent

Brother or Sister

Non-dependent Child

Niece or Nephew



Figure 4

CONCLUSIONS BY CPAs Relative Has Immaterial Financial Interest in the Client



For all relationships represented above, the current AICPA rules and interpretations

would conclude that the auditor was independent. For "Uncle or Aunt" noted by Not Significant (NS), there is no consensus as to

independence. For those noted by SIG INDEP, the sample indicates that CPAs would have a consensus that the auditor was independent. In all other situations, the consensus was that the auditor lacked independence (Sample supports that over 50% of population would judge auditor lacks independence at .05 significance level).

0% 20% 40% 60% 80% 100%

Neice or Nephew

Cousin

Uncle or Aunt



Parent-in-Law

Father or Mother

Grandparent

Brother or Sister

Non-dependent Child

NS

SIG INDEP

SIG INDEP Niece or Nephew



REFERENCES

American Institute of Certified Public Accountants. June 1, 1995. AICPA Professional Standards. New York: AICPA.

Bartlett, Roger. 1993. “A Scale of Perceived Independence: New Evidence on an Old Concept,”

Accounting, Auditing & Accountability Journal (Vol. 6, No. 2): 52-67. Boswell, Thomas D. and James R. Curtis. 1983. The Cuban-American Experience, Culture, Images, and

Perspectives. Totowa, New Jersey: Rowman & Allanheld. Coffey, Susan S. 1993. “Test Your Knowledge of Professional Ethics,” Journal of Accountancy

(December): 90-1. Firth, Michael. 1980. “Perceptions of Auditor Independence and Official Ethical Guidelines,” The

Accounting Review (July): 451-66. Fritzemeyer, J. R., and D. R. Carmichael. 1972. "Lack of Independence--Some Reporting Problems," The

Journal of Accountancy (August): 79-81. Lavin, David. 1976. "Perceptions of the Independence of the Auditor," The Accounting Review (January):

41-50. Lavin, David and Robert Libby. 1977. “The Effect of the Perceived Independence of the Auditor on the

Loan Decision,” Journal of Bank Research (Summer): 118-21. McKinley, Sue, Kurt Pany, and Philip M. J. Reckers. 1985. “An Examination of the Influence of CPA Firm

Type, Size, and MAS Provision on Loan Officer Decisions and Perceptions,” Journal of Accounting Research (Autumn): 887-96.

Pany, Kurt, and Philip M. J. Reckers. 1988. “Auditor Performance of MAS: A Study of Its Effects on

Decisions and Perceptions,” Accounting Horizons (June): 31-8. Peterson, Mark F. and Jaime Roquebert. 1993. "Success Patterns of Cuban-American Enterprises:

Implications for Entrepreneurial Communities," Human Relations 46 (8): 921-37. Rodriguez, Julian Montoro, 1998. "The impact of acculturation on attitudinal familism in a community of

Puerto Rican Americans" Hispanic Journal of Behavioral Sciences; (August): 375-91. Shockley, Randolph. 1981. “Perceptions of Auditors’ Independence: An Empirical Analysis,” The

Accounting Review (October): 785-800. Szapacznik, Jose, ed., 1995, A Hispanic/Latino Family Approach to Substance Abuse Prevention. CSAP

Cultural Competence Series 2, U.S. Department of Health and Human Services. Szapacznik, Jose and William M Kurtines. 1993 “Family Psychology and Cultural Diversity, Opportunities

for Theory, Research, and Application,” American Psychologist (April): 400-407.



INFORMATION SKILLS ACCOUNTING GRADUATES NEED TO HAVE –SOME

PRELIMINARY RESULTS

Corman, Lawrence S. Fort Lewis College

[email protected]

McKnight, Reed Fort Lewis College

[email protected]

ABSTRACT

In recent years, major growth in the accounting profession has occurred in the area of information systems services. Much of the growth has been in the area of accounting information systems. Correspondingly, in the job market, there is strong demand for accountants whose skill sets include information systems skills.

This study surveyed Colorado certified public accountants (CPAs) who hire new accounting graduates to assess their perceptions of the relative importance of various accounting information systems (AIS) skills that new hires should have upon entering the accounting profession.

The results from the limited response to the survey were not surprising. Practitioners want graduates to have strong skills in the areas of spreadsheets, word processing, accounting and tax software, internal controls, transactions cycles and the internet. In addition, they want graduates that have better communication skills, a more thorough knowledge of basic accounting concepts, and an improved understanding of “real-world” business practices.

INTRODUCTION

To maintain or build profit margins, accounting firms are expanding the services they provide (Covaleski, 1999). In addition to the technical expertise in accounting, taxation, and finance which they have always provided, firms now strive to provide value added expertise in a much broader business orientation (Ebel, 1998). With the evolution from technical accounting expert to business advisor (Covaleski, 1999), the skill set required for success in accounting has also evolved. Gone are the days when technical accounting expertise was enough for success.

While technical accounting skills are, and always will be, necessary, they alone are no longer sufficient (MacCallum, 1997). It is commonly agreed in the literature that future accountants must have an expanded skill set (Bukics & Fleming, 1999 and Messmer, 1999). In addition to technical accounting expertise, many believe that the required skill set includes analytical and problem solving skills, both oral and written communication skills, and both interpersonal and persuasion skills(Bukics & Fleming, 1999 and Messmer, 1999). And in light of the fact that much traditional accounting work is now computerized, it is commonly agreed that accounting information systems (AIS) skills are no longer optional but required for accountants (Anonymous, 1999, Messmer, 1999 and Wright, 1996). However, there is little evidence regarding how much accounting and computer information systems skill is required for entry into the profession.



THE SURVEY

A survey was developed by the authors that listed various accounting information skills that might be appropriate for a recent graduate in accounting. The skills were identified by reviewing various AIS textbooks and by scanning the literature for current hot topics (.e.g. Enterprise Resource Planning). Along with the skill set, some demographic indicators also were included in the survey which is included as the Appendix.

This survey had two purposes. A primary purpose was to provide some evidence of the relative importance of a variety of AIS skills for new hires as perceived by Colorado CPAs. A secondary purpose was to gather some evidence regarding response rates using different response mediums (i.e. web based versus traditional mail response).

METHODOLOGY A mailing list of 2500 Colorado CPAs was obtained. Only firms that were not sole practitioners

were included in the survey. After eliminating duplicate addresses, 1,317 CPAs remained. These were assigned randomly to three different groups:

Those assigned to the first group (Method A) were asked to complete a traditional hard copy survey and return it in the enclosed stamped return envelope. Those assigned to the second group (Method B) were provided with a URL and asked to access http://soba.fortlewis.edu/ais/ in order to complete the survey. Those assigned to the third group (Methods C and D) were provided with both a hard copy of the survey and the URL and allowed to choose either response medium. The distribution of the sample and the associated return rates are shown in Table 1.

Table 1 - Sample Distribution

Method Results Sample Distribution Return Rate a 28 32% 357 27% 7.8% b 19 22% 344 26% 5.5% c 36 41% 324 25% 11.1% d 4 5% 292 22% 1.4%

87 100% 1,317 100% 6.6%

Interestingly, when the CPAs were provided the choice of either completing the survey online or returning a self-addressed envelope with an enclosed survey (method D vs. C), the CPAs opted to use the traditional mailing approach -- in a ratio of 9 to 1 (36 versus 4). Using a chi-square test for a difference of proportions, the return rate was significantly greater for the “snail-mail” approach versus the web-based approach at a p-value < .001. Why CPAs opted to respond with the traditional hard copy is not clear. Is this a reflection that CPAs themselves are not comfortable using the web or was the hard copy perceived to be an easier (or less costly) way to respond?

As a footnote, after the completion of the data analysis, approximately another 30 surveys have been returned. The results from these “late surveys” have not been included in this analysis. However, it should be noted that these surveys, if included, would increase the response rate from 6.6% to 8.9%.

DEMOGRAPHICS

Responses to the survey were from various sizes of firms. Table 2 provides the reader with an indication of the size dispersion of the sample. As can be seen, the majority of the respondents were from smaller firms.



Table 2 – CPA Firm Size CPA Firm

Size

Total

Percent 1-5 48 55% 6-10 13 15%

11-20 12 14% 21-50 4 5%

Over 50 10 11% Table 3 reflects the hiring habits of the responding firms. Reflective of firm size, most firms hired a very small number of graduates. Table 3 – Average Annual New Hires

Number of New Hires

Total

Percent

0 - 1 62 77% 2 7 9% 3 2 2% 4 1 1%

More than 4 9 11%

Table 4 illustrates the nature of the responding firms’ emphasis in practice. Again, reflective of the relative small average firm size, very few firms were involved in IS consulting.

Table 4 – Practice Emphasis Emphasis Percent

Tax 46% Auditing 23% Other Consulting 13% Bookkeeping 13% IS 10% Other 9%

DATA ANALYSIS

Table 5 is a condensation of Table 6 by providing a ranking of the important and non-important skills as rated by the sample of Colorado CPAs. The authors focused on the skill set by reviewing the important/extremely important and not important/minor importance responses. Table 6 contains the percentage distribution for each of the twenty-four skills.

Not surprisingly, spreadsheet skills topped the list (92%). General AIS skills also were perceived to be very important as was knowledge of the transactions cycle. The next tier of highly important skills were word processing, internal controls, general accounting, tax, along with Internet skills. Beyond these skills, none of the more sophisticated AIS skills such as database design, systems analysis, etc. were deemed to be highly important among the respondents. The low ranking of the sophisticated technical skills can be clearly seen in the rightmost column of Table 5.



Table 5 - Importance of AIS Skills Skill Important/ extremely

important Skill Not important/

minor importance

Spread_skills 92% Programming_skills 83% General ais_skills 79% erp_skills 73% Cycle_skills 76% sd_skills 73% Wordprocessing_skills 65% db_design_skills 69% Internal control_skills 62% web_devel_skills 69% General_accting_skills 61% sa_skills 54% Tax_sotftware skills 57% edp_skills 44% Internet_skills 52% Modeling_skills 44% Data base_skills 29% stat_skills 41% Edp_skills 26% Networking_skills 34% Hardware_skills 25% db_skills 32% Networking_skills 24% hw_skills 30% Stat. Sampling_skills 21% tax_skills 13% modeling_skills 17% internet_skills 12% Systems analysis_skills 15% Word_skill 11% Systems design_skills 10% ic_skills 11% web_develop._skills 10% General_accting_skills 9% Data base_design_skill 9% general ais_skills 5% Ent. Resourc plan_skill 7% Cycle_skills 4% Programming_skills 6% spread_skills 2%

Table 6 – Percentage Distribution of Perceived Skill Set General

Ais spreadsheet Wordproces

sing skills Data base

Tax software

Not important 1% 0% 0% 7% 3% Minor importance 4% 2% 11% 25% 10%

Average importance 16% 6% 23% 39% 29% Important 54% 29% 33% 23% 25% Extremely important 25% 63% 32% 6% 32%

Table 6 – continued General_accting Erp sa sd db_design Not important 0% 31% 27% 35% 34% Minor importance 9% 42% 27% 38% 35% Average importance 30% 20% 31% 16% 22% Important 37% 6% 13% 8% 8% Extremely important 24% 1% 2% 2% 1%

Table 6 – continued Programming Ic cycle Internet web_devel Not important 40% 2% 1% 1% 33% Minor importance 43% 9% 3% 11% 36% Average importance 12% 26% 20% 36% 21% Important 6% 33% 41% 39% 8% Extremely important 0% 29% 35% 13% 2%



Table 6 – continued Stat Edp Modeling hw Networking Not important 16% 22% 15% 10% 11% Minor importance 25% 22% 29% 20% 23% Average importance 37% 29% 38% 45% 41% Important 18% 22% 10% 17% 22% Extremely important 3% 4% 7% 8% 2%

Table 6 reflects CPAs' perceived importance of AIS skills for new hires. Tables 7 and 8 reflect actual skills new graduates are bringing ( or not bringing) to the job. Table 7 reflects the most frequently mentioned AIS strengths among recent graduates per question 25 in the appendix.. Table 8 reflects the most frequently mentioned AIS weaknesses among recent graduates per question 26.

Table 7 – AIS Strengths Strength Total

Spreadsheet 16 Word Processing 11 Accounting software 11 Internet 10 Willingness to learn new technology 9 Accounting cycle skills 6 General Computer Skills 6

Table 8 – AIS Weaknesses Weakness Total

Accounting software

12

Accounting cycle skills

11

Desk checking (*)

6

Internal controls

4

* Desk checking is an issue of perspective. Several comments were made by the practitioners that recent hires had difficulty in determining the reasonableness of computer-generated results..

As mentioned, Table 6 discloses the skills the profession wants; Tables 7 and 8 disclose what the profession is actually getting in terms of new graduate skills. The data represented by Table 6 (see Appendix) was provided by all respondents in the form of Likert scale responses and is expressed in percentages. The information contained in Tables 7 and 8 asked those surveyed to provide written perceptions of new hires’ greatest strengths and weaknesses and is expressed in head counts. Many respondents left the strengths and weaknesses questions unanswered; others answered, or partially answered, these questions. . Hence, care needs to be exercised when comparing the information contained in the tables.

To summarize this response rate for strengths and weaknesses, 42 respondents had identified at least one strength. Of these 42 respondents, 11 respondents only listed one strength, 7 respondents listed two strengths, while the remaining 24 respondents identified three strengths. For the weaknesses question, 43 respondents identified at least one weakness. Of these 43 repondents, 17 respondents listed only one weakness, 8 listed two weaknesses, and the remaining 18 respondents identified three weaknesses

If those who responded are representative of the profession, then it appears that what the profession wants, and what colleges are delivering, is essentially the same with respect to spreadsheet, word processing and internet skills. The respondents appear to be equally divided on the adequacy of new graduates accounting software skills. In open-ended questions 25 and 26 (see appendix), practitioners noted strengths and weaknesses in both "software" and accounting software. The authors have grouped software and accounting software together (in Table 7) assuming that practitioners were describing the same subject. A similar comparison of Tables 5 and 7 reveals that CPAs desire that new graduates have strong knowledge of transactions cycles and internal control but that colleges are not delivering graduates with these skills. This comparison can be summarized in Table 9:



Table 9 – Table 5 & 7 Comparison of Noted Weaknesses

Skill

Respondents’

Rating of

Importance

(per Table 5)

Identified as

Weaknesses

% of Respondents noting

Weakness (based on 43

respondents)

Transaction

Cycles

76% 11 26%

Internal

Controls

62% 4 9%

Open-ended questions 25 and 26 provided a means by which practitioners could express their

frustrations at the product that they are receiving, including but not limited to graduates’ AIS skills. A recurring suggestion is that colleges need to graduate students with practical experience (e.g. basic bookkeeping skills, internships, and basic business machine skills such as keyboarding and ten-keying. At our college, this is a bit of a Catch 22. Practitioners demand graduates with experience, but few local practitioners are willing to make the investments necessary to provide internships. This suggests colleges have an opportunity to provide value-added services to their clients (both students and practitioners) but that colleges are going to have to develop innovative ways of doing so, probably without, or with little, direct support of CPAs.

Although responding practitioners believe that our students have a good grasp on all-purpose software (e.g. spreadsheet/word processing), they were divided in terms of whether or not graduates have an adequate understanding of accounting-specific software. This issue is now being addressed at our own college with accounting and AIS curriculums. Students are now getting experience with bookkeeping software such as Peachtree, and tax preparation software such as Turbo Tax. But practitioners want more than just basic clerical knowledge of how to operate the software; they want employees who understand how the software articulates with the financial statements. A few of their comments are reproduced below:

♦ “linking computer software (accounting G/L packages) to internal controls (they don't understand the link, proper controls, how to test)”.

♦ “troubleshooting accounting software, not (in a) technical computer (sense) but bookkeeping errors”.

♦ “understanding of the overall acc(oun)ting processing (what is accomplished in AIS functions)”.

♦ “unthinking acceptance of results from (the) computer”.

From these comments, it appears that accounting and AIS faculty must emphasize the basics during the instruction of accounting and accounting software. Students need to be well grounded in basic accounting concepts, internal controls, and transaction flows.

The last question posed in the survey (question 27) concerned what universities could do that would be most beneficial to developing graduates’ AIS skill sets. Again, the majority of the comments from the respondents were not directly related to the graduate’s technical AIS skills but rather their overall accounting and business skills sets. Some comments included:

♦ “Improve writing / communication skills. What good is it to do all of the above, if you cannot



communicate what you have done (for) clients in a way that they can understand? I would grade nearly every new graduate that I come across as a D- or F.”

♦ “Make certain that accounting graduates have a solid understanding of accounting fundamentals - too often we find that because the computer processed the information, we have a limited knowledge of the source, the trail, and the meaning of the data.

♦ “Provide as much "real life" scenarios/projects as possible to pull together knowledge into one valuable skill set. This will enhance learning as practical use of knowledge put into action (and) should make new graduates more attractive to the job market.”

These comments reiterate what is already well documented in the literature. Colleges need to

produce graduates with better communication skills, a better understanding of basic accounting principles, and as much practical experience as possible (internships and business community projects).

CONCLUSION

The low response rate combined with the narrowly defined sample (Colorado CPAs only) preempt

making strong statements regarding what CPAs want graduates to have in the way of AIS skills. Efforts are underway to expand the scope of the study and increase the response rate.

Based on the preliminary results we have at this time, it appears that graduates have adequate spreadsheet, word processing, and Internet skills. However, it appears that colleges need to reemphasize the teaching of transactions cycles and accounting fundamentals so that graduates can critically assess whether or not computer generated-results make sense. The profession does not appear to be concerned with graduates’ lack of AIS technical skills such as programming skills, enterprise resource planning skills or data base design skills. And finally, although they were not the focus of this survey, members of the profession reiterated previous statements in the literature that graduates need to bring good communication skills and a better understanding of business concepts to the job market.

APPENDIX

Demographics

1. ___________ Size of the CPA firm (in terms of professional employees) 2. ___________ Zip Code of town in which your firm is located 3. ___________ Average number of new graduates hired annually for professional positions 4. Percentage of services offered by firm (based on revenue)

___________ % Tax preparation/planning

___________ % Auditing

___________ % Information systems consulting

___________ % Other Consulting

___________ % Bookkeeping

___________ % other

___100%___ Total

AIS Skills Please rank the following skills on a scale of 1 to 5 (1 least important, 5 most important) regarding the importance for a recent accounting graduate. (the skills below are listed in random order).



Please circle the most appropriate response:

Skill Not

important Minor

importance Average

importance

Important Extremely Important

5. AIS skills in general 1 2 3 4 5 6. Spreadsheet 1 2 3 4 5 7. Word processing 1 2 3 4 5 8. Database software 1 2 3 4 5 9. Tax software 1 2 3 4 5 10. General accounting

software 1 2 3 4 5

11. Enterprise Resource Planning (e.g. SAP, PeopleSoft, etc.)

1 2 3 4 5

12. Systems Analysis 1 2 3 4 5 13. Systems Design 1 2 3 4 5 14. Database Design 1 2 3 4 5 15. Computer programming 1 2 3 4 5 16. Knowledge of Internal

Controls 1 2 3 4 5

17. Knowledge of transaction cycles

1 2 3 4 5

18. Internet 1 2 3 4 5 19. Web Development 1 2 3 4 5 20. Statistical sampling 1 2 3 4 5 21. EDP auditing 1 2 3 4 5 22. Data modeling (Flowcharts,

dataflow diagrams, etc.) 1 2 3 4 5

23. Computer hardware 1 2 3 4 5 24. Computer networking 1 2 3 4 5

25. In my opinion, new graduates greatest AIS strengths are (please rank by importance) A) B) C)

26. In my opinion, new graduates greatest AIS weaknesses are (please rank by importance) A) B) C)

27. In my opinion, the most helpful thing colleges and universities could do to improve new graduates AIS

skills would be to . . . . .(please complete the sentence). 28. Other comments?



REFERENCES Anonymous (1999). IT Knowledge Crucial for Accountants. HR Focus, Vol. 76, No. 9, September 1999,

5. Bukics, Rose Marie L & Fleming, John M. (1999). New Hires. Pennsylvania CPA Journal, Vol. 70, No.

1, Spring 1999, 22-27. Ebel, Maria (1998). Employment Trends in the Accounting Field. Ohio CPA Journal, Vol. 57, No. 3,

July-September 1998, 52-53. MacCallum, Ian (1997). Recruitment: What Skills? Australian Accountant, Vol. 67, No. 5, June 1997, 18-

20. Messmer, Max (1999). Skills for a New Millennium. Strategic Finance, Vol. 81, No. 2, August 1999 10-

12. Wright, Desmond (1996). The Accountant in 2005. Accountancy, Vol. 117, No. 1232, April 1996, 73.



INTERMEDIATE ACCOUNTING: AN EXAMINATION OF THE BENEFITS OF A TEAM

LEARNING ENVIRONMENT

Parker, D. J. University of Washington, Tacoma

[email protected]

Prentice, Deb University of Washington, Tacoma

[email protected]

ABSTRACT

Team or cooperative learning is a fairly new pedagogy in the field of accounting education. There are relatively few studies in the accounting literature that directly examine outcome benefits or drawbacks of cooperative learning. The small number of studies is an indication of resistance to implementation of new pedagogy in accounting education. Innovations in educational techniques are developed, examined and published. However, few accounting educators have embraced new pedagogy despite the findings of the Accounting Education Change Commission (1990). Accounting education tends to follow traditional teaching methodology.

On the other hand, the typical accounting graduate is expected to demonstrate proficiency in an extensive body of core knowledge in financial accounting, auditing, and other areas of accounting, as well as be able to work effectively in a group setting. The traditional emphasis of accounting education has been on individual proficiency, demonstrated by knowledge of accounting and business. However, working in a team setting to accomplish tasks and achieve goals is more reflective of current business reality. In the classroom, team learning requires the formation of small student groups to create a dynamic and active learning environment. Most of the cooperative learning literature that addresses pedagogical issues and examines outcomes is found in the fields of education and educational psychology. Only limited team learning studies are found in the accounting literature (Parry, 1990; Patten and Williams, 1990; Peek, 1995; Ravenscroft, McCombs, and Zuckerman, 1995; Hite, 1996; Saudagaran, 1996; Parker, 1997).

This study examines possible benefits of implementing team learning in intermediate accounting. A lab experiment format was used to determine the extent of possible increases in students' academic achievement and interpersonal skills as a result of participation in a team learning environment. Two classes of intermediate accounting were used for this study and the experiment time period was a full semester. The control group received class material and works on assignments in a traditional teaching setting. The experimental group covered the same class material, but team learning pedagogy was employed.

Individual examinations were used as one of the assessment outcomes. Statistical comparison of the two classes’ grades revealed moderate support for increased academic benefits from adopting a team learning approach. Prior research on team learning has focused on increases in academic performance. However, working in teams may actually benefit students on a individual personal level. Working in teams could lead to greater loyalty to the group and commitment to a task or project. Encouragement of team members could increased motivation to do one’s best and team feedback could provide increased job satisfaction.

The Job Diagnostic Survey is a well tested, long standing instrument that has been used in management research to examine characteristics related to job satisfaction and job worth. The survey was originally developed to diagnosis work settings affect on employees and assess how a redesigned job might affect employees’ motivation and overall job satisfaction (Hackman and Oldham, 1975).

The Job Diagnostic Survey examines the following job characteristics: skill and task variety, task significance, autonomy, and feedback. The survey also measures specific job-related psychological states



of meaningfulness, responsibility, and knowledge of results. Other measures include general satisfaction, internal work motivation, and motivating potential strength. This survey has been adapted for use in an academic setting (Watts and Jackson, 1994; Watts, Jackson, Box, 1995).

The instrument was administered to students in both classes at the end of the semester. Comparison of the survey results indicates that students in both classes perceived the same level of skill and task variety, complexity and significance in intermediate accounting. However, there was a divergence between the two classes on dimensions related to motivation and interpersonal and psychological outcome factors.

Students in the team learning class measured significantly higher in the motivating potential strength factor which indicates a greater feeling of having their growth needs met. Analysis of responses indicated that the team learning group gained greater satisfaction from class work and received more feedback than the individual learning group. The results indicate that students’ perception of their contribution differed between the two classes. Students in the individual learning class felt that they could make a greater contribution to a class as a whole, while the team learning group felt that they could make a greater contribution to the team. The team group indicated greater appreciation for diversity, but the individual group demonstrated a heightened ability to think globally.

The findings of this study indicate that team learning may influence the development of students’ interpersonal skills. Given the increasing need for accountants to work with others in a variety of group setting, employing a team learning setting in the curriculum may help students develop and refine the skills required for success both now and in the future.



INTERNET ASSIGNMENTS IN INTRODUCTORY ACCOUNTING: LEARNING FOR THE NEW

MILLENNIUM

Frazier, Jessica Johnson, D.B.A. Professor of Accounting

Eastern Kentucky University

Mounce, Patricia H., Ph.D. Assistant Professor of Accounting

Eastern Kentucky University

ABSTRACT Accounting education has been criticized for not meeting the needs of the accounting profession. The Big Eight White Paper, The Bedford Committee and the Accounting Education Change Commission have all expressed concerns relating to this issue. Introductory accounting faculty members have been challenged by the Accounting Education Change Commission to teach students to learn on their own. Several methods have emerged in recent years that advocate this approach. Group work or collaborative-learning projects have been widely used in the last several years. Another emerging force is the use of the Internet. Until recently, arguments against relying heavily on the use of Internet resources to help students learn included high fixed cost, limited availability of computer facilities, and lack of computer knowledge of students. Even the smallest colleges now offer computer access to students in traditional computer labs, dormitories, libraries, and classrooms. Today almost all students entering college have adequate computer knowledge. Using the Internet, students can easily access annual reports of major corporations, providing them with not only the primary financial statements, but also communication from corporate management and footnote information. Students can find an abundance of information on the accounting profession. Another important Internet resource is tutorials that can enhance students' basic accounting skills. The purpose of this research is to investigate the use of the Internet in the Introductory accounting courses to help students analyze financial information and to shape their perceptions of the accounting profession, the skills and attitudes needed for successful accounting careers, and the nature of career opportunities in accounting. Research was conducted to determine if students using the Internet to complete assignments perform better overall than their counterparts using traditional library resources. In addition, research was conducted to determine if students using the Internet have more positive perceptions of the accounting profession, the skills and attitudes needed for successful accounting careers, and the nature of career opportunities in accounting than do students using traditional library resources. Students enrolled in the Introduction to Financial Accounting course were given various assignments throughout the semester relating to the accounting profession, skills and attitudes needed for successful careers in accounting, career opportunities in accounting, and financial statement analysis. Students in an experimental group were required to complete the assignments using the Internet. Students in the control group completed the assignments using traditional library resources. Results of this study suggest that students using the Internet to complete assignments do not perform significantly better and do not have more positive perceptions of the accounting profession, the skills and attitudes needed for successful accounting careers, or the nature of career opportunities in accounting than do their counterparts using traditional library resources.



INTRODUCTION

In September 1990, the Accounting Education Change Commission (AECC) issued Objectives of Education for Accountants: Position Statement No. One. This statement suggested that accounting graduates should possess communication skills, including the ability to locate, obtain, and organize information. The AECC also emphasized that the overriding objective of accounting programs should be to teach students to learn on their own and that students should be active participants in the learning process. In addition to the AECC, the Big Eight White Paper and the Bedford Committee have expressed concerns about accounting education meeting the needs of the accounting profession.

In June 1992, the AECC issued The First Course in Accounting: Position Statement No. Two. According to this statement, the primary objective of the first course in accounting is for students to learn about accounting as an information development and communication function that supports economic decision-making. Again, the AECC put an emphasis on teaching the student to learn on his or her own. Several methods have emerged in recent years that advocate this approach. Group work or collaborative-learning projects have been widely used in the last several years. The use of case studies has also been a popular teaching tool. Another emerging force is the use of the Internet.

Until recently, arguments against relying heavily on the use of Internet resources to help students learn included high fixed cost, limited availability of computer facilities, and lack of computer knowledge of students. Even the smallest colleges now offer computer access to students in traditional computer labs, dormitories, libraries, and classrooms. Today almost all students entering college have adequate computer knowledge.

Using the Internet, students can easily access annual reports of major corporations, providing them with more than simply the financial statements. Most major corporate Web sites provide complete annual reports including communication from corporate management and footnote information. Students can find an abundance of information on the accounting profession. An important Internet resource is tutorials that can enhance students' basic accounting skills. Whereas the use of cases oftentimes restricts the amount and quality of information used by students, the use of actual annual reports provides students with qualitative and quantitative information that can help them in making informed business decisions.

The purpose of this research is twofold. First, this study is designed to investigate the use of the Internet in the introductory accounting courses to help students analyze financial information. Second, this study analyzes the perceptions of students relating to the accounting profession, the skills needed for successful careers in accounting, and the nature of career opportunities in accounting.

LITERATURE REVIEW AND HYPOTHESES DEVELOPMENT

Accounting literature contains numerous articles addressing the concerns of the Big Eight White Paper, the Bedford Committee and the Position Statements of the Accounting Education Change Commission. One of the most comprehensive and constructive articles to address these concerns is written by Holcomb and Michaelsen (1996). In this article, the authors summarize the problems in accounting education by saying that students are not taught now to learn or to utilize technology. Accounting education does not bridge the gap between the classroom and the work environment. In addition, while in the classroom, learning is very structured, while in the real world problems are not clearly defined. Holcomb and Michaelson (1996) advocate the use of educational technology (ET) in accounting to improve accounting education. At the present time, most accounting curriculums are knowledge-based. However, because of automation the knowledge component is becoming less important. For motivational purposes, information concerning accounting careers should be included in the introductory accounting courses. In order to pass the CPA exam students must memorize rules and procedures. However, much of what accounting students learn changes before they have an opportunity to apply it. Students become bored with accounting because they do not have a mental picture of what they are studying. Most accounting curriculums fail to keep up with developments in information systems. Ethical issues should be taught in all accounting courses as the profession continues to face new and more complex ethical issues. Students need to be exposed to the historical development of accounting. Also, students need to be aware of social and political forces impacting accounting and the reasons for FASB pronouncements. Holcomb and Michaelson acknowledge faculty may resist educational technology because it is an unknown commodity. Faculty members realize they will be forced to attempt new, challenging and time-consuming



tasks. In addition, some faculty may fear they will be replaced by technology. The second position statement issued by the Accounting Education Change Commission was

entitled The First Course in Accounting (1992). While most accounting academicians agree that there is need to institute changes throughout the curriculum, the majority recognizes that change is most urgent in the first accounting course (Saudagaran, 1996). Evidence indicates that the decision to major in accounting is often made during the first two introductory accounting courses (Graves, et al., 1993; Saudagaran, 1996). If accounting is to attract and retain good students, introductory accounting classes must fairly depict the field of accounting. Students frequently say that accounting is boring. Holcomb and Michaelson (1996) reference a study conducted at the University of Southern California to determine why students left accounting to major in finance, information systems, economics, etc. The primary reason students gave for changing their major was that accounting was so boring. The authors suggest that it may not be accounting that is boring. Rather, the boredom may come from the way in which the information is presented (Holcomb and Michaelson, 1996).

Recognizing the importance of the first accounting course, Saudagaran (1996) designed an innovative course in introductory accounting. The course emphasizes the development of judgment analysis, oral and written communication skills, and interpersonal skills. In addition, students are taught the research skills needed to find answers to questions in the work environment. When evaluated at the end of the term, 74 percent of the students indicated the course improved their perception of accounting.

Acknowledging that the delivery system is a critical factor in accounting courses, one accounting faculty member used cooperative learning methods to increase student success rates (Hite, 1996). Cooperative learning may be defined as a small group of heterogeneous students working together to help each other learn. Evidence indicated that students participating in cooperative learning scored significantly higher on exams compared to other students. This study validates the conclusions of a 1993 study (Hite, 1996) of over 200 four-year colleges. The previous study found that form and content of curriculum made little difference in student success.

Supplemental Instruction (SI), an out-of-class collaborative learning model, has been used to improve student retention and performance in accounting principles courses. In one study (Etter, Burmeister, and Elder, 1997), SI sessions are used in high-risk courses, not with high-risk students. Only the courses that are challenging courses for all students are selected for SI support. All students in the SI courses are invited to participate in SI sessions on a voluntary basis. Students who have successfully completed a target course, have a GPA of 3.5 or greater, and have interpersonal and communication skills are selected to serve as group facilitators. Throughout the course the SI supervisor monitors and evaluates the effectiveness of the SI session by observing individual sessions. Benefits of using SI include better course grades and lower and withdrawal percentages. An exhaustive work by Kimmel (1995) provides a framework for incorporating critical thinking into accounting education. Kimmel focuses on the entire accounting curriculum. The author provides a definition of critical thinking set forth by Kurfiss (1988) as “an investigation whose purpose is to explore a situation, phenomenon, question, or problem to arrive at a hypothesis or conclusion about it that integrates all available information and that therefore be convincingly justified.” The definition of critical thinking provided by Kurfiss suggests that critical thinking involves two phases: discovery and justification of ideas. Kimmel provides a table showing how critical thinking can be used in each accounting course. In addition, he includes a table showing strategies for developing critical thinking elements.

Based on the above literature and objectives of this study, the following hypotheses have been developed to statistically evaluate the use of the Internet in the introductory accounting courses.

H1: Students using Internet resources will outperform students using traditional resources with performance measured by total points earned in class

H2: Students using Internet resources will develop more positive perceptions of the accounting profession than students using traditional resources

H3: Students using Internet resources will develop more positive perceptions of the skills needed for successful careers in accounting than students using traditional resources

H4: Students using Internet resources will develop more positive perceptions of the nature of career opportunities in accounting than students using traditional resources



DATA COLLECTION

Eastern Kentucky University offers several business program that require students to take the

Introduction to Financial Accounting course. Other programs outside business also require students to successfully complete this course. For instance, paralegal, agriculture and law enforcement programs include this course as a major requirement. Accounting majors must complete this course with a grade of "C" or better. This study involved surveying students enrolled in the Introduction to Financial Accounting and analyzing their performance during the course.

Participants in the study came from four sections of Introduction to Financial Accounting. The same instructor taught all four sections. The Instructor had over ten years of experience teaching introductory accounting. The enrollment at the latest drop date in the four courses ranged from 21 to 35, with a total of 111 students receiving grades for the courses. The classes met on various days at various times. However, each class met for 60 minutes each period. As stated earlier, enrollment was not limited to accounting or business students, but included a variety of other majors. All participants used the accounting textbook, Financial Accounting: The Impact on Decision Makers, Alternate Edition by Porter and Norton. Students were not assigned randomly to experimental and control groups. Two large morning classes and two small afternoon classes were included in the study. One large morning class and one small afternoon class were randomly selected for each group.

Data were collected in two ways. First, measure of performance was based on participants' total points received in the courses. Students earned points from outside research assignments from each chapter (either Internet or traditional library research), four quizzes taken during the semester with each covering material from several chapters and at least one question relating to outside research assignments, homework and class participation, and a comprehensive final examination. Second, student surveys were taken at the beginning and end of the semester in all classes. At the beginning of the semester, students were asked to provide certain demographic information. They were also asked to indicate, on a scale of 1 to 10, their familiarity with computers, the Internet, library research, the University library. At the end of the semester, students completed a similar survey. Students were also asked for their perception of the accounting profession, their perception of the aptitudes and skills needed for successful careers in accounting, and their perception of the nature of career opportunities in accounting. These were open-ended questions with responses judged by the researchers to be positive or negative.

A total of 90 useable responses was received and included in this study. Although 111 students received grades, several of these students were excluded from the study because they did not attend class during the final weeks of class, take the final exam, or complete the end-of-semester survey.

Students in four sections of Introduction of Financial Accounting participated in the study. All sections were given reading and homework assignments from an accounting textbook. In addition, two sections were given assignments for each chapter and were required to complete the assignments using information found on the Internet. Web addresses were provided to the students with basic instructions for searching the Web. Two sections were given the same assignments, but were required to complete the assignments using traditional resources. Traditional resources, as defined for this study, included information found in the reference section, the stacks, or the reserve desk of the library.

RESULTS

As stated earlier, 90 useable responses were obtained from participants. Demographic data included age, classification, gender, major, whether the course was being repeated, and whether the course was required. The mean age of participants was 21, with the youngest participant being 18 and the oldest being 53. Participants were from a variety of colleges within the University. Approximately one-half (49) of the participants were students in the College of Business. Other areas included law enforcement (7), agriculture (7), technology (5), paralegal (4), undeclared (4), nursing and dietetics (3), music (2), and other miscellaneous majors (9). Participants included 10 freshmen, 37 sophomores, 30 juniors, and 13 seniors. Most of the students (69) had attempted the course previously while 21of the participants were enrolled in the course for the first time. Forty-six males and 44 females participated in the study. All but 10 of the participants were required to take the course for their majors. To determine whether systematic differences in the dependent variable, total points, existed due to potential differences in the demographic characteristics of participants, the



demographic characteristics were regressed against performance. Results indicate that demographic characteristics were not significant predictors of total points. Table 1 provides a summary of the demographic information relevant to the participants shown in total and by group (participants completing Internet assignments in one group and participants using traditional resources in the other group.)

TABLE 1 DEMOGRAPHIC INFORMATION

Mean Age of Participants

TOTAL INTERNET TRADITIONAL 21 21 22

Number of Participants by Classification Freshman Sophomore Junior Senior Number of Participants by Gender Male Female

10 5 5 37 17 20 30 17 13 13 6 7 46 23 23 44 22 22

Number of Participants by Major Business and Accounting Other Number of Participants In Course First Time Repeat

49 23 26 41 22 19 21 10 11 69 35 34

Number of Participants required to take course 80 38 42

At the beginning of the semester, students were also asked to indicate, on a scale of 1 to 10, how familiar they were at searching on the Internet, how familiar they were with computers, how familiar they were with conducting library research, and how familiar they were with using the University library (with 1 being no familiarity and 10 being totally familiar). Mean responses, as shown in Table 2, indicate that students are more familiar with searching on the Internet than conducting library research (7.42 vs. 6.30). Participants completed the survey soliciting information on their familiarity with the Internet and library research before they were aware of how they would complete their research assignments, and participants were assigned to experimental or control groups before the survey was completed. It is interesting to note that participants using the Internet to complete assignments were more familiar with the Internet than their counterparts using traditional research (7.85 vs. 6.98). Although participants using the traditional resources were more familiar with the University library than their Internet counterparts (6.59 vs. 5.86), they were less familiar with conducting library research than the Internet group (6.13 vs. 6.48).

TABLE 2 FAMILIARITY WITH RESEARCH TOOLS

Familiarity with operating computers Familiarity with searching on the Internet Familiarity with using the University library Familiarity with conducting library research

TOTAL INTERNET TRADITIONAL 7.31 7.40 7.22 7.42 7.85 6.98 6.22 5.85 6.59 6.30 6.48 6.13

The research hypotheses were designed to test for differences in participants using the Internet and those using traditional resources in the introductory accounting courses. Hypothesis H1 proposes that



students using Internet resources will outperform students using traditional resources. The points earned during the semester were used to measure performance. In order to test this hypothesis, regression analysis was conducted with group (Internet vs. traditional) as the independent variable and total points as the dependent variable. The results of this analysis are reported in Table 3. No significant differences were found between grades of students using Internet resources and those using traditional resources (Prob>T=.129). As a result, H1 is not supported. It is interesting to note, however, that 11 percent of students completing Internet assignments received an A in the course while almost 27 percent of those completing traditional research received an A. In addition, 11 percent of those completing Internet assignments failed the course, while only 4 percent of those completing library research failed. At the beginning of the semester, students were asked what grade they expected to receive. Most students were overly optimistic in that each participant expected to receive a grade above a D. In the Internet group, 29 percent expected to receive an A while 18 percent in the traditional group expected an A, 62 percent of the Internet group expected a B while 66 percent of the traditional group expected a B, and nine percent of the Internet group expected to receive a C while 16 percent of the traditional group expected to receive a C.

TABLE 3 PERFORMANCE OF STUDENTS

TEST OF H1 GROUP Internet vs. Library

T-VALUE

1.534

PROB > T

.129

Hypothesis H2 suggests that students using Internet resources will develop more positive perceptions of the accounting profession than students using traditional resources. Because the perception of profession (positive or negative) and group (Internet or traditional) were dichotomous variables, a Chi-Square test of independence was performed using a crosstabulation of group with perception of profession. As stated earlier, students' responses to open-ended questions obtained from surveys completed at the end of the semester were judged by the researchers to be positive or negative perceptions. In general, negative responses were number cruncher, stuff shirt, dull and boring, anal people, and tedious. Positive responses included highly respected, admirable profession, versatile, and prestigious. The results of this analysis are reported in Table 4. A significant difference was found between perceptions of students using Internet resources and those using traditional resources. Approximately half of the students completing Internet assignments had positive perceptions of the accounting profession while almost 74 percent of those completing traditional library research indicated a positive perception. As a result, H1 is not supported. Students completing Internet assignments during the semester did not develop more positive perceptions of the accounting profession than students completing traditional library research.

TABLE 4 PERCEPTION OF PROFESSION


×2 VALUE PROB > ×2 5.130 .0235

Hypothesis H3 suggests that students using Internet resources will develop more positive perceptions of the skills needed for successful careers in accounting than students using traditional resources. Again, a Chi-Square test of independence was performed using a crosstabulation of group (Internet vs. traditional



resources) with perception of attitude and skills (positive vs. negative). As stated earlier, students' responses to open-ended questions were judged by the researchers to be positive or negative. In general, responses were hard work, don't know, and "I feel sorry for those people." Positive responses included communication, analytical, and math skills. If students indicated only math skills were needed, this was deemed to be a negative response. Throughout the semester the instructor emphasized through assignments and discussions that accountants need good communication skills, high ethical standards, familiarity with business systems and computers, and various other skills in addition to analytical and math skills. The results of this analysis are reported in Table 5. No significant difference was found between perceptions of students using Internet resources and those using traditional resources. Approximately half of the students completing Internet assignments and traditional resources had a positive perception of the skills and attitudes needed for successful careers in accounting. As a result, H1 is not supported.

TABLE 5 PERCEPTION OF SKILLS AND ATTITUDES NEEDED


×2 VALUE PROB > ×2 .013 .909

Hypothesis H4 proposes that students using Internet resources will have more positive perceptions of the nature of career opportunities in accounting than students using traditional resources. Again, a Chi-Square test of independence was performed using a crosstabulation of group (Internet vs. traditional resources) with perception of the nature of career opportunities in accounting (positive vs. negative). As stated earlier, students' responses to open-ended questions were judged by the researchers to be positive or negative perceptions. Some of the negative responses included "all involve same skills", "too limited", and "I don't know." Positive responses included "diverse", "plentiful", and "unlimited." The results of this analysis are reported in Table 6. No significant difference was found between perceptions of students using Internet resources and those using traditional resources. Approximately 89 percent of the students completing Internet assignments and 97 percent of the students using traditional library resources had a positive perception of the skills and attitudes needed for successful careers in accounting. As a result, H1 is not supported.

TABLE 6 PERCEPTION OF CAREER OPPORTUNTIES

TEST OF H4 GROUP Internet vs. Library Resources

×2 VALUE PROB > ×2 2.387 .122

SUMMARY AND CONCLUSION

As accounting programs search for means to meet the goals and challenges of the accounting profession, the Internet has become one popular tool to introduce students to accounting information including annual reports, ethical issues, and information relating to the accounting profession. The purpose of this study was to investigate the use of the Internet in the introductory accounting courses to help students analyze financial information and to shape their perceptions of the accounting profession, the skills and attitudes needed for successful accounting careers, and the nature of career opportunities in accounting. Results of this study provide educators with valuable information about using the Internet in introductory accounting courses. Based on comparisons of students using the Internet to complete assignments vs. students using traditional resources, no statistically significant difference was found as far



as performance during the course. No significant differences were found in students' perceptions of the skills and attitudes needed for successful careers in accounting or the nature of career opportunities in accounting. However, students conducting traditional library research had more positive perceptions of the accounting profession than their counterparts using the Internet. A limitation of this study is the nonramdom selection of participants. Conducting student performance research based on actual course section enrollment is subject to control limitations since students are not randomly assigned to treatments. Another limitation is that students from only one university were included in the study. Nevertheless, using actual student data is an objective basis for studies of this type.

Research is important in the area of identifying tools and methods of instruction that enhance accounting educators' ability to prepare students to succeed in the work place. This study is a preliminary investigation of using the Internet to help students analyze financial information and shape their perceptions of accounting.

Although results of this study were not as expected, there are other considerations that are worthy of mention. First, the Internet may help bridge the gap between the classroom and the work place, as many employers expect new hires to be able to search for information using the Internet. Second, it is one method of using technology in the classroom and encouraging students to learn to use technology to analyze real-world financial information. Finally, students will probably agree that Internet research is not as boring as traditional library research. Additional research is warranted in this area to provide continuous improvement for teaching the introductory accounting courses.



REFERENCES Accounting Education Change Commission. 1990. Objectives of Education for Accountants: Position

Statement Number One. Torrance, CA. . 1992. The First Course in Accounting: Position Statement No. 2. Torrance, CA. Etter, Edwin, Sandra L. Burmeister, and Randal J. Elder. 1997. "Supplemental Instruction in Accounting

Principles Courses." Working Paper. Graves, O. Finley, Irv Tom Nelson, and Dan S. Deines. 1993. "Accounting Student Characteristics:

Results of the 1992 Federation of Schools of Accountancy (FSA) Schools," Journal of Accounting Education 10: p.31.

Hite, Peggy A. 1996. "An Experimental Study of the Effectiveness of Group exams in an Individual

Income Tax Class." Issues in Accounting Education. 11: p.61. Holcomb, Terry and Robert Michaelsen. 1996. "A Strategic Plan for Educational Technology in

Accounting. Journal of Accounting Education. 14: p. 277. Kimmel, Paul. 1995. "A Framework for Incorporating Critical Thinking into Accounting Education.

Journal of Accounting Education. 13: p. 299. Kurfiss, J. G. 1988. Critical Thinking: Theory, Research, Practice and Possibilities. Washington, D. C.:

Association for the Study of Higher Education. P.2. Saudagaran, Shahrokh M. 1996. "The First Course in Accounting: An Innovative Approach." Issues in

Accounting Education. 11: p. 83.



INTRODUCING THE CPA VISION TO FUTURE ACCOUNTING PROFESSIONALS: A CASE STUDY

Fischer, Carol M. St. Bonaventure University

[email protected]

Fischer, Michael J. St. Bonaventure University

[email protected]

Orsini, Larry L. St. Bonaventure University

[email protected]

ABSTRACT The CPA Vision Process represents a major grass roots effort by the accounting profession to reposition itself for the challenges it will face in the 21st century. In a joint project of the American Institute of Certified Public Accountants and State CPA Societies, accounting professionals from public practice, industry, government, and education worked together to develop a profile of the changing accounting profession and the core competencies needed to succeed in the future. The vision that emerged from this extensive process has been communicated to accounting professionals through special features in the Journal of Accountancy, conference sessions at a number of professional and academic meetings, and discussion on many internet sites. However, if this vision is to become a reality, it is critical for future accounting professionals—current accounting students—to be aware of and embrace the vision for the future. This paper describes an approach to introducing the CPA Vision to fourth and fifth year students enrolled in a five-year accounting program during a team-taught session that encouraged interaction among the students and solicited their reactions and responses to the CPA Vision Project. Specifically, the objectives of the session were to: (1) familiarize students with the CPA Vision Project; (2) encourage students to take a personal responsibility for their future profession; and (3) develop, through student input, ways that these students and others can prepare for the changes required.

In addition, the paper reports the results of a survey of these students completed shortly after the joint session to solicit their feedback concerning the Vision Project class. The survey results suggest that the objectives were achieved and that the students gained a new appreciation for the dynamic nature of the accounting profession. Students also identified some concerns that are unique to future professionals and should be addressed by both educators and the profession as a whole.

This paper concludes with recommendations for making the Vision a reality by integrating the CPA Vision Project in upper-level accounting education and helping future accounting professionals to develop a closer association with the profession and a better understanding of the diversity of the accounting profession.

INTRODUCTION

During the last several years, members of the CPA profession have become increasingly

concerned about the public perception of the profession and the future of accounting professionals. Unwilling to simply react to changes in the business world as they occur, the CPA profession recently embarked on a proactive process designed to identify the major challenges the profession is facing and to



develop a framework for dealing with those challenges in the 21st century. The intent was to create a future in which CPAs would be well positioned to take advantage of the opportunities afforded by changes in the business environment.

In light of the large number of CPAs and the diversity of their positions in business, the CPA Vision Project was a particularly daunting task. Nevertheless, through a combination of publications, presentations, and widely publicized meetings, members of the profession were invited to participate in the project at virtually every stage of the process. In addition, the vision that ultimately emerged was widely communicated to accounting professionals through a variety of methods. However, there is little evidence that the new vision has been integrated into the teaching of future accounting professionals—current accounting students—although they certainly will be greatly affected by changes in the profession.

If the new vision for the CPA profession is to become a reality, it is important for new accounting professionals to understand and adopt this vision as their own. This paper describes an approach to introducing the CPA Vision Project to upper-level accounting students and is organized as follows. The first section provides an overview of the CPA Vision Project, identifying the core values that emerged from this process. Next, the structure of the team-taught session used to introduce the CPA Vision Project to students is described. This is followed by a discussion of student perceptions of the session. Finally, the paper concludes with recommendations for integrating the CPA Vision Project into the accounting curriculum.

THE CPA VISION PROJECT

The CPA Vision Project represents a major grass roots effort by members of the accounting

profession to prepare for the unique challenges of doing business in the 21st century. As CPAs debated the future, many important conditions of the current business environment were identified:

• The number of new non-CPA competitors not bound by the profession’s code of ethics is increasing rapidly.

• The perceived value of the cornerstones of the profession—audit and tax compliance—is declining.

• The world is growing more borderless all the time and people all over are demanding new, more complex and real-time financial advice and services.

• Fewer and fewer young people are selecting the CPA profession as their life’s work.

• Very few CPAs are aware of how diverse the members of the profession are in terms of skills, ideas, and focus, and how much potential they represent.

• Technological developments are rewriting the rules of business and threatening to leave behind all who do not stay current. (Thomas, 1998)

In a process involving the American Institute of Certified Public Accountants and the CPA societies of all 50 states, members of the accounting profession worked toward the goal of developing a Core Purpose and Vision Statement for CPAs.

In the first research phase of the project, four different groups of stakeholders were interviewed—CPAs engaged in different types of work, owners of small businesses, influential professionals and business leaders, and business students who were not accounting majors. Focus groups were held throughout the country in an effort to identify the forces most likely to affect the profession in the future, the characteristics of accounting professionals that were considered most important, and perceptions of the profession. Significantly, while students perceived CPAs to be intelligent, they did not consider their work to be particularly important or interesting, but rather felt that CPAs were focused on tedious and methodical tasks. This last point is of particular interest to accounting educators as well as the profession. Accounting programs nationwide are experiencing significant decreases in enrollment and the decreased supply of graduates may, in the very near future, impact the profession’s ability to realize its vision.

This research was followed by a series of 177 “future forums,” daylong meetings during which input was solicited from CPAs from all over the country (CPA Vision Report, 1998, p. 10). Participants in the future forums worked in teams to consider the results of the research that had been conducted and to plot the future of the profession. The materials gathered through these meetings then served as a basis for a national future forum, attended by delegates from all of the state CPA societies, where a core purpose and vision statement were drafted (see Figure 1).



This vision statement was then presented to the same four groups that were interviewed in the initial research stage. Their reaction to the vision was very positive, with the majority indicating that the profession described in the vision would be vital to global economic welfare and would be a highly appealing career choice for students (Thomas, 1998, p. 24).

Delegates to the national future forum also identified the implications of this new vision statement. This contributed to the development of the top five core values, core services, and core competencies for the accounting profession (see Figure 2).

A TEAM-TAUGHT SESSION TO INTRODUCE THE CPA VISION PROJECT

When the CPA Vision Report was published in late 1998, it served to provide all members of the accounting profession with a blueprint for the future. However, it seemed very important to the authors to ensure that the report was disseminated not just to existing professionals, but also to current students, as they are likely to be most affected by the changes in the profession that are anticipated by this report. This paper describes how the authors did this at a small private university in the northeastern United States.

Students at this university have the option of enrolling in a five-year program in accounting. They apply to the program in the third year of their undergraduate program, and if accepted, earn a dual degree (Bachelors in Business Administration and Masters in Business Administration) at the end of the fifth year of study. The program graduated its first cohort of students in 1995 and has proven to be very attractive to both students and recruiters. Since the students enrolled in this program are generally those who are most likely to become CPAs, the authors elected to focus their efforts on this group of students.

To introduce the CPA Vision Project in a team-taught session, two cohorts of five-year accounting students met in a joint 75-minute class session, taught by three instructors. The students in the fourth year of the program were currently enrolled in an advanced auditing seminar taught by a single instructor, while

Figure 1 CORE PURPOSE: CPAs make sense of a changing and

CPAs are the trusted professionals who enable people and organizations to shape

• Communicating the total picture with

• Translating complex information into

critical knowledge,•

opportunities, and

re 2

Education -

Learning• Competenc

Core Services

• Assurance

Informatio

Services• Management

& Performance

Core Competencies

• Communic

Leadership

Critical

Skills• Focus on



the students in the fifth year of the program were enrolled in an accounting theory and research course taught by two instructors. Both courses end with a discussion of the future of the profession, so the CPA Vision Project was a good topical fit for both groups of students.

Prior to the class meeting, students were asked to read the CPA Vision Report. The class meeting then focused on a discussion of the report in small groups. The objectives for the class, which were presented at the beginning of the session, were as follows:

1. to familiarize students with the CPA Vision Project, 2. to encourage students to take personal responsibility for their prospective profession, and 3. to develop, through student input, ways that the students and other accounting professionals

can prepare for the changes required. The instructors formed six groups of 5 to 6 students each in advance. Each group included males

and females from both classes. The groups were each asked to focus on a different part of the CPA Vision Project. Specifically, two groups were assigned to core values, with the first group developing recommendations for enhancing core values during their graduate education and the other group focusing on recommendations for enhancing core values during the first year of employment. Two groups focused on developing recommendations for preparing to function effectively in a multi-service profession (core services), with one group identifying ways to prepare during their graduate studies and the other group focusing on things that they and their employers could do in the first year of work. Finally, two groups were assigned to core competencies, and prepared recommendations for further developing core competencies during graduate education and in the first year of employment, respectively.

After discussion for approximately 30 minutes, each group selected a representative who presented the group’s recommendations to the class. Students were provided with transparencies to facilitate the presentation. During the informal presentations, the class discussed the recommendations, noting similarities and differences among the groups’ suggestions.

STUDENT PERCEPTIONS

Since this was the first time that the instructors scheduled a joint class session, we decided that we

wanted to obtain some formal feedback from the students concerning the class. The students’ reactions to both the class session and the CPA Vision Project itself were solicited two days after the joint session. The instrument is shown in Table 1, which also provides the mean responses to each question. The responses of all students were combined.

As is shown by the table, student responses to the class were very positive. In addition, open-ended comments provided by the students were favorable. Of particular interest to this study, the students felt that the objectives of the class were achieved. Thus, this group of future accounting professionals left the class with a familiarity with the CPA Vision Project and a greater understanding of how they can prepare for success in a changing profession.

The majority of the open-ended comments were favorable. Student comments generally focused on the structure of the class, with several recommending that the two groups of students be brought together earlier in the semester and/or more frequently. A number of students commented that the class was fun. With respect to the CPA Vision Project, a few students suggested a more detailed assignment in advance to allow for more time to develop recommendations. There were a few negative comments from the students concerning the length of the article that was assigned for the class. In addition, one student felt that there was too much focus on the CPA designation (as opposed to other paths for accounting majors).


Proceedings

Table 1Summary of Student Evaluations of the CPA Vision Project Class

The assigned article was

Working in groups was a useful method of conducting the class. 4.83The following objectives were accomplished:

familiarize students with t - encourage students to take personal responsibility for

- develop, through student input, ways that they and

4.53 s was an effective class technique.

Bringing the 4 and 5th 4.94Overall, I rate the Vision Project class as beneficial.

CONCLUSIONS AND RECOMMENDATIONS

The CPA profession has invested significant time and financial resources in developing the CPA

professionals if it is to become reality. Students who are nearing the end of their education would seem to

favorably to the class focusing on the CPA Vision Project. Several factors helped to make the class a success, as bri

The CPA Vision Project was introduced to students in their 4 and 5th

students had enough background about the profession and were committed enough to the accounting profession to be receplevels of study (and is necessary at the introductory level if it is to influence students’ decisions about majoring in accounting), a detailed consideration of the visi -level

The format of the CPA Vision class was different than other classes. Student interest was

-taught session. Although it inot always possible to design a class with a unique format, this was a good way to stimulate student enthusiasm for this topic.

The use of groups, particularly groups comprised of students at different points in their studies, worked very well to generanew people and during the session it was apparent that lively discussion was taking place throughout the room. Since classes at this university are generally small and studentsaccounting program all know one another, an added bonus of combining the two classes was that group members did not already know each other. As a result, they did not have preconceived notions about each

or positions on the issues discussed.

magnitude of the CPA Vision was reduced somewhat, allowing students to meaningfully discuss the vision. While studethe key issues much better when they had been broken down for them. To help students retain this information, the group presentations were summarized and distribuclass.

have helped the students to further develop some of the core competencies—critical thinking skills seen as critical in the CPA Vision for the future. The effectiveness of the CPA Vision Class might be further enhanced by providing students with a brief introduction to the Vision in

s relevant to accounting professionals in all types of



careers would also help students to appreciate the relevance of the Vision to them, even if they do not plan to pursue the CPA designation.

In summary, this case study demonstrated that it is possible to make the CPA Vision come alive for future accounting professionals. Given the magnitude of changes that the accounting profession will face as the twenty-first century begins, it is critical to ensure that future accounting professionals are prepared. Further, many accounting professionals have invested significant time and resources in the development of the vision for the future. Classes like the one described in this paper will help to bring future accounting professionals on board, contributing to a vibrant profession in the decades to come.



REFERENCES

CPA Vision Report (1998). “CPA Vision 2011 and Beyond: Focus on the Horizon,” Journal of Accountancy, Volume 186, Number 6, December 1998, 25-74.

Thomas, J. (1998). “The Future—It is Us.” Journal of Accountancy, Volume 186, Number 6, December

1998, 23-24.



INVESTIGATING THE PERSONALITY OF ACCOUNTING STUDENTS

Deb Prentice

University of Washington, Tacoma

D. J. Parker University of Washington, Tacoma

ABSTRACT

The purpose of the study is to investigate the personality profile of current and recent accounting students. It is a traditional stereotyped perception that accountants or members of the accounting profession have a personality such as being introverted, pedantic, unsociable, and boring (Shackleton, 1980). But do the current students of accountancy, who will become accountants, fit this same mold. Wolk and Nikolai (1997) suggest that there is a need for accountants personality to be different than this mold to meet the demands of the 21st century (Wolk and Nikolai, 1997). This study examines the Research question, “What is the personality profile of the current accounting student?”

In the accounting literature the Myers Briggs Type Indicator (MBTI) has often been used to capture the personality of the accountant. The MBTI gives qualitative and compariable results. In psychological theory, the personality types, developed by Carl Jung, were employed by Katherine Briggs and Isabel Briggs Myers in the 1940s with some slight modifications in the construction and the evaluation of the MBTI as an instrument. (See Buros, 1974.) Jung’s theory gives the MBTI its bases of validity and must be appraised within the context of this theory.

Jungian theory deals with the basic behavior patterns of a psychologically healthy human being. To Jung there are only two basic psychological functions: (1) the perceptions of events and (2) the process of decision making. All mental activity is composed of taking in information and then using that information in some way. Each of these basic functions has two ways of being manifested. The perception process is manifested as sensing and intuition (S and N). The judgment process is manifested as thinking and feeling (T and F). Each person uses all four of these process but has an innate preference for one or the other according to the attitude they have toward the world, whether as an extrovert or introvert.

Taken together the combination of a person’s preferences in Jungian theory is the person’s pattern or type (Jackson, 1989). Myers and Briggs added another dimension to the Jungian theory: whether the person’s preferred attitude toward the outside world is toward judgment (J) or (P). This leaves the personality results as letters and does not render a quantitative answer that can be examined parametrically and compared to other instruments. The Big Five Inventory-44 (BFI-44)that this study uses capture s the personality in quantitative terms of the Likert scale in terms of the five dimensions of the instrument.

Seven universities participated in this study to investigate the personality profile of accounting students. Accounting professors from different universities were asked to administer the BFI-44 personality instrument to their classes. Approximately 800 usable responses were obtained. The BFI-44 five subscales are: (1) Openness - which expresses a persons ability to be ”imaginative” and “perceptive” (Fiske, 1949; Hogan, 1986; Digman 1990), Conscientiousness - to the extent a person is governed by conscience, diligence and thoroughness, Agreeableness - “prosocial tendency”, Extroversion - positive affectivity, and Neuroticism - negative affectivity. The aggregate mean score of all the participants reveals the personality profile of accounting students. The personality profile picture that emerged demonstrated that the current accounting student does not fit the mold of the traditional stereotype. The accounting profession at this point in time performs

257


many services for their clients. The more aggressive, outgoing , and warm the accountant the better and easier these services will be able to be achieved. , emphasizing their ability to solve problems to get the job done. The high level for Extraversion reveals them to be more outgoing and

Conscientiousness was high indicating the students’ willingness to stick with a job until done. The

of solving problems. ployers in terms of the personality of

accounting students as employees. In generals, desirable employees are well adjusted and conscientious. -analysis has identified Conscientiousness as a predictor of successful performance in a wide variety upations (Barrick & Mount, 1991). The study emphasizes the need for a better understanding

needed of the abilities, interest, and values required of accounting students for their vocation. Knowing the ease the knowledge of improving employee ‘fit’ and

perhaps decrease the occurrence and cost of employee turnover.



IS THERE AN ASSOCIATION BETWEEN PERFORMANCE AND GRADING SCALE?

Elikai, Fara University of North Carolina-Wilmington

[email protected]

Marts, John University of North Carolina-Wilmington

[email protected]

ABSTRACT

To succeed in today's environment students must be motivated to master precise definitions, terms, and systematic problem-solving techniques. They must also think analytically, conceive abstractions, and be able to understand and apply principles and regulations. The method most often used to let a student know how well they have mastered these skills is usually disseminated in the form of a letter grade or the percentage correct on an exam, or, on the course as a whole. Like standards or quota systems in industry the standard or system should in itself play a significant role in encouraging the worker, or in this case, the student, to exert a certain degree of effort to reach the desired standard or quota. This current study was designed to examine the effect of changing the grading scale used in accounting courses in relation to the level of student performance. In this study the grading scale was increased to determine if the student would raise their level of performance to meet the new standards. The results indicate that by using a higher grading scale the students exerted greater effort in their classroom performances and as a result acquire better skills and understanding of the subject matter. In this experiment, a significant shift toward higher scores in quizzes and examinations was observed when a higher standard was applied. This implies that setting a higher attainable standard encourages students to take their class work more seriously. In effect the students put more effort into learning and understanding the required course materials to meet the new standards. As a sidebar the results of this study also indicated that under a higher standard fewer students dropped the course.


of the American Society of Business and Behavioral Sciences, Volume 7, Number 1 Las Vegas, 2000

FOCUS, AND CURRICULUM ISSUES: STUDENT PERCEPTIONS

Bush, Jr., James L.

Middle Tennessee State [email protected]

Farmer, Larry E.

[email protected]

Gober, R. WayneMiddle Tennessee State University

[email protected]

ABSTRACT

This paper reports the results of a survey administered to 215 undergraduate accounting majors

questionnaire designed to determine student interest in certain advanced professional examinations,

identifiable changes as accounting majors progressed toward earning their degrees. The findings seem to support the notion that students cloaked in a traditional financial accounting

choices will be made in that setting, students expressed an interest in searching for those limited career

obtaining a CPA certificate. Finally, student responses to curriculum issues are so random as to infer

students are not interested in this issue. The survey instrument did not allow for gathering of demographic data that may have reve

upon the accounting profession. As we leave the twentieth century, we find many unsettled issues in

advanced professional examinations, the restructure of accounting education, and the prospect for fundamental change in the services which the pThese issues have already generated substantial discussion among educators, those in the accounting profession, regulators and others. It is time to incorporate student career desires into tequation. Fundamentally, how much can the traditional curriculum model be changed if the student is still saying that the first task after graduation is sitting for the CPA Exam! While a broad discussion of these

of this paper, it is important to observe the environment, which encompasses the analysis contained in this paper. The thrust of this research is to investigate the views of accounting majors and how those views

l examinations, probable career paths, and certain curriculum issues during their collegiate years. The authors were interested in trying to determine whether their



students seemed to be more or less interested in taking advanced professional examinations and whether the interest of the students majoring in accounting tended to increase or decrease as graduation drew nearer. Further, there was interest in trying to determine how heavily skewed toward careers in public accounting our students are. Lastly, there was interest in attempting to determine the level of interest that our students exhibited in certain aspects of the accounting curriculum as it is currently structured at Middle Tennessee State University.

RESEARCH METHODOLOGY

A questionnaire was designed and administered to 215 upper division accounting classes during the spring semester of 1999 at Middle Tennessee State University. The students were asked to relate their views on nine issues. The questionnaire employed a Likert-type scale from 1 (strongly agree) to 5 (strongly disagree) to attempt to gather information which would provide information with respect to the strength of student’s perceptions of each of the nine statements. The list of statements provided to students and the percentage of student responses to each statement is given in Table 1.

Table 1 Percentage of Respondents to Each Statement STATEMENT Strongly

Agree Agree Undecided Disagree Strongly

Disagree I plan to sit for the CPA exam. 54.8% 13.3% 20.0% 3.8% 8.1% I plan to sit for other professional exams. 27.0% 22.8% 41.9% 3.3% 5.1% I plan to seek initial employment in a public accounting firm.

24.9% 15.3% 28.7% 18.2% 12.9%

I expect to make a career in public accounting.

16.7% 20.0% 35.3% 17.7% 10.2%

I plan to work in the area of taxation, whether in public accounting or not.

4.8% 13.4% 40.7% 22.5% 18.7%

I would choose a more general tax course over the current Federal Tax I.

10.5% 47.4% 13.9% 19.6% 8.6%

I would choose an internal auditing course over traditional external auditing course.

11.4% 33.3% 40.0% 11.9% 3.3%

I would substitute other courses for currently required accounting courses.

18.2% 37.8% 23.9% 18.7% 1.4%

I would choose a different minor that currently built into the curriculum.

31.9% 31.0% 16.2% 15.7% 5.2%

A null hypothesis that the midpoint of responses equals 3 was tested for each statement in order to identify those statements that the students either agreed or disagreed. A response of 3, therefore, could be considered the point of indifference for the statement or an indication that the student was undecided on that particular issue. To determine which statistical tests might be appropriately applied to the data gathered, an Anderson-Darling test for normality of responses was performed. None of the nine statements were found to have responses that were normally distributed at the .005 level of significance. Since t-tests require the assumption of normally distributed data, the Wilcoxon Signed Rank Test was used to test whether the median response was significantly different from an undecided or indifferent response. Table 2 presents the results of the Wilcoxon Signed Rank Test on each of the nine statements. Statement numbers are used in all succeeding tables and correspond to the statements provided above in Table 1.

Table 2 Wilcoxon Signed Rank Test in Test of Median = 3.00 versus Median Not = 3.00 STATEMENT N FOR

TEST WILCOXON STATISTIC

P ESTIMATED MEDIAN

Z FOR W

1 95 1150.0 0.000 2.000 -4.19440 2 66 558.0 0.000 2.500 -3.49747



3 86 1952.5 0.726 3.000 0.35309 4 75 1474.5 0.796 3.000 0.26139 5 75 2235.0 0.000 3.500 4.27725 6 96 1717.5 0.026 2.500 -2.23096 7 69 649.0 0.001 2.500 -3.33924 8 89 748.0 0.000 2.500 -5.13255 9 96 1142.0 0.000 2.500 -4.33401

DATA ANALYSIS

Students completing the questionnaire expressed agreement that was significantly different from an undecided response at the .05 significance level for all of the statements included on the questionnaire except the statements related to career paths. Students expressed disagreement that was significantly different from an undecided response at the .05 significance level when queried about the possibility of pursuing a career in taxation—whether they were in public accounting or not. To investigate whether the perceptions expressed by the respondents could be determined to change as they moved through their educations further analysis was necessary. In order to gain insight into whether the opinions of the respondents differed depending on their progress toward graduation, Mann-Whitney-Wilcoxon (MWW) Rank Sum Tests were performed by dividing the students’ responses into various sets of two groups. These groupings permitted the testing of the null hypothesis that students’ perceptions change as they progress through the accounting program. Four different MWW Rank Sum Tests were performed. Student responses were grouped according to: • Intermediate I enrollment and not Intermediate I enrollment • Intermediate I enrollment and Intermediate II enrollment • Intermediate I or II enrollment and not Intermediate I or II enrollment • Enrollment in one junior level course and enrollment in one senior level course When the responses of those currently enrolled in the Intermediate I course are separated from the remaining responses, it becomes possible to test how quickly student perception changed. No statistically significant difference (at a significance level of .10) was found by separating Intermediate I responses from all others. However, tests of both Intermediate I and Intermediate II enrollments against non-intermediate accounting enrollment and tests of enrollment in one junior level class against enrollment in one senior level class found three statistically significant differences in the perceptions expressed. Respondents enrolled in the higher level classes were more likely to pursue a public accounting entry level job, a public accounting career, and a career in taxation. The results of the third grouping are provided in Table 3. Other results are similar. Table 3 Mann-Whitney-Wilcoxon Rank Sum Test of Median for Group 1 (Intermediate I or II Enrollment) Not Equal to Median for Group 2 (Not Enrolled in Intermediate I or II)

STATEMENT N FOR TEST Group 1 Group 2

MWW STATISTIC

EST MEDIAN Group 1 Group 2

Z FOR W P

1 110 104 12427.5 1.000 1.000 1.32970 .1836 2 110 104 11556.0 3.000 2.000 -0.57098 .5680 3 110 104 12571.0 3.000 3.000 2.01837 .0436 4 110 103 12748.5 3.000 3.000 2.17574 .0296 5 110 103 12471.5 3.000 4.000 1.93209 .0533 6 110 104 12153.5 2.000 2.000 1.08981 .2758 7 110 104 12467.0 3.000 3.000 1.41695 .1565 8 110 104 11966.5 2.000 2.000 .31144 .7555 9 110 104 11484.0 2.000 2.000 -.75210 .4520

Some might argue that course content could influence students’ perceptions about certain statements contained in the questionnaire. For example, students in certain accounting courses might be



more (or less) inclined to take professional examinations other than the CPA exam because the course content might be more likely to appear on other professional exams. Simply put, students enrolled in a cost accounting course might be more interested in sitting for the CMA examination as they would tend to be exposed to discussions about this exam in class and exposed to CMA adapted assignments in their textbooks. Student responses were grouped according to whether the respondent was enrolled in each required class against a second group consisting, in each case, of students not enrolled in that class. A MWW Rank Sum Test was then performed to test for significantly different responses between the two groups. Complete results of these tests are not presented in the body of this paper (these results may be obtained by contacting authors). Table 4 lists only those statements that proved to have statistically different means. The instructor, the instructor’s biases, and the instructor’s background might influence student responses as much or more than the content of the course. For example, the instructor assigned to teach all Accounting Theory sections started her career in public accounting and was never in the corporate accounting sector. Table 4 Statement Numbers Corresponding to Significant MWW Rank Sum Test Statistic When Testing Nonequality of Medians

Class Statements That Enrollees Agreed With More Often

Statements That Enrollees Disagreed With More Often

Intermediate II 4*,7* Cost Accounting 1***,4* Accounting Theory 1*** Accounting Systems 7** Federal Tax I 1***,3**,4**,5** Auditing 2* Elective 7***

* - Significant at .10 level ** - Significant at .05 level *** - Significant at .01 level It is possible that student responses to one statement might tend to be a predictor of student responses to other statements. Therefore, one could argue that the students did not take the questionnaire seriously because students merely went down the questionnaire marking the same response to all statements. Alternatively, no set of statements might be correlated and the argument could be raised that all responses appeared randomly distributed. Others might argue that the response given to one statement might bias the responses given to other statements. To test these arguments, Wilcoxon Signed Rank Tests were performed on each combination of statements that dealt with professional exams and career choices and on each combination of statements dealing with curriculum. Table 5 contains the results of these tests. The results of these tests indicate much significance in different student responses among the statements on professional exams and career choices. All combinations of Statements 1 through 5 have statistically significant medians not equal to 0.000 except the combination of Statements 3 and 4. Between Statements 3 and 4, there is no statistical difference in the students’ responses, possibly indicating that the respondents desiring to enter public accounting planned on staying in public accounting and those students not desiring to enter public accounting initially not planning on a career in public accounting. Interestingly, there is also no significant difference between student responses to Statements 1 and 2, indicating that those planning to sit for the CPA exam were the same respondents who planned to sit for other professional exams. Finally, there appears to be minimal correlation of responses to the statements that dealt with curriculum issues. Two possible inferences can be drawn from these results. Either students are not really concerned about curriculum issues, or students are very concerned about these issues, but there is so much dispersion in their agreement and disagreement with certain statements that their responses appear random.



FINDINGS

The accounting curriculum at Middle Tennessee State University, not unlike many traditional programs, contains a heavy dose of financial accounting. It should not be totally unexpected that a significant portion of the student population would lean toward expressing an interest in taking the CPA examination. However, conventional wisdom has suggested that the financial accounting bias, has been eliminated by graduation. The results obtained from analysis of the responses to the statements contained in Table 1, however, would seem to indicate that the only time the students appear not to reflect the financial accounting bias is during the students enrollment in cost accounting. Table 5 Wilcoxon Signed Rank Test of Differences of Medians Between Statements Being Significantly Different From 0.00

STATEMENTS TESTED

N N FOR TEST

WILCOXON STATISTIC

ESTIMATED MEDIAN

P

1:2 215 139 3046.0 -0.500 0.000 1:3 214 135 1067.5 -1.000 0.000 1:4 214 144 1002.0 .1.000 0.000 1:5 213 176 920.0 -1.500 0.000 2:3 214 148 3589.0 -0.500 0.000 2:4 214 144 2932.0 -0.500 0.000 2:5 213 156 1431.0 -1.000 0.000 3:4 213 97 2188.5 0.000 0.500 3:5 212 137 2093.0 -0.500 0.000 4:5 212 111 1156.0 -0.500 0.000 6:7 214 128 4444.0 0.000 0.453 6:8 214 133 5257.5 0.000 0.072 6:9 214 149 7332.0 0.500 0.001 7:8 215 149 6216.5 0.000 0.234 7:9 215 149 7185.0 0.500 0.002 8:9 215 154 7034.0 0.000 0.054

It should be noted that students at Middle Tennessee State University have a number of CPA review course alternatives available to them. Student awareness of these options comes mainly from advertising by the providers, discussion with faculty members, the grapevine, and professional association. There are no CPA review courses offered as a part of the curriculum or by faculty members on a for-profit basis. Similarly, there are no CMA review programs available to the students through the curriculum or on campus from any provider—internal or external. Thus, any bias or preference which students’ responses reflect appear to be most likely related to their experience on campus rather than exogenous factors. When one considers the proliferation in recent years of the number of advanced professional examinations, it is somewhat surprising that there continues to be such a high degree of identification with public accounting as a likely career path. These results raise questions about the traditional structure of accounting curriculum and the emphasis on financial accounting topics within that structure. Students at Middle Tennessee are not exposed, at this point in time, to tracks within their course of study, so they have been exposed to no common body of knowledge for career paths such as management accounting or internal auditing. Student awareness currently is cultivated primarily through extracurricular activities such as Beta Alpha Psi and an IMA student chapter.

CONCLUSIONS

The AICPA, through its Vision 2011 Program, has emphasized that the demand for traditional services from CPAs will be reduced in the near future. The Vision 2011 Report presents the case for the need for accounting graduates to emerge from their colleges and universities with a new set of skills compared with those which have been higher education’s stock-in-trade for the last five or six decades—skills that would be necessary for providing those services which are anticipated to be in demand. The



traditional accounting curriculum, and possibly even the traditional method of knowledge transfer in the classroom, must evolve away from the traditional heavy financial accounting and financial statement preparation emphasis. It is possible that we are influencing our students into a career direction that will lead to frustration in later years when jobs or career advancements are not available in the chosen area. Student perceptions of curriculum issues are dispersed. Maybe students feel that these issues are best left to faculty members. Maybe there is enough dispersion of student interest among these issues to economically justify multiple tracks.



MAJOR CHANGES IN THE ACCOUNTING PROFESSION? AN UPDATED ASSESSMENT OF

THE UNIFORM ACCOUTANCY ACT

Paul Cameron Texas A&M University-Corpus Christi

Cheryl Hein


ABSTRACT The “big five” accounting firms are no longer just public accounting firms. In recent years their management advisory services have grown extensively and now provide a major source of their revenue. In order to accommodate this expanded organization structure in their multi-national operations the American Institute of Certified Public Accountants has proposed major changes to the laws governing the public accounting profession. These changes are reflected in the proposed Uniform Accountancy Act (UAA). Many of the proposed changes are opposed by small and medium-size public accounting firms. This paper examines the conflicts that have resulted from the proposed UAA and the outcome of some of these conflicts. This paper also provides an updated assessment of the status of the UAA in Texas and the potential impact of the UAA on the accounting profession.

INTRODUCTION

The purpose of this paper is to provide an update on the AICPA/NASBA Uniform Accountancy Act, its implementation status and specifically its status in the state of Texas. The UAA was designed as model legislation for state public accountancy laws. CPAs are currently licensed and regulated at the state rather than the national level. There are 54 separate licensing jurisdictions which are the 50 states, the District of Columbia, Puerto Rico, Guam and the U.S. Virgin Islands. Each of these entries has its own set of laws that license and regulate the accounting profession in their state. The differences in these laws vary in the area of education requirements, experience requirements, exam scoring and continuing education. Some feel that these different rules are a detriment to interstate practice and mobility.

BACKGROUND

One of the most significant recent initiatives that could affect the accounting profession is the proposed Uniform Accountancy Act (UAA). The UAA is being proposed by the American Institute of Certified Public Accountants (AICPA) and the National Association of State Boards of Accounting (NASBA). After long deliberation, a joint agreement was finally reached by representatives from these two groups (Joint Committee) and in 1997 the UAA was finalized. During its deliberations, the Joint Committee considered a number of current environmental conditions that they believed were motivating factors in why a uniform approach to regulating the accounting profession was needed. These include: Expansion of Services Increased Capability of Information Technology Globalization of Business Legal Challenges to Current Regulatory System. The legal challenges to state public accounting laws include several high-profile court cases dealing with CPAs doing work for the public in a non-CPA owned firm and the non-CPA ownership of CPA firms raised by purchases of CPA firms by American Express and Century Business Services.



For a number of years the NASBA has been trying to increase the uniformity among state accountancy laws. A “model act” has been used in this effort and some degree of success has been reached. The AICPA has pressed for increased uniformity and, after reaching some agreement with NASBA, is now promoting the adoption of the UAA by the 54 licensing jurisdictions in the U.S. The AICPA undertaking has a goal of getting 40 states to adopt the UAA by the year 2000. In order to accomplish this goal, new legislation must be enacted in each of the 54 jurisdictions. In addition to the legislators the support of key CPA leadership must be attained. Therefore, the support of the State CPA Societies and the State Boards of Public Accountancy is essential. However, some State Board members do not believe that the UAA protects the public. Hunter (1997) stated that the UAA “is by the profession, for the profession, and selfishly in the best interests of the profession.” Some State Boards are angry because “NABA pressured to represent Boards – with recommendations that dilute and diminish the prestige of the CPA certificate and license to practice.”

UAA PERSPECTIVE

The Joint Committee designed the UAA to be responsive to the problems and challenges of the profession while maintaining the public role of the CPA. They identified several key goals that they felt were of prime importance in any uniform regulatory system for CPAs. These goals are to:

1) Permit easy movement of CPAs across state lines – to permit ease of mobility for CPAs across state lines, in person or electronically, in order to serve clients and employers outside the state where CPAs are licensed.

2) Remove barriers that limit CPAs and CPA firms in a competitive marketplace – to remove barriers that unnecessarily limit CPAs and CPA firms from competing effectively in the marketplace for a broad range of professional services. The new UAA provides a balance between public protection and free market competition.

3) Implement consistent standards and credentials for all who are CPAs – to ensure that all who wish to use the CPA title are licensed and subject to state board of accountancy regulation regardless of their field of employment. The Act also promotes rules for licensing, practice and ethics that are more uniform across jurisdictions and removes barriers that limit CPAs from using the CPA title.

4) Protect the public interest – to ensure an effective enforcement system. The new UAA enhances protection of the public interest where it is most critical – that is, in the area of attest services. But the Act also assures that anyone who uses the CPA title must adhere to an appropriate level of professionalism.

Underlying the push for changing the CPA regulatory laws are the needs of the “big five” firms.

They are no longer just “public accounting firms.” The have become multi-national businesses that are involved is providing professional services for companies around the world with a smaller and smaller percent of their business in the accounting/financial area. In order to satisfy the full spectrum of problems faces by their clients the “big five” now hire employees with a myriad of business skills. Accountants are no longer the predominant new employees and have been replaced with massive hirings of other public professionals such as attorneys. The income from other than accounting sources has rapidly increased. These new earnings have been generated primarily from non-CPA employees who have demanded a larger share in the profits of the “big five” and also a stake in the ownership. To provide these non-CPA employees an ownership in the “big five” would require a major change in the accounting regulatory laws of most states. Today most states require that public accounting firms be 100% owned by CPAs which would prohibit non-CPAs from becoming a partner in a “big five” public accounting firm. If the “big five” firms are to retain their identity and prestige as public accounting firms and at the same time accommodate their non-CPA employees as owners, then current state accounting laws must be changed. The initial proposal contained in the UAA was to allow non-CPAs to be 100% owners of public accounting firms. Due to immediate heavy resistance to this proposal, the UAA was revised to limit non-CPA ownerships to not more than 49%. Even though CPAs would have at least 51% ownerships some would argue that non-CPAs could still control the firms by having the non-CPA owning the largest



individual share (49%) while several CPA partners own shares of about 10% each. This scenario could give the non-CPA owner the individual controlling interest in the firm.

TEXAS LAW VS UAA

A comparison of the key features of the UAA with the current Public Accounting Law of one of the larger states such as Texas should provide some insight into the nature and magnitude of the changes being proposed. The current Texas accounting law was passed in 1991 and has subsequently been amended as necessary. It appears to have served the Texas CPA profession well and has, so far, survived legal challenges.

Ownership of CPA Firms Texas: The current Texas law requires that accounting firms that do accounting work for the public including attest work defined as audits, reviews, compilations and examinations of prospective financial information, must be licensed by the State Board of Accountancy. It also requires that the firm be 100% owned by CPAs, that CPAs in the firm are licensed in Texas, that the firm name cannot include the name of a non CPA and that the firm undergo as a peer review every three years. UAA: The UAA proposal concerning the ownership of public accounting is significantly different from the Texas law and the laws of most states. Rather that 100% CPA ownership, it proposes that only a simple majority (51%) of owners be CPAs and that the remaining owners could be non-CPAs. This is probably one of the most controversial parts of the UAA proposal. Even though a firm might be 51% owned by CPAs, it does not necessarily mean that the firm would be run by the CPAs. Forty nine percent ownership by a non-CPA party could result in their controlling the operation of the public accounting firm. This non-CPA owner would not personally be subject to the regulation of the State Board or subject to the CPA standards of conduct. This change also raises the question as to whether the public interest is protected. CPAs in Non-CPA Owned Firms Texas: With some minor exceptions, all work done for the public by a licensed CPA must be done through a firm licensed by the Texas State Board with 100% CPA ownership. This requirement provides for the Texas State Board to be involved in licensing all firms that use CPAs in providing accounting services to the public. UAA: The UAA proposal would permit CPAs to be employed by a completely non-CPA owned firm and perform all accounting work for the public except the attest function. Proponents of this change argue that some of the larger accounting firms are already doing this by shifting their non-attest activities into separate entities in order to get around the law. Whether this skirting of the law is ample justification to lower the accountability of CPAs to the public remains to be seen. Another argument for this change is that a “CPA is a CPA” no matter where he practices and should be able to use the title in any employment situation. Opponents to this proposal argue that allowing CPAs to serve the public in unlicensed, non-CPA owned firms would lessen the accountability of CPAs and not be in the best interest of the public. Equivalency of CPA Licenses CPAs are currently licensed and regulated by each of the 54 U.S. entities rather than at the national level. Each state has their own rules concerning experience, education, continuing education, etc. To practice as a CPA in various states a CPA must obtain a license/permit in each state. CPAs that move must obtain a new license. In some cases this process can be difficult. Another problem concerns the CPA who practices in other states electronically rather than in person. A movement for equivalency among all 54 licenses has been in progress for some time and some improvements have been made. Texas: Licensing requirements in Texas have been modified in recent years to be more closely aligned with the AICPA “model act.” Reciprocity agreements with other states have been simplified and streamlined. UAA: The most obvious solution to the license problem would be a national license; however, most states would not be willing to give up their control over licenses. The UAA therefore proposes a concept of substantial license equivalency. This means that a CPA from a state that has adopted the UAA licensing requirements can automatically practice in a state that has also adopted the UAA licensing



requirements or the equivalent. The CPA could legally practice in the new state without a reciprocal or temporary license. Under this proposal the present system would continue to be used when equivalency does not exist between the states involved. This proposed change would not solve the problem completely but should provide considerable improvements over the present situation. Commissions and Contingent Fee Even though many states permit CPAs to receive commissions and contingent fees, it remains a controversial issue. Many feel that the basic requirement of independence is compromised when commissions and contingent fees are accepted. Texas: Commission and contingent fees are permitted in Texas provided they are disclosed by the CPA before the service is provided and no attest services are provided to a client who pays these fees. UAA: The UAA would permit the acceptance of commissions and contingent fees as long as they are disclosed to the client and no attest work is done for the client. Commissions, for example, would be permissible in engagements for financial planning. Commissions or contingent fees would not be acceptable for attest clients and preparation of initial tax returns. CPA Experience Requirements The experience requirements to become a licensed CPA do vary slightly from state to state. Even though it has been difficult to prove there is a link between meeting experience requirements and competency as a CPA, states still insist on experience prior to granting a license. Experience requirements typically vary from one to two years. Some states have traded off experience for education. For example, a candidate with a bachelor’s degree would need two years of experience while a candidate with a masters degree or 150 semester hours would need only one year. Some states require that experience must be obtained in a public accounting firm while others allow it in any accounting environment while under the direct supervision of a licensed CPA. Texas: Texas has adopted the 150 semester hours license requirement and along with that a requirement of only one year of experience working under the direct supervision of a licensed CPA in any professional accounting environment. There is no requirement that a candidate get their experience in a public accounting firm in order to perform attest work. UAA: The UAA proposal would require one year of experience for candidates who will be working outside the attest area. This experience could be obtained in any professional accounting environment and provided that it is verified by a licensed CPA. The candidate’s work experience would not have to be supervised by a licensed CPA. This proposal to not require CPA supervision is a change from most state requirements. For licensees who would supervise attest engagements or sign attest reports, the UAA would require an additional year of experience working in the delivery of attest services. The UAA advocates argue that since more than half of accounting graduates are initially employed outside of public accounting, and that the majority of CPAs never perform attest services, why should they be required to have attest work experience in order to become a CPA. In states that require attest work experience for all CPA candidates there are many accounting professionals who have been unable to obtain the attest experience therefore never obtaining the CPA designation. It is also pointed out that due to increased scope of accounting today that a variety of skills are needed by CPAs thus, a multitude of experiences for candidates should be acceptable. Opponents of the UAA proposed experience requirements point out that it will create a new class of CPAs who would be qualified and registered in a special new CPA category. The added requirement would have a detrimental effect on small CPA firms that only conduct compilations. Obtaining the extra one year of experience would tend to eliminate them from performing the attest function. It is also argued that the Peer Review process is an effective program to test competency in the attest area and could be expanded to evaluate the experience of the firm members. It is further argued that this additional one year experience for those in attest work would be a barrier to new CPA candidates. On the other hand the UAA proposal to accept non-CPA supervised accounting work as experience would open the door wider to those desiring to become a licensed CPA.

UAA PROS AND CONS Pros: On the positive side there would seem to be some definite advantages to each state adopting certain portions of the UAA. Those portions that clearly enhance the accounting profession and improve



the regulatory system should be adopted. Of the five major parts of the UAA that have been covered in this paper there are two that seem to meet this criteria. The first of these is the Equivalency of CPA Licenses, and the second is Commissions and Contingent Fees. First, the UAA proposal for Equivalency of CPA licenses would not create a national CPA license but proposes a concept of license equivalency among the 54 licensing jurisdictions. By having each jurisdiction adopt a set of equivalent licensing standards then the problems of mobility for CPAs across state lines would be greatly reduced. Even if all states did not initially adopt the standards, significant improvements would still occur. The part of the UAA proposal on the CPA experience requirements may not be a standard that most states would agree to. Efforts to establish a set of standards acceptable to most states should be implemented. Once some agreement among the states is reached then license equivalency would become a reality. The UAA provision that enables state boards to discipline licenses from other states who practice in their state would assure protection of the public. Also, the home state of the CPA would also retain authority to discipline licensees if they violate the law in another state. Second, the major provision of the UAA that seems attractive for nationwide adoption deals with Commission and Contingent Fees. Currently, states are split with slightly more than half permitting CPAs to accept these fees, while the rest continue to prohibit their acceptance. There has been a recent trend among states to move toward accepting commissions and fees. Provisions in the UAA would provide for the acceptance of commission and contingent fees in certain situations. The UAA provisions mirror these currently contained in the AICPA Code of Conduct rules. These rules enable CPAs to accept commissions that are disclosed to clients except where they also perform attest services for the client. CPAs can accept contingent fees for services provided it is not from an attest client and provided it is not for preparing an original tax return. Contingent fees for preparation of an amended tax return or referred claim would be permitted as long as the CPA had a reasonable expectation that the claim would be the subject of a substantive review by the taxing authority. Cons: On the negative side there are certain aspects of the remaining three provisions that might prevent their adoption in the majority of states. First, the provision of the UAA that would require that only 51% of the owners of a public accounting firm be CPAs is probably the most controversial provision. In most states the requirement is for 100% CPA ownership and some feel this change would have a negative impact on the profession and would not be in the best interest of the public. One argument is that the current state laws regarding CPA ownership are working well so why should they jeopardize their future by giving up any ownership to non-CPAs. CPAs can currently employ non-CPAs in their firms without giving them ownership status. Further, some argue that the integrity and high standards of the profession would be diminished by this proposal. Second, the provision to adopt a uniform set of CPA experience requirements for new licensees contains certain parts that would probably be difficult to obtain consensus on. Some would argue that requiring an additional one year of attest work experience for attest CPAs would create a two-tier licensing profession and defeat the notion that “a CPA is a CPA.” A more reasonable approach might be to make the experience requirement the same for all CPAs with possibly some trade-off for education. For example, two years of accounting experience under a CPA’s supervision for those with an undergraduate degree and one year for those with a master’s degree or 150 semester hours. The UAA requirement for the attest CPA to get an extra one year experience in an attest work environment would be a divisive requirement and for many difficult to obtain. All CPAs would not be equally qualified and two-tier licensing could result. Third, the UAA provision to allow CPAs to work in a firm, fully owned by non-CPAs and to perform all accounting work for the public except the attest function would be a significant change. Most states today require that if a CPA offers his accounting services to the public then it must be through a licensed CPA entity that is accountable to the State Board. It is argued that this requirement is needed to protect the public and to maintain the integrity of the CPA. It requires that all CPAs that do work for the public must do it in a firm licensed by the State Board. CPAs that work in the private or governmental sector and do no work for the public do not have to meet this requirement.

STATUS UPDATE ON THE UAA IN TEXAS

Some Texas CPAs believe that they may be in for some serious changes in their income, their jobs, their career opportunities and their profession if the UAA becomes the accounting law in Texas. The



AICPA has undertaken a significant campaign to get the UAA adopted in all states and UAA proponents in Texas are hoping to get it adopted by the Texas Legislature in 1999. In 1997 a survey of Texas CPAs was conducted by a Task Force of the Texas Society of CPAs. A questionnaire was completed by 234 Texas Society CPA members from 17 different chapters throughout the state. Seventy-two percent of Society CPAs that were surveyed indicated that CPA firms should be 100% owned by CPAs and 75% were opposed to the reduction of CPA ownership from 100% to 51%. On the issue of receiving commissions and contingent fees the votes for and against were about evenly split. On the issue of CPA license equivalency over 90% were for adopting an equivalency standard in Texas. On the UAA provision to allow CPAs to perform work for the public in unlicensed, non-CPA firms approximately 80% overall were opposed to this provision. One interesting note on the vote on this issue is the breakout of voters. About 30% of them were CPAs practicing in the private sector and 70% were from the public sector. Eighty-two % of CPAs in public accounting were opposed and seventy-one % of the private sector CPAs were opposed. Another survey concerning the adoption of the UAA in Texas was conducted in 1998 by the Corpus Christi Chapter of the Texas Society of CPAs. This was a limited survey and only addressed the issue of whether or not to adopt the UAA in Texas. Of those responding, approximately 90% were opposed to the adoption of the UAA in Texas. To my knowledge, there are no written polls or surveys of Texas CPAs that demonstrated that the majority of Texas CPAs want to see the UAA adopted. Based upon this somewhat limited information one could conclude that the majority of CPAs in Texas are generally opposed to the adoption of the UAA in Texas. Specifically, they are in favor of (1) maintaining 100% CPA ownership of public accounting firms and (2) requiring that all work done for the public by a CPA be conducted through a firm licensed by the State Board with 100% CPA ownership. One might also conclude that Texas CPAs would agree to adjust the current Texas accounting law to help promote CPA license equivalency across the nation. The mission of UAA proponents to get the UAA adopted by the Texas Legislature in 1999 failed. In June 1999 following a lengthy UAA briefing by UAA proponents, the Board of Directors of the Texas Society of CPAs voted to endorse the UAA. The CPA opponents of the UAA then took their objections to the Texas legislature. Based upon this opposition and the major split among Texas CPAs on UAA adoption, the Texas campaign for UAA adoption in 1999 was cancelled. This was a major setback for UAA proponents in Texas; however, they have not given up on getting the UAA adopted in Texas. The Chairman of the Board of the Texas Society of CPAs has appointed another committee to further educate Texas CPAs on the benefits of adopting the UAA. The proposed UAA legislation will continue to be a major controversial issue as long as it permits non-CPAs to own CPA firms and appears to diminish the statue of the CPA.

CHANGES IN THE PROFESSION

Adopting the UAA across the nation could have a major impact on the accounting profession. First, one of the most significant changes proposed by the UAA and the one that has raised major objections by Texas CPAs is the one that would reduce the CPA firm ownership requirement from 100% to 51% CPAs. Many argue that this change would result in a serious reduction in their income, career opportunities in accounting and in the esteem in which CPAs are held. The control and direction of CPA firms could drastically change as major corporations buy into the accounting professions. With non-CPA ownership, the power of State Boards to regulate and set standards would be diminished. Without State Board oversight authority over non-CPA owners, the protection of the public would slowly but surely decline. Also, the 51% CPA ownership requirement would not prevent a 49% owner from being the largest owner and therefore in control of the firm. The second major change proposed by the UAA would permit CPAs to perform work for the public except attest work in a firm with no CPA ownership and not licensed by a State Board. It would appear that with this change, a major acquisition of CPA firms by non-CPA owned firms could occur. Major companies who are already performing accounting-related activities would be afforded a new opportunity to quickly expand their market by acquiring accounting firms across the country. The billion dollar plus market of small and medium size accounting firms would be extremely attractive to major firms desiring to expand their services. Acquisition of accounting firms would not only allow entry into an expanded area of services but would also provide a proven set of clients. Accounting firms whose owners



are at or approaching retirement would likely be the first to sell. High dollar offers could entice others. Those who did not sell might be faced with the increased competition of a large company and could be eventually forced out of business. As we look at how other small family owned businesses across America have been replaced by corporate owned outlets, is there any reason to doubt that this will not occur in the CPA profession? The appetite of large companies for increased profits will drive the transition at an accelerated pace. Third, the UAA proposal on experience requirements for CPAs could result in two different classes of CPAs. By reducing the basic experience requirement to one year of experience in general accounting not under the supervision of a CPA possibly opens the doors of the profession to a less qualified individual than currently. The numbers of CPAs in the profession could also be expanded by this proposed lowering of the experience requirement. On the other hand the experience requirement needed to perform attest work would be increased. This would result in possibly smaller numbers of CPAs qualified for attest work thereby creating less competition and higher fees for all attest work. Under this experience proposal the philosophy that “a CPA is a CPA” would not be followed. Instead, only CPAs with certain experience requirements could perform attest activities. Some believe that this difference of qualifications of CPAs would have a detrimental impact on the meaning of “CPA” and a diminishing of its status. Regardless of any change in experience requirements the control and issuance of licenses would remain with the states. On the positive side it appears that the UAA would bring a higher degree of standardization and updating of the accounting regulatory environment. One of the areas that would be positively impacted would be the creation of license equivalency among the various states. The elimination of the multitude of problems caused by current state laws would be a major step forward in providing CPAs the flexibility to practice across state boundaries. Another positive factor that should bring more standardization to the profession is the proposal to allow for commissions and contingent fees to be accepted by CPAs under certain conditions. Opening the door to these types of revenues without compromising their independence could be attractive to certain licensees.

WHAT’S NEXT?

Legal challenges and debate will continue across the country as firms seek to penetrate the accounting market and modify state accountancy laws. The UAA will continue to meet stout resistance to several of its propositions. The equivalency licensing provision will probably be the portion of the UAA most easily adopted by states. Legal challenges and debate regarding the regulatory laws of the accounting profession will continue. In order for non-CPAs owned firms to obtain a market foothold in certain states requires that the accounting laws of that state be changed. The UAA has become one vehicle for accomplishing these changes in the accounting laws throughout the nation. Due to certain controversial provisions of the UAA, however, there will be continued state resistance to its adoption. All accountancy groups will be closely monitoring the impact on any state’s accounting profession should it elect to adopt the UAA. If the results appear unfavorable, then state resistance to UAA adoption would probably stiffen. A “wait and see” attitude and a “don’t fix it if it isn’t broke” approach would possibly follow. Some of the propositions of the UAA will be rejected by the states while others will be adopted. The pressure for change will continue as new competitors try to enter the accounting marketplace and others try to streamline the regulatory process. There is no doubt that the accounting profession is in the midst of a protracted struggle. Hopefully, the outcome in the future will be an improved profession that meets the needs of the public and a profession which we can be proud of.



REFERENCES

American Institute of Certified Public Accountants, Inc. and National Association of State Boards of Accountancy. (1998). Uniform Accountancy Act and Uniform Accountancy Act Rules, New York, NY and Nashville, TN.

American Institute of Certified Public Accountants, Inc. (1998, July). The New AICPA/NASBA Uniform

Accountancy Act. What Does it Mean? New York. Burnette, D. C. (1998, August). Confronting the Challenges. National Public Accountant. 19-20. Colbert, G. and D. Murray. (1999, March). An Assessment of recent Changes in the Uniform Accountancy

Act. Accounting Horizons: 54-68. Haberman, L. D. (1998, February). Regulatory Reform at NASBA Meeting. Journal of Accountancy, 16-

17. Huefner, R. J. (1998, August). The New Uniform Accountancy Act. The CPA Journal, 12-17. Hunter, D. (1997, July 6). Public Left Out of AICPA/NASBA Restructuring Plan. Accounting Today: 7-9. McDonald, E. (1998, September 10). The Wall Street Journal Interactive Edition. Mason, E. (1997, November 23). NASBA – Do Unto Others. Accounting Today: 6, 34. Shapiro, L. (1998, Mar/Apr). Washington Comment. National Public Accountant. 7-8. Telberg, R. (1999, September 5). Orphaned Compilations Go Friendless, Accounting Today: 36. Texas Society of CPAs Task Force to Prepare for Sunset Review. (1997, November 3). Survey Results of

Texas Society of CPAs. Texas State Board of Public Accountancy. (August 1998). The Public Accountancy Act of 1991 as

amended. Austin, TX.



HOW CONSERVATIVE ACCOUNTING PRACTICES INFLATE TWO IMPORTANT

FINANCIAL RATIOS

McDonald, Robert University of New Haven [email protected]

INTRODUCTION

For twenty-eight years researchers in finance and accounting have tried to determine how and why price earnings (PE) ratios differ for firms in all industries. Finance researchers have focused on growth rates and levels of risk, while accounting researchers have tested whether different accounting methods can influence PEs. Neither group has met with impressive success in explaining the differences in PEs.

In 1997 the FASB revised the calculation for earnings per share (EPS) through the issuance of Statement 128. For several years there had been moderate dissatisfaction with Statement 128's predecessor, APB Opinion 15. Before the effective date of Statement 128, several researchers have probed what differences the new statement could generate, and whether it provides better disclosure for users of financial statements. This study continues the recent trend in researching EPS calculations and any impact on PE and dividend payout ratios.

Statement 128 requires several pro forma calculations for potentially dilutive securities. Dilutive securities would be securities that are not common stock, but could be converted into common stock in the future. Examples are options, warrants, convertible bonds and convertible preferred stock. Statement 128 requires two earnings per share calculations: basic EPS with no pro forma calculations and no dilution effects, and diluted EPS with the pro forma calculations to show dilution. The second calculation of diluted EPS is conservative in that it assumes the dilutive securities have been converted into common stock, and these shares are divided into net income to arrive at earnings per share, giving a lower EPS than the basic EPS.

The PE ratio is the price of the common stock divided by EPS. It is a way to capitalize the stream of earnings into a value or price of the common stock today. The conservative approach is to use diluted EPS in the denominator. But by using a reduced denominator due to dilution, we make the final PE ratio higher. An algebraic presentation of the PE shows PE = Price = Market value of common stock EPS shares (outstanding) Net income shares (diluted)

It there are no dilutive securities outstanding, then the outstanding shares in the numerator equal the shares in the denominator; after cancellation of shares the formula becomes: PE = Market value Net income

If there is dilution, then the number of shares in the denominator is larger than the outstanding



shares. The PE then becomes: Market value X shares (dilutive) Net income shares (outstanding)

With this last formulation we see that dilution should increase the PE, with the PE increasing to the extent of the ratio of dilutive shares to outstanding shares.

The dividend payout ratio is frequently defined as dividends per share divided by diluted EPS. The same argument holds for the dividend payout ratio as in the PE, in that a smaller denominator in the form of diluted EPS raises the final payout ratio.

PREVIOUS RESEARCH

Much of the research on PEs over the past twenty eight years is based on a valuation model formulated by Litzenberger and Rao (1971). They used the reciprocal of the PE or E/P and proposed a linear model in which risk and growth explained PE differences. Beaver and Morse (1978) concluded that growth and risk explained little of the differences in PEs, but that the explanation must lie in accounting methods. Craig, Johnson, and Joy (1987) found that differences in inventory and investment tax credit accounting methods explained different PEs, but that differences in depreciation methods had little affect on PEs. Zarowin (1990) found that forecasted long term EPS growth rates are the dominant source of differences in PEs. Zarowin used long term forecasted growth, while Beaver and Morse used one year realized growth in EPS. Jennings, LeClere, and Thompson (1997) compared EPS figures under the new FASB Statement # 128 and the earlier APB Opinion 15. They found that primary EPS under APB 15 explained more of a variation in stock prices than basic EPS under Statement 128. A second finding was that fully diluted EPS under APB 15, which is similar to diluted EPS Statement 128, explained more of the variation in stock price that either basic or primary EPS. Finally, Neill and Pfeiffer (1999) found that PEs are understated in the presence of unexpired options and warrants, and convertible preferred and bonds.

DATA AND METHOD PE Ratio

We used the thirty Dow Jones Industrial firms in 1998 for one sample of PE and dividend payout ratios. We chose the Dow Jones Industrial firms because they represent a considerable segment of US industry, and if anything would tend to show less distortion in the two ratios. These firms have been in business in some cases for over 100 years and have had time to develop huge capital bases of non dilutive securities. These firms also tend to compensate employees less through stock options versus newer, smaller firms with high growth rates. We then took a second sample of firms on the NASDAQ or firms that have been mentioned in Wall Street Journal articles as firms with large amounts of dilutive securities. From the NASDAQ we took the four largest firms in market capitalization.

The majority of firms had a 12/31/98 year end; however a few firms had different year ends, such as 6/30, or 10/31. For the standard calculation of PE, as reported in the Wall Street Journal, we took the stock price on 12/31/98 and divided by the diluted earnings per share (EPS) for 12/31/98. If year end was different from 12/31/98, we used that date's closing stock price and diluted EPS for that date.

For the alternate PE calculation, one avoiding the use of common shares, we calculated total market value of common stock at 12/31/98 and divided by total net income on the same date. Market value or market capitalization was outstanding shares times closing stock price on 12/31/98. Net income was taken from the income statement and was the number used to calculate diluted EPS.

We compared the two calculations by taking the ratio of the standard PE divided by the alternate PE, with the expectation that the standard PE was greater than the alternate PE. The final ratio should be greater than 100%. Dividend Payout Ratio

For the standard dividend payout ratio we took declared dividends per share and divided by diluted EPS. The EPS were taken from the income statement; the dividend per share could have appeared in several locations: the income statement, the financial summary on the inside cover, or in management's



discussion and analysis. For the alternate dividend payout calculation we avoided the use of common shares by taking total

dividends paid from the statement of cash flows and divided by total income on the income statement. We compared the dividend payout ratios by taking a ratio of the standard dividend payout ratio

divided by the alternate dividend payout ratio. We again expected the standard payout ratio to be greater than the alternate payout ratio, giving a final ratio greater than 100%.

RESULTS

PE Ratio On table 1 we listed the required data on the PE ratio for the Dow Jones firms and the same data for the NASDAQ firms on table 3. Column 2 has the diluted EPS for the 12/31/98 or appropriate year end in 1998. Column 3 shows the year end stock price. Column 4 has the standard PE, stock price divided by diluted EPS, or column 3 divided by column 2. Column 5 has the number of shares outstanding at year end. Column 6 shows market value or total capitalization of the company at year end 1998- stock price times shares outstanding. It is column 3 times column 5. Column 7 has net income for 1998. Column 8 has the alternate PE or market value divided by net income; this is column 6 divided by column 7. Column 9 has the ratio of standard PE divided by alternate PE.

Column 9 in table 1 lists in descending order for the thirty firms the ratio of standard PE divided by alternate PE. Column 9 shows the distortion in the PE ratio by using diluted EPS in the denominator. For the first firm, J P Morgan, the standard PE calculation is almost 17% higher than the alternate PE calculation. The alternate PE calculation bypasses the use of number of shares by working with gross dollar amounts of market capitalization divided by net income.

Of the thirty Dow Jones firms studied, 27 or 90% show the expected distortion of standard PE greater than the alternate PE. The distortion ranges from 17% for J P Morgan down to 0.4% for Walt Disney. The weighted average distortion for the thirty firms, weighed by market capitalization, is 2.7%.

For the three remaining firms that did not reflect the expected distortion, two showed a ratio of 99.8% - the alternate calculation was 0.2% greater than the standard PE. The last firm showed a ratio of 95.8%, thus the alternate PE was greater than the standard PE by 4.2%. For the fifteen NASDAQ and other firms, all fifteen demonstrated the expected PE distortion of the standard calculation larger than the revised calculation. The distortion ranged from almost 9% for Apple Computer down to 0.8% for Union Planters. The weighted average distortion, weighted by market capitalization, was 4.8%.

It is possible that the unexpected result of the alternate PE greater than the standard PE for the three Dow Jones firms was caused by changes in shares outstanding toward year end. Increases in shares outstanding late in the year would inflate the market value of the firm, and the alternate PE uses market value in the numerator. Dividend Payout Table 2 we have the required data for the dividend payout ratio for the Dow Jones firms and the same data for the NASDAQ firms on table 4. Column 2 has the diluted EPS for 1998. Column 3 has the declared dividend per share for 1998. Column 4 has the standard calculation for dividend payout, dividend per share divided by diluted EPS, or column 3 divided by column 2. Column 5 has total dividends paid in dollars from the statement of cash flows. Column 6 shows net income in dollars for 1998. Column 7 shows the alternate dividend payout ratio, or total dividends paid divided by net income or column 5 divided by column 6.



Column 8 shows a ratio of the standard payout ratio divided by the alternate payout ratio, or column 4 divided by column 7.

Table 2 lists the thirty Dow Jones firms in descending order of the ratio of standard payout divided by alternate payout ratio. Column 8 shows the distortion in the standard dividend payout ratio by using diluted EPS in the denominator of the calculation.

For the first firm, Sears, the standard dividend payout ratio is 29% greater than the alternate payout calculation. As in the PE example, the alternate payout calculation bypasses the use of shares by working with gross amounts of dividends divided by net income.

Of the thirty firms studied, 27 or 90% demonstrated the expected distortion of a greater standard payout calculation versus the alternate calculation. The distortion ranges from 29% for Sears down to 0.16% for International Paper. The weighted average distortion for the thirty firms, weighed by market capitalization, is 2.6%.

For the three remaining firms that did not reflect the expected distortion of standard payout greater than the alternate payout, one showed a ratio of 99.7% - the alternate calculation is 0.3% higher than the standard calculation. The other two firms show ratios of 96.7% and 81.77%, indicating the alternate payout greater than the standard payout calculation. Of the fifteen NASDAQ and other firms studied, six do not pay a dividend. Of the nine firms that paid a dividend, eight showed the expected dividend payout distortion of the standard calculation greater than the revised calculation. It ranged from almost 12% distortion for Chase Manhattan down to 1.8% for American Home Products. Only one of the nine dividend paying firms, Intel, showed the revised payout ratio greater than the standard payout ratio calculation. Intel has phased in the unusual procedure of declaring dividends in two quarters but paying dividends in four quarters.

We expect that further analysis of the three Dow Jones firms would show that differences between accrued (declared) dividends and dividends actually paid, differing reporting formats for dividend reinvestment plans, and year end changes in shares outstanding would explain the unexpected results.

CONCLUSION

In this study we have tried to indicate that the use of diluted EPS inflates both the PE and the dividend payout ratios. We used a sample of the thirty Dow Jones Industrial firms and 90% of the firms demonstrated the expected inflation of the two ratios. For the NASDAQ and other firm sample, all fifteen firms demonstrated the PE inflation, and eight of nine firms paying a dividend showed the dividend payout inflation.

For the PE ratio, investment mangers should be aware that part of the difference in PE ratios across firms could be the number of dilutive securities used in diluted EPS. Firms with large amounts of dilutive securities would have slightly higher PEs due to the use of diluted EPS in the denominator of the PE calculation. There is a sense of relief in the study's conclusion that PE ratios are not as high as initially reported. Possibly there is less "irrational exuberance" in the market.

If the standard PE ratio is overstated, then the reciprocal of the ratio is understated. The reciprocal is the earnings yield or the discount rate used to discount earnings to a current price. A higher discount rate or earnings yield indicates that investors require higher rates of return on stock investments, taking into account returns on alternative investments and existing risk levels.

If the dividend payout ratio is inflated, then firms have not been as generous in paying dividends to owners as previously believed. A lower payout ratio indicates more funds are available for reinvestment within the firm, and there is less need for external financing.

The dividend payout ratio appears in the sustainable growth rate model: return on equity times ( 1 minus the dividend payout ratio.) If the dividend payout ratio is overstated with the EPS calculations, then the sustainable growth figures would have to be adjusted upward.

There is much work to be done to resolve the questions on differences in PE ratios. The overall question remains after twenty-eight years of research on what determines different PEs for various firms. Do growth, risk, or accounting methods explain much, if any, of the differences in PEs across firms?

We have taken a rather narrow and mechanical view of the calculation of shares used in PE and dividend payout ratios. Further research can be done to determine the affect of large year end changes in outstanding stock on the PE and dividend payout ratios. Year end changes in outstanding stock would be treasury stock transactions or issuances of common stock. A second area for further research could



determine if the distortion in PE ratios can be explained by a ratio of dilutive shares used in diluted EPS to outstanding shares.



REFERENCES

Beaver, W., and D. Morse.1978. "What Determines Price-Earnings Ratios?" Financial Analysts Journal, vol.34, no.4(July/August):65-78.

Brackney, K., W. Collins, and R. Mautz. 1998. "Potential Effects of the Changing EPS Calculation Rules."

Journal of Financial Statement Analysis, vol.2, no. 3(Spring):51-57. Craig, D., G. Johnson, and M. Joy. 1987. "Accounting Methods and P/Es." Financial Analysts Journal, vol

43, no. 2(March/April):41-45.

Financial Accounting Standards Board. 1997. "Earnings per Share." Norwalk, CT: Financial Accounting Standards Board. Jennings, R., M. LeClere, and R. Thompson II. 1997. "Evidence on the Usefulness of Alternative Earnings

per Share Measures." Financial Analysts Journal, vol. 53, no.6 (November/December):24-33.

Litzenberger, R., and C. Rao. 1971. "Estimates of the Marginal Rate of Time Preference and Average Risk

Aversion of Investors in Electric Utility Shares: 1960-1966." Bell Journal of Economics and Management Science,vol. 2, no. 1 (Spring):265-277.

Mozes, H. 1997. "Computing EPS in the Presence of Instruments Convertible into Common Stock: A

Valuation Approach." Journal of Financial Statement Analysis, vol. 2, no. 2(Winter):26-36. Neill, John D., and Glenn M. Pfeiffer. 1999. " The Effect of Potentially Dilutive Securities on P/Es."

Financial Analysts Journal, vol. 55, no. 4(July/August):58-64. Zarowin, Paul. 1990. "What Determines Earnings-Price Ratios: Revisited." Journal of Accounting,

Auditing and Finance. vol. 5, no. 3(Summer):439-454.



ADDRESSING TAX AND LEGAL ISSUES FOR NOT-FOR-PROFITS IN THE GOVERNMENTAL AND

NOT-FOR-PROFIT ACCOUNTING COURSE

Sanderson, George Moorhead State University

[email protected]

Phillips, Cynthia Moorhead State University

[email protected]

ABSTRACT Despite their significance to the U. S. economy, not-for-profit entities get little attention in the

typical accounting curriculum. Accounting textbook coverage of not-for-profits focuses almost entirely on financial accounting and reporting issues as dictated by generally accepted accounting principles, while mainline business law and tax texts tend to ignore the not-for-profit form of organization. However, the very existence of not-for-profits is highly dependent on compliance with regulatory provisions embodied in the Internal Revenue Code and related regulations. Either as employees of not-for-profits or as members of their boards, accountants are often looked to for expertise on accounting, tax, and related issues. This paper will discuss an approach our department has used to include coverage of tax and legal matters in the not-for-profit accounting course.

THE IMPORTANCE OF NOT-FOR-PROFIT ENTITIES

Not-for-profit (NFP) entities provide a wide variety of services to the American public. Many hospitals are still organized as non-profits, as are museums and other performing and fine art associations, many colleges and universities, and a host of social service providers. NFP activities generally complement services available from either the for-profit sector or from governments. There are a large number of these NFP entities in the U.S., and collectively they comprise an important element of the American economy. Statistics released by the Internal Revenue Service (IRS) for 1995 indicated that NFP entities controlled assets of $1.9 trillion, generated revenues of $889 billion, and accounted for over 12% of gross domestic product. Two years later the IRS reported that there were over 1.2 million Section 501(c) organizations in the U. S., and nearly 700,000 of those were 501(c)(3) entities. Each year about 50,000 organizations apply for tax exempt status.

Given the large number of NFP entities, the significant amount of financial resources they control, and a few well-publicized failures of financial controls, it’s not surprising that demands for accountability have been increasing. The Financial Accounting Standards Board (FASB) recently began requiring application of standards that dictate the form and content of NFP financial statements as well as accounting practices with respect to contributions made and contributions received. The IRS has also been active, issuing new regulations requiring each NFP entity to take additional steps to make publicly available copies of the entity’s Form 990, the annual federal tax return required of most tax-exempt organizations. Failure to abide by standards issued by the FASB could lead to a qualified audit opinion and possible loss of support from donors, while failure to adhere to IRS requirements could lead to loss of tax-exempt status. For most NFP entities, the latter would almost certainly be a fatal blow. These are important issues for NFPs, and they are taken seriously by the IRS, by state regulatory bodies, by donors and potential donors, and by the directors of the entities themselves.

There are other complicating factors as well. Many NFPs elect to engage in income-producing activities. To the extent that these activities are closely related to the mission of the entity, profits are not



subject to income taxation. However, when the activities are “unrelated” to the entity’s mission, profits from such activities are taxable, and record-keeping requirements and tax reporting become both more complicated and more important.

HELPING STUDENTS BETTER UNDERSTAND NFP ENTITIES

As members of a NFP entity’s board seek to understand and address issues such as those mentioned above, they often turn to accountants for advice. The accountants might be external to the organization, such as independent auditors, or internal, such as employees or members of the board. Regardless of the affiliation, accountants may expect to be held to the standard of care exercised by someone in the accounting profession. The authors believe most accountants are ill prepared to work effectively with NFP entities, in part because traditional textbooks in accounting and business law pay scant attention to these organizations. This is not meant to be critical of textbook authors and editors; we realize that there are always coverage choices to be made. But by way of example, a recent review of six mainline business law texts (Beatty & Samelson, Cheeseman, Clarkson, Davidson, Mallor, Miller & Jentz) revealed coverage of NFP entities ranging from none to a maximum of forty-four paragraphs. Similarly, a review of three mainline texts in the government and not-for-profit accounting (Hay & Wilson, Freeman & Shoulders, Granof) found that, while the typical text is about 70% on governmental accounting and 30% on NFP accounting, all substantive coverage of NFP entities dealt with issues of financial accounting and reporting. None dealt with any of the very important tax reporting issues faced by exempt organizations.

Early in 1997, faculty in our department proposed a modest content change for our government and NFP accounting course. We would begin to incorporate legal and tax issues into the course by drawing on expertise of our faculty. The accounting professor assigned to teach the course would continue to focus on government and NFP financial accounting and reporting issues addressed in the text. Another faculty member, an attorney with extensive experience in legal and management issues facing NFPs, would develop and present materials focusing on governance issues. Similarly, a third faculty member, specialized in taxation, would organize and present materials dealing with key tax issues facing NFP entities. Initially, the time allotted to coverage of each of the areas amounted to one seventy-five minute class period – admittedly not a large percentage of the course, but at least an attempt to further integrate our curriculum.

GOVERNANCE ISSUES

The purpose of this coverage is to identify matters that should be of importance to the elected and hired leadership of a NFP. (The reader may want to refer to Table I to see an outline of this coverage.) We first examine the stakeholders of the NFP, including, but not limited to, the Board and officers, donors, and the entity’s clientele, i.e., those persons for whom the NFP exists to provide service. The discussion then extends to the organization’s duty, legally and ethically, to the public at large as the quid pro quo for favored tax and legal treatment. The hierarchy of laws and governing documents is discussed, with an examination of the relationship of Federal and state law to the organization’s Articles of Incorporation, bylaws and policies. Limitations on NFP activities clearly result from their tax-exempt status (e.g., direct political activity is prohibited). Determining the types of activities to pursue, allocating costs, and proper reporting are important issues relating to staying focused on the entity’s mission and keeping the stakeholders informed. Other limitations related to the tax-exempt status are also introduced. For example, the IRS has developed extensive standards related to compensation in an attempt to ensure that NFPs do not engage in activities that would “inure to the benefit of” individuals. Failure to abide by such standards may subject the entity to IRS sanctions. Another important governance issue deals with NFPs classified as “public charities,” under Section 501(c)(3) of the Internal Revenue Code. IRS tests of funding sources may limit strategic moves by an organization into certain for-profit but unrelated business activities. This is a particular challenge for many exempt organizations as they are often asked to develop alternative funding sources. Entrepreneurial choices and endeavors may be limited by Federal tax laws. The role and responsibilities of the members of the Board of Directors are discussed. As traditional business law courses focus more attention on new forms of doing business, such as the Limited



Liability Partnership and Limited Liability Corporation, less time is paid to the operation of traditional corporations – the usual form of organization for NFP entities. Coverage in this area involves discussion of the duties of care, loyalty, and obedience of board members in both the general and NFP settings. Other relevant Federal and state laws are introduced. For example, we include brief discussion of the Federal law that limits the liability of volunteers. This is an important issue for NFPs that often need to rely extensively on volunteer workers to carry out the entity’s mission. State charitable solicitation laws and reporting requirements are also introduced, and there is some discussion of the use of professional fund raisers. Finally, other recent legislation or regulation affecting NFPs is discussed. For example, one of the major reporting issues recently imposed by IRS regulation requires each tax exempt entity to make its Form 990 readily available to the public.

TAX ISSUES Understanding tax issues and reporting are critical to the successful operation of most tax-exempt organizations. (See Table II for an outline of tax issues.) Our coverage in this area begins with a discussion of the principal reason that the Federal government grants tax-exempt status in the first place, i.e., that the government is compensated for the loss of tax revenue by relief from the financial burden that would otherwise have fallen on public funds. We then discuss the advantages enjoyed by tax-exempt entities, e.g, exemption from income, property, and sales taxes; special mailing privileges; and eligibility for certain grants. Various types of tax-exempt entities are identified in relation to the Internal Revenue Code sections under which they are authorized. Students are provided with copies of IRS Form 1023 (used to apply for 501(c)(3) status) and Form 1024 (used by other types of entities seeking tax-exempt designation). The tests for becoming a 501(c)(3) entity are discussed in relation to Form 1023. These tests involve the purpose for which the entity is created, the operation of the entity in accordance with its stated purpose, a ban on private inurement, and a prohibition on lobbying and political activities. Students are also provided with copies for IRS Forms 990 and 990-T, and annual tax filing and public disclosure requirements are discussed. Form 990-T must be filed by exempt organizations having $1,000 or more of “unrelated business income.” We then discuss the nature of unrelated business income and the reasons that such income becomes subject to income tax at the normal corporate rates. We include a brief discussion of the differences between, and tax implications for, public charities and private foundations. This section then concludes with coverage of activities that might cause the entity to lose its tax exempt status.

STUDENT FEEDBACK Student reaction to the integration of governance and tax issues has been positive. For example, when surveyed at the end of the course in the fall semester 1999, 77% of students in the course indicated that the coverage of governance issues should be maintained or expanded, while 23% favored reduction or deletion. Comparable numbers for the tax issues were 74% and 26%. While some students would clearly prefer to focus entirely on financial accounting and reporting issues in this course, others now understand that the very existence of NFP entities depends heavily on compliance with Federal and state laws and tax regulations. Absent substantial compliance, there would not be any NFP entities existing to need financial accounting and reporting. We believe our students now complete our course with a better appreciation of the role of NFP entities and the important roles accountants play in helping these organizations carry out their service missions. We will maintain and perhaps expand coverage in both areas.



APPENDIX I NONPROFIT GOVERNANCE ISSUES OUTLINE

PROFESSOR CYNTHIA PHILLIPS, JD

I. Introduction A. Point of View 1. Accountant/Auditor 2. Board Member B Organizational Constituencies 1. Elect/Select 2. Service/Purpose 3. Public Accountability II. Legal Hierarchy A. Federal Law 1. IRS Tax and Regulation a. Application for Exempt Status b. Annual Return c. Limitations on Activities 2. General Laws Governing “Business” a. Social Security b. Anti-discrimination c. Antitrust 3. Limited Protection for Volunteers B. State Law 1. Nonprofit Corporation Statute 2. Charitable Solicitation a. Organization b. Professional Fundraisers 3. Taxation 4. Attorney General Oversight C. Organizational Documents 1. Articles of Incorporation 2. Bylaws 3. Mission, Vision, and Policy Statements 4. “Voluntary” Obligations III. Board of Directors A. Governance as a Group Responsibility B. Duties 1. Generally – As a Prudent Person Similarly Situated 2. Common Law and Statutory Duties a. Duty of Care b. Duty of Loyalty c. Duty of Obedience C. Rights 1. Generally 2. Information 3. Participation IV. Current Issues A. Disclosure B. Public Accountability C. Conflict of Interest



APPENDIX II TAX ISSUES OUTLINE

PROFESSOR MARY BADER, JD, LLM, CPA

I. Introduction A. Nature of Tax Exempt Organizations B. Importance of Exempt Organizations in the Economy. II. Types of Exempt Organizations (Complete IRS List Provided to Students) III. Tax Exempt Status A. Organization under State Law B. Form 1023 and Requirements C. Form 1024 IV. Annual Filing Requirements A. Form 990 B. Form 990-T 1. Purpose of UBIT 2. Entities Subject to UBIT 3. Definitions 4. Calculation of UBIT V. Public Charity v. Private Foundation A. What’s the Difference; Why Should We Care? B. Public Support Test C. Consequences of Private Foundation Status VI. Loss of Exempt Organization Status A. Organizational and Operational Tests B. Participation in Political Campaigns C. Lobbying Activities



NOTES TO FINANCIAL STATEMENTS: INTENTIONS VS. PERCEPTIONS

Bean, Dr. David Iona College

[email protected]

ABSTRACT

Financial statements are generally viewed as essential to gaining an understanding of a particular organization’s operations as well as assessing its performance and risks. The notes to financial statements generally expand and explain items that appear in the formal financial statements (balance sheet, income statement, etc.). Notes can be partially or wholly narrative in presentation and their purpose is to assist readers in gaining a more complete understanding of an organization’s performance and financial position. However, organizations continue to voice concerns about costs they incur to comply with disclosures required by “generally accepted accounting principles”. The usefulness of financial statement notes to some ‘experts’, ‘day traders’ and other users is an empirical issue that remains to be addressed. This study focuses on the usefulness of selected notes to “knowledgeable readers” in understanding the risks and performance of an organization. The author’s interpretation of the research results suggests that required notes to financial statements, and perhaps other disclosures, should be reconsidered by authoritative bodies.

INTRODUCTION

An organization’s external financial reports are required to be prepared in accordance with “generally accepted accounting principles” (GAAP). Two major benefits associated with the use of GAAP are: (1) there is a set of rules that have to be followed, and (2) full disclosure of both favorable and unfavorable events must be provided within the financial statements. The primary accounting rule-making authorities within the United States are the Securities and Exchange Commission and the Financial Accounting Standards Board. Both groups have issued numerous reporting requirements in the past. The Financial Accounting Standards Board currently has issued one-hundred and thirty-seven Statements of Financial Accounting Standards. The promulgation and reasoning associated with the various reporting requirements are not the subject of this study. However, there are concerns about the informativeness and costs of the reporting requirements.

Some have argued that due to the proliferation of ever increasing accounting standards and disclosures, the cost of financial reporting is becoming prohibitive. Some question whether the costs of GAAP are justified in light of the benefits being provided. Some argue that due to the high costs of financial reporting there should be differing sets of GAAP for small versus large organizations. These concerns are being voiced by both “expert” and other users of financial reports, as well as by the preparers of financial reports.

The author is unaware of any empirical study that classifies in any sort of quantitative manner the types and number of users of financial reports. A working presumption by accounting practitioners, who prepare the financial reports, is “readers of financial reports are informed with respect to financial matters and they possess more than a basic level of knowledge, with respect to the ability to read and utilize the information contained in financial reports.” It appears that the prima-facie position with respect to readers and users of financial reports are that there are many different types – bankers, financiers, parents investing for their children’s education, individuals saving for their retirement, etc. The presumption that the majority or even a large percentage of users of financial reports being experts would appear to be incredulous. The author’s position is that there is a large contingent of readers that are not experts but are knowledgeable readers.



INHERENT PROBLEMS IN FOOTNOTE DISCLOSURES

In essence, footnotes are intended to be a means of enhancing the information contained in the basic financial statements (Income Statement, Balance Sheet and Statement of Cash Flows). Whether required by GAAP or not, footnotes generally enable the preparers of financial reports to expand/explain items found in the financial statements and/or provide additional important details. However, footnotes are problematic with respect to readers/users assurances. Some have found that disclosures reported outside of the basic financial statements appear to be infected by self-serving managerial bias (Lewellen et al. 1996; Murphy, 1996). Some take the position that items recognized in the financial statements may be more credible than footnote disclosures due to a presumed lower scrutiny by auditors (Amir and Ziv, 1997; Wiedman and Wier, 1999). These suggest that there may be a credibility problem and footnotes may appear suspect to some users.

In addition to the general problem of information overload some readers are also prone to the dilution effect. The dilution effect basically states that the presence of irrelevant information weakens the implication of relevant information. The accounting and psychology literature (Nisbett et al. 1981; Hunter and McEwen 1999; Patel and Groen 1986; Shelton 1999) suggests that experienced (expert) decision-makers have very developed knowledge structures. They use directed strategies to focus on only relevant information – they select specific information from a given information set. In contrast, novice decision-makers tend to go through information in a sequential order – they review information in the step by step sequence that it is presented. Shelton (1999) suggests that one important goal for training programs and decision aids is to help less experienced auditors ignore irrelevant information and focus on relevant information. Thus the appearance, in fact or perception, of irrelevant information in the footnotes would appear to have a negative impact on the decision quality of some users.

In summary, the shortcomings associated with presenting information in footnotes is that some view this information as less credible and that excess information, either perceived or real, can lead to poor decisions by some decision makers. The concerns of this study are decision-makers, who are non-expert but have some fundamental understanding of financial reporting (knowledgeable readers). The basic research questions that are addressed in this study are (1) do certain required footnotes add value to a readers information level in assessing the risk and performance of an organization and (2) are there differences in the degree of information with respect to these footnotes.

SUBJECTS

There is no generally accepted definitional classification of non-experts. However, it is possible to arrive at an acceptable surrogate for this rather equivocal grouping. It is reasonable to presume that those who have taken the basic introductory accounting course sequence and have been exposed to the basic concepts of finance have a reasonable understanding of financial reports. Thus they can be classified as knowledgeable readers and most researchers would consider them to be non-expert users. Thus, the surrogates for non-experts in this study are thirty-four upper-level, undergraduate, business students enrolled in a required introductory finance course.

RESEARCH DESIGN

The subjects were assigned a comprehensive annual report project from a Fortune 500 company

that was due at the completion of the finance course. Among other tasks, each student was required to indicate how informative they found each of the following footnotes with respect to understanding the risk and performance of their company: Accounting Policy Footnote Geographic Segment Footnote Product Line Footnote A separate scale for each aspect (risk and performance) was used for each footnote. The scale ranged from 1 (Information uninformative) to 9 (Information Very Informative).



RESULTS

The means for the footnotes are reported in Table 1. Subjects rated the informativeness higher for understanding performance than understanding risk for all of the footnotes. The Product Line footnote had the largest number of subjects reporting an increase in informativeness for understanding performance, relative to risk. There were obvious differences in the perceptions of the footnotes, with the Product Line footnote receiving the lowest rating for understanding risk and the Geographic Segment footnote receiving the highest rating for understanding performance. ________________________________________________________________________

TABLE 1 Footnote Accounting Policies Geographic Segment Product Line Risk Performance Risk Performance Risk Performance Mean 5.57 6.41 5.18 7.00 4.76 6.94 Number Reporting: Performance > Risk 20 24 29 Risk > Performance 10 8 1 No Change 4 2 4

DISCUSSION

The results are disturbing. Given their importance to financial reporting, the mean rating for these selected footnotes is relatively poor,. Additionally, the footnotes appear to be valued more highly for understanding performance than understanding risk. To the extent that there are differential weighting values assigned to factors in decision making, this suggests that there may be unintended effects associated with footnote disclosures. The potential adverse impact from the dilution effect associated with footnote disclosures appears to be potentially large but has been empirically neglected. Given the propensity of authoritative bodies to expand footnote disclosures, the results of this study suggest that such a policy may be counterproductive with respect to at least some users of financial reports. This suggests that non-experts should be considered/involved in the promulgation of authoritative pronouncements. The Securities and Exchange Commission’s requirement for Management’s Discussion and Analysis, although replete with good intentions, may ultimately prove to be detrimental to the quality of decision making.

FUTURE RESEARCH SUGGESTIONS

Given the initial results reported in this study, it would appear that there are numerous research questions that remain to be addressed. The author suggests that researchers consider the following brief listing of research opportunities: 1. Quantification and Classification of the major users of financial reports

2. Impact of financial reporting and disclosures on non-experts 3. Benefits/Disadvantages associated with the inclusion of non experts in accounting governance

bodies. 4. A reconsideration of the importance and values added by student versus expert/experienced

subjects.



REFERENCES Amir, Eli and Amir Ziv (1997). “Recognition, Disclosure, or Delay: Timing the Adoption of SFAS No.

106.” Journal of Accounting Research, Volume Thirty-Five, Spring, 61-81. Hunter, James L. and Ruth A. McEwen (1997). “An Assessment of the Relation Between Analysts’

Earnings Forecast Accuracy, Motivational Incentive and Cognitive Search Strategy.” The Accounting Review, Volume Seventy-Two, number Four, 497-515.

Lewellen, Wilbur G, Taewoo Park and Byung T. Ro (1996). “Self-serving Behavior in Managers’

Discretionary Information Decisions.” Journal of Accounting and Economics, Volume Twenty-One, April 1996, 227-251.

Murphy, Kevin J. (1996). “Reporting Choice and the 1992 Proxy Disclosure Rules.” Journal of

Accounting, Auditing and Finance, Volume Eleven, Summer, 497-515. Nisbett, P. E., H. Zukier and R. E. Lemley (1981). “The Dilution Effect: Nondiagnostic Information

Weakens the Implications of Diagnostic Information.” Cognitive Psychology, Volume Thirteen, 248-277.

Patel, V. L. and G. L. Groen (1986). “Knowledge Based Solution Strategies in Medical Reasoning.”

Cognitive Science, Volume 10, 91-116. Shelton, Sandra W. (1999). “The Effects of Experience on the Use of Irrelevant Evidence in Auditor

Judgment.” The Accounting Review, Volume Seventy-Four, Number Two, 217-224. Wiedman, Christine I. and Heather A. Wier (1999). “Management of Note Disclosures: The Case of

Unconsolidated Subsidiaries Prior to FAS No. 94.” Journal of Accounting, Auditing and Finance, Volume Fourteen, Number One, 73-94.



OLD WINE IN NEW BOTTLES: THE RISKS AND BENEFITS OF NEW TRADING OUTLETS

Mark C. Mitschow

SUNY College at Geneseo Traditional stock markets have undergone a revolution in the 1990s. The growth of the Internet has lead to the development of both on-line trading and day trading. The opening of world markets has caused publicly traded firms to be listed on different exchanges. Discount brokerages and deregulation have placed additional pressures on traditional brokerages. Stock markets have responded by initiating expanded trading hours, merging operations, and issuing publicly traded stock. Changes in traditional markets present some opportunities for investors. However, the changes also raise new problems, particularly fragmented trading. With no comprehensive market for a given stock, there may be no guarantee that investors are getting the best price when trading securities. The purpose of this paper is to examine the issue of fragmented trading. Specifically, do fragmented markets currently exist? If so, what risks do they pose to consumers?

INTRODUCTION Traditional financial markets have undergone a revolution in the 1990s. The growth of the Internet has reduced transaction costs and made possible the phenomenon of day trading. This in turn has increased pressure on traditional stock markets to offer after hours trading. The liberalization of trade rules in this decade has also had an affect on the stock markets. Many firms now trade on a global scale. This has increased pressure on companies to list their stock on a number of exchanges. Regulatory changes in the United States have also had an impact on traditional stock markets. Gone are the days when regulatory agencies dictated commissions paid to stockbrokers. Now banks and other financial institutions are beginning offer equity securities, thus placing additional pressure on traditional securities brokers. Some observers are now worried that the changes described above may lead to fragmented trading markets. Specifically, investors may not be able to obtain the best price if small numbers of stocks are traded in a variety of locations. A number of solutions have been proposed, but so far there appears to be little action by decision-makers. The paper will be divided into three sections. The first section will discuss the causes and the risks of fragmented markets. Section II will examine whether current circumstances warrant any concern regarding the danger of fragmented markets, while Section III provides some potential solutions and avenues for future research. Section IV summarizes and concludes the paper.



INTERNAL CONTROL EVALUATIONS IN THE

FIXED ASSETS SYSTEM: A COMPARISON OF THE JUDGMENTS OF HONG KONG AND CHINESE

AUDITORS

Shifei Chung Rowan University

[email protected]

Ramesh Narasimhan Montclair State University

[email protected]

ABSTRACT

The purpose of this paper is to compare the judgments of Hong Kong and Chinese Auditors in

their evaluations of internal controls in the fixed assets system. The Chinese economy has undergone a significant change in the last decade. The growth in the international trade has forced the Chinese government to "privatize" some of its state-owned enterprises, resulting in more authority being placed in the hands of the managers of these "private" enterprises. For the first time in their communist history, companies have some control over the acquisition and disposition of fixed assets. At the same time auditing standards have been developed, again for the first time, to deal with audits of these enterprises. Since the Hong Kong auditing profession is quite developed and there is a lot of interaction between the Chinese and Hong Kong economy, our exploratory study compares the judgments of Hong Kong and Chinese auditors in their evaluation of internal controls in the fixed assets systems.

Chinese and Hong Kong auditors from a large international accounting firm were chosen for this study. The auditors were given sixteen scenarios based on four internal control variables and asked to judge the reliability of the system. Demographic and other information were also collected from the auditors. 55 Hong Kong auditors and 25 Chinese auditors participated in the study.

Our results indicate that the judgments of Hong Kong and Chinese auditors were consistent and not statistically different. Overseas education was the significant covariant in both the places. One reason for the lack of difference in the judgments of the auditors from the two countries may be due to the fact that both groups of auditors were from the same large international accounting firm and hence may have received similar training in their approach to evaluating internal controls. We recommend future research use a more diverse group of auditors from both countries to identify differences in the judgment processes.

INTRODUCTION AND BACKGROUND

The purpose of this paper is to compare the judgments of Hong Kong and Chinese Auditors in their

evaluations of internal controls in the fixed assets system. The topic is important, as China’s economy is playing an increasingly influential role in the world economy. A great change has occurred in economic environment of China since the late 70’s to 90’s, which has entailed a need for new accounting and auditing standards. In 1978, economic reforms began and triggered China’s transition from a command control economy to a market oriented economy. An Open Door Policy was enacted in the 80’s. This breakthrough has brought about a lot of rigorous changes in society. The management structure of state enterprises has become more decentralized. The profit oriented non-state sector is developing rapidly. The growth of



foreign investment is rapid. The new forms of business have caused the business transactions to be more complex than before and many new forms of transactions have been introduced. Many international accounting conventions are being introduced in China. The emphasis on auditing was increased largely as a result of tax control. Reliable information provided for decision making in China is essential. Nowadays, business transactions are getting more complex and business competition is very keen. So, the true and fair reflections of financial position of companies are crucial to investors, shareholders and the government. The financial statements of a firm are the fundamental information given to stakeholders about its business. Stakeholders can use financial statements to have more effective and efficient planning and allocation of resources in the future. Hence, the quality of financial statements should be controlled tightly. CPAs should be required to issue audit reports with appropriate opinions. In order to reduce the audit risk and increase the reliability of the audit report, CPAs should consider the client’s internal control system with caution. Consistent and stable internal control judgments by auditors are important in making the audit plan. The audit plan will eventually affect the audit risk and reliability of the audit report. A low reliability of the audit report undermines the credibility of financial statements.

China’s economic reforms have necessitated the improvement of auditing and accounting systems. The accounting reforms in 1980s aimed to establish a full set of unified accounting standards, which are suitable to China’s socialist market economy and are comparable to international standards. In December 1995 and December 1996, the Financial Ministry promulgated two groups of auditing standards. The full set of these new standards became effective on 1 January 1996 and 1 January 1997 respectively (Adhikari and Wang 1995).

The economic environment of Hong Kong, world-famous for being a nexus of international financial and commercial activity, has enabled an international auditing system to develop. Accounting and reporting standards in Hong Kong are largely based on those in the United Kingdom or international standards (Yuen 1992). Hong Kong’s accounting and auditing systems are well developed and accepted internationally.

Hong Kong and China have a close relationship. Even before the hand-over of sovereignty in 1997, there had been a large amount of business transactions between Hong Kong and China. In 1997, Hong Kong reverted to Chinese rule, with the policy of “one country, two systems” becoming into effective. More business transactions are expected between the two places. Foreign investors may see Hong Kong as the stepping stone to the potential China market.

The great increase in foreign direct investments in China leads to the expectation of reliable financial statements from investors. The foreign direct investments in 1995 were worth $37 billions, with a high potential to grow (Fernandes and Gao 1997). Therefore, a comparison between a more developed auditing system, Hong Kong, and China on the vital auditing procedure (judgments on internal control systems) is the focus of our study.

In Hong Kong, the standards about internal controls are stated in the Statement of Auditing Standards (SAS) 300 - Audit Risk Assessments and Accounting and Internal Control Systems, which is effective from 30 September 1997. The internal control standards in China are stated in the Specific Independent Auditing Standard (SIAS) No. 9 - Internal Controls and Audit Risk, which took effect from 1 January 1997.

The purposes of these two standards are nearly the same. The purpose of SAS 300 in Hong Kong is to provide guidance on obtaining an understanding of the accounting and internal control systems and on audit risk and its components: inherent risk, control risk and detection risk (SAS 300 1995). The purpose of SIAS in China is to establish standards for CPAs on the study and evaluation of an entity’s internal controls in the audit of financial statements, to assess audit risk, to improve audit efficiency and to ensure a high standard of professional work (SIAS No. 9 1997).

Our comparison between SAS 300 and SIAS No.9 (refer to Table 1) is focused only on the content of internal controls rather than audit risk. Table 1 shows the similar and comparable elements of Hong Kong’s and China’s Internal Control Standards. Two elements stated in SAS 500 (1997) – Considering the Work of Internal Auditing and Practice Note (PN) 600.3 (1997) – Reports to Directors on Management in HK SASs are very similar to Chapter 3 Article 16 and 18 in SIAS No. 9 respectively.

The main difference between these two standards is that all articles in SIAS No.9 are mandatory standards while SAS 300 is not. It means that all the auditors are required to comply with the whole SIAS No. 9 in the conduct of any audit. However, in Hong Kong, SAS 300 includes only a few mandatory parts, but most parts of the content are about explanatory and other material which is designed to assist auditors in interpreting and applying the auditing standards. Although all the standards in SIAS No.9 are mandatory



standards, much of these standards are very similar to the explanation or guidance which are stated in SAS 300 and only have some wording differences.

Table 1

The Comparable Elements in Hong Kong’s and China’s Internal Control Standards.*

Comparable Elements Hong Kong SAS ** China SIAS No.9

(1) General Principles Paragraph 2 (SAS 300.1) Chapter 2 Article 5 and 7

(2) Definition of Internal Control Paragraph 8 (Explanatory) Chapter 1 Article 2

(3) Definition of Control Environment

Paragraph 8a (Explanatory) Chapter 3 Article 13

(4) Definition of Control Procedure

Paragraph 8b (Explanatory) Chapter 3 Article 15

(5) Considerable Factors of the Internal control

Paragraph 13 (Explanatory) Chapter 3 Article 9

(6) The Inherent Limitations of Internal Controls


(7) Understanding of the Internal Control Systems

Paragraph 15 and 17 (Explanatory)

Chapter 3 Article 11 and 12

(8) Determination of the Nature, Timing and Extent of the Audit Procedures


(9) Understanding of the Accounting System

Paragraph 18 (SAS 300.3) Chapter 3 Article 14

(10) Understanding of the Control Environment


(11) Understanding of the Control Procedure


(12) Studying and Evaluating the Quality of the Internal Audit

Paragraph 11 and 13 (SAS 500.3)

Chapter 3 Article 16

(13) Communication of weaknesses to directors or management

PN 600.3 Chapter 3 Article 18

* Comparison of Internal Control Standards on Audit Risk and Inherent Risk are excluded.

** All the Paragraphs are come from SAS 300 except (12) and (13).

METHOLODGY

The development of the framework for this study was based on the experimental study by R. H.



Ashton (1974). The fixed assets internal control subsystem was selected and only four indicators were manipulated. The subjects were practicing auditors in Hong Kong and China. The consistency on judgment on internal control by these two groups of professionals was compared.

The fixed asset internal control subsystem was chosen for two reasons; one is because most companies in China were publicly owned before economic reforms. The officials may only have had a cursory control and workers seldom seemed to comply with the internal control system. Now, more privately owned companies have been started but managers may not have a close supervision of the fixed assets. Secondly, fixed assets cannot generate profit directly and after its purchase it becomes a sunk cost. Transactions that involve fixed assets in daily operation are rare. So, managers or even auditors may de-emphasize the importance of internal controls on fixed assets.

Questionnaires about internal control were used to collect the opinions of Hong Kong’s CPAs and China’s CPAs. The questionnaires were in English and Chinese versions. The judgments on scenarios and background information of the auditors were collected from the questionnaires. The scenarios were used to study whether China’s and Hong Kong’s auditors would choose the same approaches when making decision on client’s internal control performance. A pilot study was done before the survey to rectify any snags and ensure the survey is workable. The same procedures as the pilot study were used again in the survey.

200 questionnaires were given to a large international accounting firm with offices in Hong Kong and China. They helped us to distribute 50 copies to China’s CPAs and 100 copies to Hong Kong’s CPAs. The respondents were senior staff in auditing. The respondents from China were local CPAs and not CPAs transferred from Hong Kong.

In the scenarios, a hypothetical unchanged background of a Real Estate Company was given based on four indicators of fixed asset internal control. The four indicators were separation of duties, previous internal control performance, documentation on addition and disposal, and recording of cost and accumulated depreciation according to General Accepted Accounting Principles (GAAP). The four indicators were manipulated. Sixteen different combinations were formed and a repeated case was added to ensure reliability. Cases 9 and 16 were the same in the questionnaires. Results of case 16 were discarded from the analysis. Auditors were invited to make judgments on scale from 0 (no confidence) to 100 (complete confidence). If the difference in the selected confidence levels between the two repeated cases was greater than 20, the particular questionnaire was not analyzed. A sample case scenario is included in Table 2. The consistency of the remaining auditor’s judgments was then evaluated and analyzed statistically. We analyzed data by using analysis of variance: simple factorial using SPSS 7.5 software. The consistency of the auditor’s judgments between Hong Kong and China respondents was compared. The significant main effects were identified from separation of duties (A), satisfactory previous audit result (B), adequate documentation (C) and preparation of financial statements according to GAAP (D). The statistical significance of the covariates (country, overseas education, education level, experience, high experience and qualifications) were also analyzed.

Table 2

Sample Case Case 1

Yes No Indicators 3

1. Are the duties and responsibilities in authorizing, processing, recording, and reviewing transactions on fixed assets adequately separated?

3 2. Was the internal control over fixed assets found to be satisfactory during the previous audit?

3 3. Is the documentation on addition and disposal of fixed assets sufficiently kept? 3 4. Is the recording of cost and accumulated depreciation according to GAAP? 0 10 20 30 40 50 60 70 80 90 100 No Confidence Complete Confidence



RESULTS

55 completed questionnaires were collected from Hong Kong’s CPAs and 25 from China’s CPAs. The response rate is 40.00%. The difference between the results of case 9 and case 16 from 5 respondents was greater than 20. Three of them were China’s CPAs and two were Hong Kong’s CPAs. These questionnaires were not used in our analysis. The total number of questionnaires used in the survey was 75. 43 of the respondents had studied or trained overseas. 68 (90.67%) of the respondents had a bachelor’s degree or above. Most (81.13%) of the Hong Kong respondents were qualified members of HKSA and/or ACCA. Nearly half (45.45%) of the China respondents were qualified members of CICPA. The mean of the experience in auditing of the Hong Kong respondents was 4.74 years while for those from China the figure was 8.75 years (refer to Table 3).

Table 3 Demographic information about the respondents.

Hong Kong China Total

Number of valid questionnaires 53 22 75

Number of respondents studied or trained overseas 28 15 43

Number of respondents had bachelor’s degree or above

48 20 68

Mean of experience of respondents / years 4.74 8.75 -

Number of respondents qualified in HKSA and/or ACCA

43 10 53

Number of respondents qualified in CICPA 0 10 10

The means of the results of the Hong Kong and China respondents were 41.26 and 40.12

respectively, which were very similar. The standard deviations of the results were quite small which is 2.80 for the Hong Kong respondents and 5.34 for the China respondents.

The statistics show that country was not a significant covariate for judgments on internal control by the Hong Kong and China respondents. A significant main effect of all the indicators was obtained. For the China respondents, the two-way interactions of separation of duties and adequate documentation, satisfactory previous audit result and adequate documentation are significant. Also, the three-way interactions, separation of duties, adequate documentation and preparation of financial statements according to General Accepted Accounting Principles (GAAP) are significant. For Hong Kong respondents, the two-way interactions of separation of duties and adequate documentation, separation of duties and preparation of financial statements according to GAAP are significant (refer to Table 4).



Table 4 ANOVA of Judgments of Hong Kong and China respondents

Sum of Squres df Mean Square F Sig. B

Response Covariates country 129.834 1 129.834 0.411 0.522 -0.73

Main Effects (Combine) 497465.1 4 124366.3 393.72 0.000

A 184304.4 1 184304.4 583.48 0.000

B 150064.8 1 150064.8 475.08 0.000

C 119056 1 119056 376.91 0.000

D 41888.186 1 41888.186 132.61 0.000

2-Way Interactions (Combine) 11380.084 6 1896.681 6.005 0.000

A*B 666.427 1 666.427 2.11 0.147

A*C 5772.064 1 5772.064 18.273 0.000

A*D 3191.92 1 3191.92 10.105 0.002

B*C 1491.023 1 1491.023 4.72 0.030

B*D 229.871 1 229.871 0.728 0.394

C*D 12.637 1 12.637 0.04 0.842

3-Way Interactions (Combine) 3160.35 4 790.081 2.501 0.041

A*B*C 804.695 1 804.695 2.548 0.111

A*B*D 1.56E-02 1 1.56E-02 0 0.994

A*C*D 2151.129 1 2151.129 6.81 0.009

B*C*D 204.64 1 204.64 0.648 0.421

U nique M ethod

A: Separation of duties

B: Satisfactory previous audit result

C: Adequate documentation

D: Preparation of financial statements according to GAAP

The statistics show that education level is a significant covariate in the judgments of internal controls for both places’ respondents (refer to Table 5).

Table 5 Analysis of Covariance

Panel A: Hong Kong Auditors

Covariate SS df Mean Square F Sig.

Education 1376.021 1 1376.021 4.434 0.036*

Overseas Education 276.912 1 276.912 0.889 0.346

Experience 421.461 1 421.461 1.535 0.245

High Experience 259.567 1 259.567 0.833 0.362

Panel B: Chinese Auditors

Covariate SS df Mean Square F Sig.

Education 1485.112 1 1485.112 4.506 0.035*

Overseas Education 9330.026 1 9330.026 30.5 0.000*

Experience 406.255 1 409.255 1.23 0.268

High Experience 3.876 1 3.875 0.012 0.914



• = significant at p=0.05

Overseas education is a significant covariant for the China respondents but not for the Hong Kong respondents. Experience and high experience are not significant covariates for both places’ respondents. Membership in both the professional organizations in Hong Kong and China is not a significant covariate.

DISCUSSION OF RESULTS AND CONCLUSIONS

The study shows that the judgments on internal controls by China’s CPAs and Hong Kong’s CPAs

seem to be consistent. The judgments of the seventy-five auditors studied were found to exhibit a fairly high level of consistency. A reason for this phenomenon may be that the subjects of the study were highly qualified senior auditors in the same big firm. They may have been trained in similar programs. The corporate culture of the firm may influence the values of their CPAs. So, the techniques of analysis of client’s internal control system are similar. The consistency may be also attributable to the use of simple dichotomous indicators in the questionnaires.

Different education levels of auditors seem to be connected with different judgments on internal control. This effect was also noted by Ashton (1974) who recommended that auditors be given extensive training in their early years with the firm to compensate for this. Overseas education affects China’s CPAs judgments on internal controls but Hong Kong CPAs’ judgments are affected by this factor. This may be because Hong Kong accounting and auditing education and training programs are similar to those overseas. However, China’s education and training of CPAs may be very different from those in other countries. So, the concepts and knowledge gained are not the same, which make their practice different.

CPAs with different degrees of experience in auditing may have similar judgments on internal controls both in Hong Kong and China. This may be because the auditors’ experiences are always gained through the learning process from more experienced auditors, so they may rely on the similar indicators in the same manner to determine the confidence level on the client’s internal control systems. It seems that the techniques of internal control judgments can be mastered in quite a short period of time. Less experienced auditors, therefore, can make judgments comparable with those of more experienced auditors.

The survey results show that internal control judgments seem to be quite consistent between the two places. There were only a few differences in the interaction of some main effects. We think that this may be a result of the environmental and cultural differences between Hong Kong and China.

LIMITATIONS

The interpretations of the results in this study are subject to a few limitations. First, all the subjects of the survey were senior auditors in a leading international auditing firm with high reputation. As they come from a single organization, the results collected may not be representative enough. Future research may need to survey a wider variety of auditors in both countries to see if differences in judgments exist. Second, compared to the auditors’ populations in Hong Kong and China, the sample size is relatively small in the study. The results obtained may not fairly reflect the real situation. Third, the cases set in the questionnaire are concerned only with one internal control subsystem (fixed assets). Internal control judgments on other items in the financial statements are not investigated. The result show may not represent the general internal control judgments by CPAs in Hong Kong and China. Fourth, only a few indicators of internal control judgment were used. Different degrees of reliance on other indicators and external factors are not considered (e.g., compensating controls). However, different judgments may be made in other circumstances. Hence, the study may not reflect all the real situations inclusively in assessing clients’ internal controls. Lastly, the indicators are set as “yes” or “no”. However, in reality, most of the indicators are fulfilled to some extent. The internal control judgments by considering dichotomous indicators may not represent CPA’s judgments in practices.



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PENSION ACCOUNTING CHOICE: A NEURAL FUZZY APPROACH

Jerry W. Lin

University of Minnesota – Duluth

Mark I. Hwang Central Michigan University

ABSTRACT

In 1985 the FASB issued SFAS No. 87 on employer�s accounting for pension benefits. Firms were allowed to adopt the standard early or till it was required in 1987. Some firms chose to adopt SFAS 87 early, while others did not. Prior studies suggested that adoption of SFAS 87 had differential financial effect on early and late adopters and that the adoption date choice was related to certain financial characteristics of firms. This study integrated fuzzy logic and artificial neural network into one system, which was then applied to predict management choice of adoption dates for SFAS 87. The integrated neural fuzzy system outperformed a traditional statistical prediction model.

INTRODUCTION

Accounting and reporting for defined-benefit pension plans has been a controversial issue for some time. Prior to 1985, employer's accounting and reporting for defined-benefit pension plans was based on the provisions of Accounting Principles Board Opinion (APBO) No. 8, as amended by Statement of Financial Accounting Standards (SFAS) No. 35 and No. 36. In response to the criticisms of APBO 8, the Financial Accounting Standards Board (FASB) issued SFAS No. 87: Employers' Accounting for Pensions in December 1985 after 10 years of deliberation. SFAS 87 substantially changed the accounting and reporting requirements for defined-benefit pension plans. The disclosure requirements of SFAS 87 were subsequently expanded or streamlined by SFAS 132 (FASB, 1998). These accounting and reporting requirements were discussed in section 2. The adoption of SFAS 87 was not required until fiscal year 1987 but the FASB encouraged firms to adopt its provisions earlier than required.

Prior studies (e.g., Norton, 1988; Senteney and Strawser, 1990) found that the adoption of SFAS 87 had favorable financial impact on most firms, especially for the early adopters. These studies also suggested that the choice of adoption dates appeared to be associated with certain financial characteristics of firms. Further, other studies found that the new pension disclosures had significant but asymmetric securities valuation implications for early and late adopters (e.g., Carroll and Niehaus, 1998). It is of interest to use the financial characteristics to predict the pension accounting adoption choice.

This study integrated fuzzy logic and artificial neural networks into one system, which was then used to predict the adoption choice. Fuzzy logic and neural networks are two constituent technologies of �soft computing� (Zadeh, 1994). Fuzzy logic is based on the theory of fuzzy set, which is a set without a crisp, clearly defined boundary and, unlike a classical set, can contain elements with only a partial degree of membership (von Altrock, 1997; Zadeh, 1965). Artificial neural networks are computer algorithms that simulate the functioning of the human brain and consist of simulated neurons used to process inputs to produce outputs (Zadeh, 1994). The integrated neural fuzzy system can �learn� from the patterns of input data and strives to model the pervasive imprecision of the real world phenomena. Our empirical results suggested that, compared to a popular statistical prediction techniques such as the probit model, the integrated neural fuzzy system achieved a higher overall prediction accuracy.

The remainder of this paper is organized as follows. Section 2 provides some background on pension accounting, including the financial impact of SFAS 87 adoption. Section 3 describes research methodology. Section 4 discusses the empirical results. The last section presents a summary and concluding remarks.



OVERVIEW OF PENSION ACCOUNTING STANDARDS

Prior to the issuance of SFAS 87, employer's accounting and reporting for defined benefit pension

plans was based on the provisions of Accounting Principles Board Opinion (APBO) No. 8 (APB, 1966), as amended by SFAS 35 (FASB, 1980) and SFAS 36 (FASB, 1980). Subsequent changes in legal and economic environments and the criticisms of APBO No. 8 prompted the FASB to reconsider the entire pension accounting issue and the FASB, after 10-year of deliberations, finally issued SFAS No. 87: Employers' Accounting for Pensions in December 1985.

Table 1 Major Differences Between APB 8 and SFAS 87

Attribution Method: APB 8: Any "acceptable" actuarial cost method. SFAS 87: Unit credit method. Discount Rate: APB 8: Any "reasonable" rate. SFAS 87: External, market-determined settlement rate. Amortization of unrecognized prior service cost: APB 8: Any systematic and rational method; in practice, interest method predominates;

amortized from 10 to 40 years. SFAS 87: Equal amortization over the average service life of active employees on the date of

amendment or initiation; specific formula provided; Allows alternatives that amortize no less rapidly.

Amortization of unrecognized gains and losses: APB 8: Various methods allowed; amortized from 10 to 20 years. SFAS 87: Minimum rate equal to 1 divided by average remaining employee service life applied to

amount outside a prescribed range. Alternatives that amortizes no less rapidly allowed. Actual Return on Pension Assets: APB 8: Calculated by applying the discount rate to a smoothed actuarial value of pension plan

assets. SFAS 87: Computed as the difference between ending and beginning fair market values of plan

assets after adjustments for contributions and benefit payments. New Disclosure Requirements under SFAS 87: a. Components of net periodic pension expense. b. Discount rate for computing interest cost and present values of ABO and PBO; expected rate of

increase in salaries. c. PBO for each plan and ABO for underfunded plan; separate disclosure of plan assets and benefit

obligations for each overfunded and underfunded plan. d. Market value of pension assets and their actual and expected returns and the type of assets held. e. Detailed information on amortization components of pension expense. f. Amount of actuarial gains and losses recognized in earnings. g. Details of changes in benefit obligation and plan asset due to plan amendments, actuarial changes,

acquisitions, contributions, and benefit payments. Note: ABO: Accumulated Benefit Obligations. PBO: Projected Benefit Obligations. VBO: Vested Benefit Obligations. SFAS 87 substantially changed the accounting and reporting requirements for defined-benefit pension plans (Berliner and Gerboth, 1986; Rollins and Welsh, 1994). Among the more important changes required by SFAS 87 are: (1) more standardized computations of pension expense, (2) the disclosure of pension expense components, (3) the disclosure of projected benefit obligations (PBO) in addition to



accumulated benefit obligations (ABO) previously required, (4) the recognition of a minimum liability for underfunded pension plans, and (5) other important footnote disclosures. The disclosures under SFAS 87 were expanded or streamlined by SFAS 132. The new disclosure requirements under SFAS 132 include (1) detailed information on the expected pension asset return and amortization components of pension expense; (2) the amount of actuarial gains and losses recognized in earnings; (3) details of changes in benefit obligation and plan assets such as information on plan amendments, actuarial changes, acquisition contributions, and benefit payments; (4) discontinuance of disclosure of vested benefit obligations. Table 1 summarizes these changes and compares the major provisions of APB 8 (as amended by SFAS 35 and SFAS 36) and SFAS 87 (as amended by SFAS132).

A number of studies have examined the financial effects of adopting SFAS 87 (e.g., Jarnagin et al., 1987; Norton, 1988; Stone and Ingram, 1988; Norton, 1989; Senteney and Strawser, 1990), while others examined the security valuation implications of new pension disclosures required by SFAS 87 (e.g., Barth, 1991; Carroll and Niehaus, 1998; Gopalakrishnan and Sugrue, 1993; Maher and Thompson, 1998). The results suggested that SFAS 87 generally had a favorable financial impact and that the impact was greater and more favorable for early adopters than for late adopters. Also, the pension plan assets and projected and accumulated benefit obligations disclosed in the footnotes to financial statements were valued by the capital markets as the sponsoring firm's assets and liabilities and benefit obligations were valued more heavily than plan assets (i.e., asymmetric valuation of benefit obligation and plan assets). Finally, the funding status of early adopters' pension plans was generally much better than that of late adopters (Norton, 1989; Senteney and Strawser, 1990).


The initial sample consisted of all OTC (over the counter) firms that sponsored defined benefit pension plans during the period of 1985-1987. Firms retained in the sample met all of the following criteria: First, requisite financial statement data were available on the COMPUSTAT tapes. Second, no firm adopted both SFAS 87 and SFAS 88 in the same year. The second criterion was used to avoid the potentially confounding effects from curtailment or settlement of pension plans due to the adoption of SFAS 88. Finally, a firm adopted SFAS 87 for either fiscal year 1986 (i.e., early adopter) or year 1987 (i.e., late adopter). These criteria reduced the final sample to 120 firms, of which 41 were early adopters, while the remaining 79 were late adopters. The sample was then randomly split into two equal halves. The first half (training data) was used to develop a fuzzy model, which was then refined using neural network techniques. The final model was validated using the second half of the sample (checking or validating data). Prior positive accounting research on accounting choice suggests that the following variables may influence

managerial choice of adoption dates for new accounting standards (see Watts and Zimmerman, 1986 and 1990 for review).

Firm Size: Prior positive accounting studies (e.g., Ayres, 1986; Lilien and Pastena, 1982) suggest that management's preference for an accounting method depends on the income effect of the method and the size of the firm. They maintain that because of political visibility, large firms tend to adopt income-decreasing accounting methods. Extant studies (e.g., Norton, 1989) report that early adoption of SFAS 87 generally decreased periodic pension expense, and, thus, ceteris paribus, increased reported income. Thus, larger firms should be less likely to adopt SFAS 87 early than smaller firms. Firm size (SIZE) was measured as the natural logarithm of total assets.

Debt Covenants: Restrictive debt covenants are written to limit the transfer of wealth from debt-holders to equity-holders. Common debt covenant constraints include generally accepted accounting principles-based constraints on (1) the long-term debt to assets (or equity) ratio, (2) the working capital requirement, (3) the interest coverage ratio, and (4) the dividend payout ratio.

The directional impact of adopting SFAS 87 on leverage ratios based on liabilities and assets recognized on the financial statements is ambiguous. Although the income effect is generally positive, the effect of adopting SFAS 87 on recognized liability and net assets depends on the magnitude of unfunded accumulated benefit obligations (ABO) and of pension liability recognized prior to SFAS 87 adoption. However, projected benefit obligations (PBO) and ABO disclosed in the footnote to financial statements may be viewed by the capital markets as the sponsoring firm's liabilities (Barth, 1991; Carroll and Niehaus, 1998; Maher and Thompson, 1998). Also, the size of ABO and PBO is generally greater than the reduction in pension expense due to adopting SFAS 87 (Stone and Ingram, 1988). Thus, the probability of early



adoption should be inversely related to leverage ratio (LEVER), measured as the ratio of total long-term debt (adjusted for unfunded ABO) to stockholders' equity.

Another common debt covenant is the maintenance of a minimum amount of working capital. Since the adoption of SFAS 87 generally reduced pension expense, a firm can reduce pension funding without increasing recognized pension liability. Also, Berliner and Gerboth (1986) stated that companies have generally tried to keep pension funding equal to pension expense, which was supported by Ghicas (1990), who found that firms with lower current ratios (current assets to current liabilities) would choose an actuarial cost method to lower pension expense and funding. Thus, a firm's current ratio (CACL) should be negatively related to the probability of early adoption.

Because of the positive income effect of adopting SFAS 87, the interest coverage ratio (net income to interest expense) increases and, thus, become less restrictive. Prior studies (e.g., Ayres, 1986; Bowen et al., 1981) suggest that lower interest coverage ratios (i.e., higher inverse interest coverage ratios) increase the likelihood of default on existing loans, making it more difficult for a firm to issue additional debt, and may affect its debt rating. Thus, a firm with higher inverse interest coverage ratio is more likely to elect early adoption. Inverse interest coverage ratio (INTCOV) was measured as interest expense divided by net income in order to avoid division by zero in cases where no interest expense was reported.

Dividends are often limited to available retained earnings. Adoption of SFAS 87 would increase income and retained earnings and, thus, lower dividend payout ratio. As a result, firms with higher payout ratios are more likely to choose early adoption (Ayres, 1986). The dividend payout ratio (DIVPO) was measured as the ratio of total preferred and common dividends to retained earnings.

Volatile accounting numbers increase potential debt contracting costs because the swings in accounting numbers will likely increase the possibility of violating debt covenants in some years (Lilien and Pastena, 1982). Hence, firms with volatile earnings may be motivated to take action, including appropriate accounting policy choices, to reduce the volatility. SFAS 87 standardizes pension expense computation and ties the measurement of pension assets and liabilities to the market interest rate. Many researchers have voiced concerns that these requirements would greatly increase the volatility of pension expense, pension assets and obligations, earnings, and related financial ratios (Gropper, 1986; Liebtag, 1986). Thus, to the extent that SFAS 87 would increase pension expense volatility, firms with more volatile pension expense or earnings in prior years are less likely to choose early adoption. Volatilities of pension expense (PENVAR) and of earnings (NIVAR) were measured, respectively, as the natural logarithms of the standard deviations of pension expense and of gross profits over the prior five years (Shehata, 1991).

In addition, the higher a firm's pension expense relative to its income, the greater the financial impact (in magnitude and volatility) SFAS 87 adoption can bring; thus, the firm would delay adoption of SFAS 87. In addition, firms with large pension obligations (and often more complicated pension plans) may need more time and, thus, delay adoption to deal with practical implementation issues or take action to minimize the potential financial impact of SFAS 87 adoption. Pension expense materiality (PENMAT) was measured as the logarithm of the ratio of pension expense to net income.

Management Incentives: Management bonuses or compensations are often based on some accounting measure of profitability. Prior studies (e.g., Bowen et al., 1981; Zmijewski and Hagerman, 1981) have examined whether the existence of earnings-based bonus schemes affects management's accounting choice with mixed results. Based on the evidence in Healy (1985) and a survey by M. E. Segal & Company, Ayres (1986) characterizes management as striving to accomplish a certain earnings growth target. Managers of firms with a "poor" earnings performance may be motivated to adopt income increasing accounting policies in order to improve reported earnings. Ayres (1986), Trombley (1989), and Ghicas (1990) found evidence consistent with this hypothesis. Since the adoption of SFAS 87 would generally increase income, firms with a lower growth in reported income are more likely to adopt SFAS 87 early. Earning growth (NIGRODM) was measured as a dichotomous variable: a firm was considered growing if its net income increased from prior year (coded as 1); otherwise it was considered not growing (coded as 0).

Pension Funding Status: Prior market-based accounting studies (e.g., Barth, 1991; Carroll and Niehaus, 1998; Landsman, 1986) suggest that pension assets and benefit obligations (PBO and ABO) disclosed in the footnotes are valued by the capital markets as the sponsoring firm's assets and liabilities and pension obligations may be valued more heavily than pension assets. Firms with unfunded pension benefit obligations may wish to avoid or delay the disclosure of their pension plan funding status (Norton, 1989). Thus, firms with a less favorable funding status are less likely to elect early adoption than firms with better funding status. Pension plan funding status (FUND) was measured as the natural logarithm of the



ratio of pension assets to ABO. A fuzzy system can be built based on human expertise or experience about the definition of

membership functions or, if such knowledge is unavailable, on sample data to derive membership functions using techniques known collectively as fuzzy clustering. The purpose of fuzzy clustering is to identify the number of clusters that exist in a given data set. Similar to

traditional clustering procedures, a user can specify the expected number of clusters or let the system to "find" the likely number of clusters from input data.

In this study, we used the GENFIS2 function of the Fuzzy Logic Toolbox (Gulley and Jang, 1996). This function can extract a set of rules by clustering the training data to generate an initial fuzzy model that describes the data behavior. The general format of the GENFIS2 function is:

Fismat = genfis2 (Xin, Xout, radius) (1)

where Fismat is the fuzzy model estimation, Xin is the input data set (i.e., factors influencing choice of adoption dates for pension accounting), Xout is the output data set (choice of adoption dates), and radius specifies a cluster center’s range of influence on each variable. A large radius results in fewer rules and clusters, whereas a small radius results in more rules and clusters. Since, ideally, the data should form two clusters (i.e., early and late adopter groups), a large weight (0.5) was used for the GENFIS2 function. The resulting fuzzy model includes two membership functions for each input variable. For the first input variable, Firm Size, for example, a small firm membership function and a large firm membership function were derived.

The fuzzy model also includes two fuzzy rules that take the following form:

if x is A and y is B then z = p*x + q* y + r (2)

where A and B are fuzzy sets (of input variables); p, q, and r are constants estimated by the model; and z is the output variable; i.e., the adoption date decision. The consequent of the rules is a linear function rather than a fuzzy set. A fuzzy model that has this type of fuzzy rules is known as a Sugeno fuzzy model (Sugeno 1985). A Sugeno fuzzy model is easier to work with than the other type, the Mamdani fuzzy model (Mamdani and Assilian, 1975), because the defuzzification process is simplified.

The fuzzy model developed from the first step was improved through an iterative adaptive learning process. The training algorithm was developed by Jang (1993) and termed ANFIS or Adaptive Neuro-Fuzzy Inference System. Basically, ANFIS takes a fuzzy model and tunes it with a back propagation algorithm. During each epoch, an error measure, usually defined as the sum of the squared difference between actual and desired output, is reduced. Training stops when the predefined epoch number or error rate is obtained. The ANFIS technique is implemented in Fuzzy Logic Toolbox as a function with the following format:

Fismat1, TrnErr, StepSize, Fismat2, ChkErr = Anfis (TrnData, Fismat, ChkData) (3)

where Fismat is the fuzzy model to be trained, TrnData is the training data set and ChkData is the checking data set. Fismatl is the resulting fuzzy model that records the minimum training error and Fismat2 is the resulting fuzzy model that records the minimum checking error. Usually we are interested in finding out the model that minimizes checking error. Therefore, Fismat2 was the model used to compute outputs.

EMPIRICAL RESULTS

Table 2 presents the prediction results of the fuzzy system without learning, which correctly predicted 7 out of 20 early adopters and 26 out of 40 late adopters. The total prediction accuracy (hit ratio) was 55% (33/60). Table 3 displays the prediction results of the neural fuzzy system, which was obtained by subjecting the fuzzy system to 50 epochs of learning. The results showed a significant improvement as the total prediction accuracy rate increased to 70% (42/60). As a comparison, Table 4 presents the prediction results of Probit, a popular statistical procedure. The neural fuzzy system outperformed the Probit model in the prediction of early adopters while achieved the same level of accuracy in predicting late adopters as the Probit model. The overall prediction accuracy of Probit was 65% (39/60), which was lower than the neural fuzzy system. We then subjected the fuzzy system to additional learning (100 epochs) but



did not observe significant performance improvement. Overall, the results indicate that the prediction of pension accounting adoption decision can benefit from an integration of fuzzy logic and neural network technologies.

Table 2 Prediction Results of Fuzzy System (without learning)

Predicted Case

Total

Hit Ratio

Actual Case

Early

Late

Early

7

13

20

35%

Late

14

26

40

65%

Total

21

39

60

55%

Table 3

Prediction Results of Neural Fuzzy System (with learning)

Predicted Case

Total Hit Ratio

Actual Case

Early

Late

Early

11

9

20

55%

Late

9

31

40

77%

Total

20

40

60

70%

Table 4

Prediction Results of Probit

Predicted Case

Total Hit Ratio

Actual Case

Early

Late

Early

8

12

20

40%

Late

9

31

40

77%

Total

17

43

60

65%



CONCLUSION

The integration of the constituent technologies of soft computing is a new and exciting area. Compared to traditional data analysis techniques such as statistical procedures, new techniques such as neural fuzzy systems do not provide a means to test the �significance� of individual variables. Rather, the focus of their use is to produce prediction models with satisfactory prediction accuracy based on mining of empirical data. At the same time, using these new techniques does not require that individual variables conform to certain functional relationships, thus increasing their application domains. This research has provided empirical evidence that the integration of fuzzy logic and neural networks is an effective solution to the pension accounting adoption problem. The application of the same approach to other classification problems looks promising and awaits empirical testing. Other forms of integration have been proposed and should be empirically tested as well.



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The Accounting Review 66, (July), 433-463. Berliner, R. W., and D. L. Gerboth. (1986). Accounting for pensions- new FASB statements. The CPA

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_____. (1980). Statement of Financial Accounting Standard No. 36: Disclosure of Pension Information --

An amendment of APB Opinion No. 8. Stamford, CT.: FASB. _____. (1985). Statement of Financial Accounting Standard No. 87: Employers' Accounting for Pensions.

Stamford, CT.: FASB. _____. (1985). Statement of Financial Accounting Standard No. 88: Employers' Accounting for Settlements

and Curtailments of Defined Benefit Pension Plans and for Termination Benefits. Stamford, CT.: FASB.

_____. (1998). Statement of Financial Accounting Standard No. 132: Employers' Disclosures Pension and

Other Post-Retirement Benefits. Stamford, CT.: FASB. Ghicas, D. C. (1990). Determinants of actuarial cost method changes for pension accounting and funding.

The Accounting Review 65, (April), 384-405. Gopalakrishnan, V. and T. F. Sugrue. (1993). An empirical investigation of stock market valuation of

corporate projected pension liabilities. Journal of Business Finance and Accounting 20, (September), 711-724.

Gropper, D. H. (1986). How damaging will the new accounting laws be? Institutional Investor, (April),

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PREDICTING PERFORMANCE IN THE FIRST MBA-LEVEL ACCOUNTING COURSE

Petro, Fred

Pepperdine University [email protected]

ABSTRACT

Many students consider accounting courses to be somewhat frightening, especially students who have had no previous exposure to accounting. The study of accounting is often viewed as difficult and very demanding of time. Generally, graduate schools do not offer separate sections for students who have had prior instruction in accounting. Neither are these students exempt from the course unless they have had an extensive number of accounting courses. These factors create a dilemma for the accounting instructor in designing the course. Since many of the students have had no previous exposure to accounting, the instructor is forced to begin the course with the very rudiments of accounting. During the course, especially in the early stages, students with previous accounting study are somewhat bored and often project such a superior knowledge of accounting that many of the first-time students are intimidated and discouraged. The question then becomes: Does previous accounting instruction correlate positively to success in the first MBA-level accounting course?

Historically, studies, have produced different results concerning the relationship between previous accountinginstruction and success in the first college-level accounting course. Smith [1968] compared 20 students who had previously studied accounting in highschool with 20 students who had not studied accounting in highschool and concluded that students with prior exposure performed significantly better throughout the course. More recently, studies by Jacoby [1975], Baldwin and Howe [1982], Bergin [1983], and Canlar [1986] present results that contradict the earlier study and indicate that previous accounting course work has no significant impact on overall course performance.

Schroeder [1986] conducted a similar study; however, students were grouped by the amount of previous accounting course work (none, one year or less, and over one year). No difference in overall course performance was indicated between students with no previous accounting course work, and those with one year or less of highschool accounting course work. Students with more than one year of highschool course work performed significantly higher on all exams in the course.

Moses [1987] conducted a study on the factors explaining performance in graduate-level accounting. The results indicated that overall performance in graduate accounting is associated with work experience in accounting, and with the frequency of reading accounting or financial publications, but not by previous accounting course work.

Krauxz, Schiff and Schiff [1999] conducted a study that explored the relationship between performance in entry-level graduate accounting coursework and prior accounting work experience and undergraduate accounting coursework experience. The results suggest that both educational and work experience are necessary for either to be of help.

Although the results of the studies examining the correlation of previous exposure in accounting to performance in accounting courses are not absolutely consistent, they have established what might be considered to be a reasonably reliable pattern. The pattern being that previous exposure in accounting results in performance that is greater early in the course but much worse less later in the course so that overall performance is not affected. The obvious question then becomes: If previous exposure in accounting does not positively correlate to success in performance, then what are the factors that might be associated with predicting performance? The purpose of this study is to investigate other factors that might offer additional insight in predicting performance in not only financial accounting, but also managerial accounting classes.



RESEARCH METHOD

The sample included 52 first-term graduate students taking financial accounting and managerial accounting in the same 15 week term, which differs from previous studies where financial accounting, exclusively, was studied for the entire term. The term was equally divided into 7 1/2 weeks for each course. Separate letter grades were assigned for each course. Three sections of the two courses were studied, one in the Fall of 1987 and two in the Fall of 1988. Each section met twice a week for two hours.

The same classroom approach, mainly lecture, problem demonstration and discussion, was used in all sections. Also, the same course material was covered. Topics included in financial accounting were the accounting cycle, inventories, depreciation, stockholders' equity, long-term debt, and statements of cash flow. The managerial course included cost-volume relationships, the master budget, flexible budgets and standard costing, responsibility accounting, direct and absorption costing, relevant costs and special decisions, and capital budgeting. Outside assignments and examinations were identical.

Three exams comprised 90 percent of the term grade in each course. Outside assignments made up the remaining 10 percent of the grade. The two sections were scheduled back to back on the same day. Therefore, the possibility of passing information on exam content was severely limited.

STATISTICAL ANALYSIS

Data was collected for each student to provide measures relevant to the analysis. Descriptive

statistics for the seven variables are presented in Table I. The variables used in the analysis are defined as follows:

1. (A) The numerical course grade earned in the first graduate fmancial accounting course described as GRADE. (B) The numerical grade earned in managerial accounting described as GRADE. (C) The average fmancial-managerial numerical grade eamed described as GRADE. 2. (A) Quantitative GMAT score described as QUANT GMAT. 03) Verbal GMAT score described as VERB GMAT. 3. Undergraduate grade point average described as GPA. 4. The number of accounting courses completed before entering graduate school described as ACCTG.

In Table I, the average numerical (percentile) course grade was 86.58 in the fmancial course and 85.56 in the managerial course, while the average numerical course grade for financial and managerial combined was 86.07. With respect to the QUANT GMAT score (percentile), there was wide variation with a low of 27 and a high of 99. The VERB GMAT score (percentile) also had wide variation and the arithmetic average was 72.79 with a high of 98 and a low of 20. On a 4 point system, the average undergraduate grade was 2.89, with a grade point average that varied between 2.15 and 3.63. Previous accounting courses were also considered and it was found that 24 students had no previous accounting courses, 15 students had taken one courses and 12 had taken two courses.

This study separates the analysis into two distinct courses, financial accounting and managerial accounting to see if there are course differences. Finally, an average of the two courses combined is analyzed. The results are presented below.



THE FINANCIAL ACCOUNTING COURSE GRADE

Table II presents the results of the analysis. With respect to the QUANT GMAT score, there was a

positive correlation of .359 with GRADE . The simple predictive regression results showed that the R-square was .129 which was statistically significant. Conversely, the VERB GMAT score was found to be negatively correlated with GRADE and the regression analysis yielded no significant regression relationship. A further hypothesis was that the undergraduate GPA would be a significant grade predictor in graduate accounting. The theory was that a student who had demonstrated high academic ability at the undergraduate level would continue to do well at the graduate level. There was a positive correlation of .15 with GRADE, however; no significant relationship in the simple regression analysis was found. With respect to ACCTG, there was a positive correlation of .26 with GRADE. It was also found that ACCTG was significant at the 1.90 t-statistic test level.

To explain the course grade in the managerial course, the results are presented below.

MANAGERIAL ACCOUNTING COURSE GRADE

A summary of the regression results explaining GRADE is presented in Table III. Based on simple correlation analysis, a positive relationship was found between QUANT GMAT and GRADE. At the .0854 probability level, the QUANT GMAT was significant in explaining GRADE, an important finding. Unlike the results with financial accounting, the VERB GMAT was found to be positively related to GRADE. An analysis of GPA was found not to be significantly related to the managerial course grade. ACCTG was also insignificantly related to GRADE. This might be explained in that previous accounting courses are, for the most part, financial accounting courses, which are not entirely helpful in mastering managerial accounting. As the course material was new to the student, each student was assumed to be in an equal position for grade.

THE MULTIPLE REGRESSION MODEL

In order to extend the model to predict overall performance in the first MBA accounting course,

various factors have been combined on a hypothetical basis, believed to be indicative of performance. This was accomplished through multiple regression models.

In Table II, the results are reported for financial accounting. The VERB GMAT was found not to be significant in determining GRADE. This can be justified by the heavier concentration of quantitative and more objective and verifiable theory inherent in financial accounting. However, QUANT GMAT, GPA, and ACCTG were all significant in the more completely specified model. The R-square was .325 and the F-test was 5.648 and found to be significant for the overall regression.

Table III presents the results related to the managerial accounting course grade. These results are decidedly different. For explanation of GRADE, the QUANT GMAT was the only significant variable in the model. This was relatively significant with a t-statistic of 1.755 at the .0854 level. Based on the F-statistic, the regression model was found not to be a significant predictor for GRADE.

Table IV presents the results of combining and averaging the financial and managerial accounting grades into one. With respect to the simple regression model, it was found that VERB GMAT, GPA, and ACCTG were not significantly related. However, the QUANT GMAT was very significant at the .0 193 probability level.

In comparing the average course grade for financial and managerial, it was found that the following variables were significant contributory factors of course grade: QUANT GMAT was significant at a probability level of .0039. GPA and ACCTG were very close to being significant with levels of .0808 and .0892 respectively. VERB GMAT was not a significant factor affecting accounting grade. The F-statistic was 2.985 which was significant at the .0282 probability level. The R-square was found to be .203.



SUMMARY AND CONCLUSIONS

The conclusion yields interesting results. The QUANT GMAT score was found to be a significant variable in explaining course grades. However, verbal ability, previous accounting study, and grade point average resulted in contradictory findings when comparing financial accounting to managerial accounting. These results differed from previous studies . In most of the previous studies, it was found that previous accounting study was not a significant predictor for accounting course grades. In this study, previous accounting instruction was found to be positively correlated with course grade in financial accounting. However, this was not the case for managerial accounting. Therefore, students with no previous accounting study seemed to perform equally as well in the managerial course, and without disadvantage, when compared to the students who had previous accounting study.

Finally, with respect to admission, it seems that GMAT score is a reliable predictor for financial accounting when the quantitative GMAT is utilized. Other variables may be explaining the managerial attributes of the students and an exact study of these factors is beyond our data base. The relationship between accounting grades and other courses in the MBA program may be an area of study in the future, but it is beyond this exploratory study into grade determination. However, college admissions procedures that concentrate on accepting students with strong quantitative score would enable students to be well equipped to do satisfactory on this important and often most difficult class in the MBA program.

Table I

Explanatory Variables Descriptive Statistics

Variable Mean Std Dev. High Low Dependent 86.58 6.45 99 68 GRADE 85.56 7.78 99 68 (managerial) GRADE 86.07 6.47 99 69 (average financial- managerial) Explanatory QUANT GMAT 63.33 19.79 99 27 VERG GMAT 72.29 18.03 98 20 GPA 2.89 .36 3.63 2.15 ACCTG .77 .81 2 0

Table II



Factors Explaining Financial Accounting Grade Full Sample Test

Intercept QUANT VERB GPA ACCTG GMAT GMAT Correlations 3.59 -.066 .15 .26 Simple Regression Intercept 79.172 88.276 78.685 84.981 Slope .117 -.024 2.734 2.074 Std Error .043 .050 2.542 1.092 t 2.717 .465 1.076 1.900 Alpha .009 .6436 .2873 .0632 R2 .129 .004 .023 .067 Regression Coefficient 56.692 .166* .048 4.586* 3.459* Std. Error .043 .047 2.245 1.037 t 3.89 1.01 2.042 3.337 Alpha .0003 .3178 .0467 .0017 R2 = .325 F = 5.648* Significance level = .0009 *Denotes significance at .05 significance level

Table III



Factors Explaining Managerial Accounting Grade Full Sample Test

Intercept QUANT VERB GPA ACCTG GMAT GMAT Correlation .241 .03 .166 -.063 Simple Regression Intercept NA 79.559 84.626 75.024 86.028 Slope .095 .013 3.649 -.611 Std. Error .054 .061 3.058 1.361 T 1.755 .211 1.193 .449 Alpha .0854 .8336 .2384 .6553 R2 .058 .001 .028 .004 ---------------------------------------------------------------------------------------------------------------------------------------- Regression Coefficient 62.908 .117* .040 4.148 .463 Std. Error .05 .066 3.121 1.441 t .297 .093 .189 .048 Alpha ``` .0552 .5425 .1903 .7494 R2 = .103 F = 1.347* Significance Level = .2667 *Denotes significance at .05 significance level

Table IV



Factors Explaining Average Financial-Managerial Accounting Guide Full Sample Test

Intercept QUANT VERB GPA ACCTG GMAT GMAT Correlation .324 -.015 .175 .091 Simple Regression Intercept NA 79.365 86.451 76.854 85.505 Slope .106 -.005 3.192 .731 Std. Error .044 .051 2.54 1.129 t 2.418 .105 1.257 .648 Alpha .0193 .9171 .2147 .5201 R2 .324 2.187 .031 .008 Regression Coefficient 59.8 .044 .142 4.367 1.961 Std. Error .047 .051 2.447 1.13 T 3.038 .854 1.784 1.736 Alpha .0039 .3973 .0808 .0892 R2 = .203 F = 2.985* Significance Level = .0282 *Denotes significance at .05 significance level



REFERENCES

Baldwin, B., and K. Howe, "Secondary-level Study of Accounting and Subsequent Performance in the First College Course, " The Accounting Review (July 1892), pp. 619-626.

Becker, G., Human Capital (New York: National Bureau of Economic Research, 1975), Chapter 111.

Bergin, J., "The Effect of Previous Accounting Study on Student Performance in First CollegeLevel

Financial Accounting Course, " Issues in Accounting Education 1983 (American Accounting Association, 1983), pp. 19-28.

Canlar, M., "College-Level Exposure to Accounting Study and Its Effect on Student Performance in the

First MBA-Level Financial Accounting Course," Issues in Accounting Education (American Accounting Association, Spring, 1986), pp. 13-23.

Hicks, D., and F. Richardson, "Predicting Early Success in Inten-nediate Accounting: The Influence of

Entry Examination and GPA, " Issues in Accounting Education 1984 (American Accounting Education, 1984), pp. 61-67.

Jacoby, C., "The Effects of Teaching Methods and Experience in Achievement of Business Students in the

First College Level Accounting Course, "Unpublished doctoral dissertation, Pennsylvania State University (1975).

Krauz, J, Schiff, A and Schiff, J., “The Effects of Prior Acconting Work Experience and Education on

Performance in the Initial Graduate-LevelAccounting Course, “ Issues in Accounting Education 1999 (American Accounting Association , 1999), pp. 1-9.

Moses, D., "Factors Explaining Performance in Graduate-Level Accounting," Issues in Accounting

Education 1987 (American Accounting Association, 1987), pp 281-291.

Schroeder, N., "Previous Accounting Education and College-Level Accounting Exam Performance," Issues in Accounting Education 1986 (American Accounting Association, 1986), pp. 37-47.

Smith, J., "Articulation of High School Bookkeeping and College Elementary Accounting, Unpublished

doctoral dissertation, University of Oklahoma (1968).



COMMERCIAL LENDING AND FINANCIAL REPORTING STANDARDS

Nasrollah Ahadiat

California State Polytechnic University [email protected]

ABSTRACT

As the number and complexity of financial reporting standards (GAAP), continue to rise, small and medium-size firms that are not publicly traded find it increasingly expensive to use the GAAP-basis of accounting. Likewise, small and medium-size businesses may see no benefits in seeking the services of independent certified public accountants (CPAs) for the review or audit of their financial statements. Previous research reveals some evidence that small businesses are dissatisfied with the GAAP-basis and favor the use of other bases of accounting. This study investigates the importance of using alternative accounting basis as well as the extent of CPAs involvement with small or medium-size firms in their daily business operations.

COMMERCIAL LENDING AND FINANCIAL REPORTING STANDARDS Financial statements are the basis for commercial loan considerations. To prepare financial statements, business entities may choose one of several accounting bases, including the accrual basis, the cash basis, or the modified cash basis. Among these alternatives, only the accrual method is supported by the generally accepted accounting principles (GAAP). GAAP provides a framework for the preparation of financial statements that is intended to enhance reliability and comparability of financial statements. However, only publicly held companies (or those permitted to access the U.S. capital markets) are required by law to report on the GAAP-basis. Others are only encouraged to voluntarily comply if they so desire (e.g., in loan covenants). As the FASB continues its rule-making crusade by developing more and more accounting standards dealing with such accounting issues as leases, pensions, post-employment benefits, financial instruments, and comprehensive income, many small and closely held companies find it overly complex and expensive to apply GAAP on a consistent basis [O'Dell, 1991]. Instead, other accounting bases have gained popularity over the past few years. A survey of 2,175 Certified Public Accountants (CPA) revealed that the majority of these practitioners (81%) have clients who use non-GAAP methods of accounting. In addition, over one-third of the respondents (36%) reported having some GAAP clients who could benefit changing to a non-GAAP basis [O'Dell, 1991]. The decision as to whether or not to use the GAAP-basis may entail both costs and benefits for the firm involved. On the one hand, there is some evidence indicating that the cost of compliance with GAAP is greater than the benefits that small business owners will receive. In a survey of 70 small business bankers, 68 senior executives of privately-held companies, and 54 Certified Public Accountants, Nair and Rittenberg [1987] found strong consensus that the costs of compliance with the FASB pronouncements are disproportionately greater than the benefits received by management. On the other hand, the cost of noncompliance may also be worth considering. A study of 230 commercial loan officers across the country revealed that not only do loan officers consider the GAAP-basis reports more complete and useful for their loan considerations, but also lower interest rates are charged on GAAP-basis loans compared to those supported by the tax-basis statements [Baker, 1990]. Regardless of what basis of accounting is being used, the issue of dependability and verifiability of financial statements also play a significant role in decisions involving loan or credit issues. In evaluating loan applications, a loan officer may consider whether the financial statements provided by clients have been audited by the independent CPAs. If unaudited statements are presented, the extent of the CPA's



involvement with the preparation or review of the statements might be important in determining financial statements’ reliability and if the loan should be authorized [Hollander, 1987]. Research evaluating the relative importance of independent accountants' involvement in the preparation or verification of financial statements tend to suggest that the greater the degree of this involvement, the more likely that the bankers will place more reliance on the financial statements. Nair and Rittenberg [1987] found that unaudited statements receive significantly lower ratings from bankers in their evaluation of loan applications. Additional evidence suggests that bank interest rates fluctuate by an amount (risk premium) that is in part dependent on the level of independent auditors' involvement with the applicant. A study by Baker [1990] demonstrated that the average interest rates on loans supported by financial statements reviewed by a CPA were 11% higher than the rates on loans backed by audited statements. Indeed, the added risk premium is a reflection of the bankers' concerns about the reliability of unaudited financial statements and the greater probability of default associated with loans that are not supported by audited statements. Thus, from an economic standpoint, as with the decision dealing with the choice between the use of the GAAP and some other basis of accounting, small and closely held companies also are faced with another decision. Whether it is worth having financial statements audited by an independent CPA. The focus of the present study is to investigate the above issues trying to find answers to such questions as: (1) which general-purpose financial statements are widely required by banks for commercial loan considerations, (2) what basis of accounting is acceptable for the preparation of financial statements, (3) should financial statements be audited, reviewed, or compiled by a Certified Public Accountant, and (4) in what interim should periods financial statements be presented to the bank for the continual assessment of future collectibility of a loan.

THE STUDY DESIGN

The data required for this research were collected via a questionnaire containing four general sections. The first section was comprised of demographic information about the banks including their nationality or the country of origin, whether they were private or public, total years of experience in commercial lending, and their primary service areas. The second section solicited certain financial information including the banks total assets, total loans, and total deposits. These questions were intended to determine the size of the participating banks. The third section contained specific questions pertaining to what financial statements the banks need for considering a loan application, what basis of accounting is required, how much CPA involvement is needed, and how frequently financial statements are issued. The fourth and final section of the instrument included questions designed on a Likert scale, to evaluate the relative importance of certain financial reporting issues.1

THE RESULTS

With reference to the first research question, the results showed that the balance sheet and income statement are the two primary statements that are required for all commercial loans, regardless of loan size. Other financial statements, such as the cash flows statement and the statement of owners' equity were not rated overly important for considering small loans. In addition, projected financial statements did not appear to be among the documents requested for considering small and medium-size loans. With respect to the accounting basis, the analysis demonstrated that bankers' strongly prefer the GAAP-based financial statements. This was a predominant response with both groups of bankers. Other bases of accounting, such as the cash-basis or the tax-basis, did not seem to be acceptable by the banks. When asked about the third question, the extent of independent verification required, bankers generally did not seem necessarily interested in receiving audited financial statements for considering small

1. The survey instrument was pre-tested by inviting three bankers to serve as a pilot group, by reviewing the instrument and providing their comments for improving the quality of the study. The input received from the group resulted in minor modifications with regard to both the content and clarity of certain questions. Upon inclusion of their comments, a revised copy was sent back to the participants in the pilot study, soliciting further comments. All participants returned their completed questionnaire with no additional comments.



loans. Perhaps most banks prefer to perform their own investigation of these clients and do not rely on the client's evidence of independent verification. Furthermore, contrary to Baker's [1990] findings, no evidence was found linking the extent of independent verification (audit, review, or compilation) of financial statements to differences in loan interest rates. Finally, with respect to the question of the frequency of interim reporting, the predominant response was the annual basis with the exception of the Filipinos, who seemingly prefer semi-annual reporting (possibly because of their business is primarily in issuing short-term loans). Bankers consider the accounting basis used by a client as the most significant criterion considered in decisions concerning small or medium-sized loans. The next most important factor is the CPA opinion. On the other hand, for larger loans, the extent of assurance provided in a CPA report received the highest rating, followed by the accounting basis. Thus, regardless of loan size, the accounting basis used and the extent of independent verification of financial statements form the two most significant lending criteria used by this group.

CONCLUSIONS

The overall analytical review of the lending practices revealed that in general the balance sheet and the income statement are universally required of all commercial loans applications. In addition, consistent with Baker's [1990] findings, this study found that regardless of loan size, bankers are nearly unanimous in their preference for the GAAP-basis of accounting. These results somewhat contradicts the research findings presented by O'Dell [1991] suggesting that more and more small businesses find it useful to move to a non-GAAP basis of accounting. The bankers surveyed, indicated their strong preference for the GAAP-basis of accounting for extending credit to their commercial borrowers. However, contrary to Baker's [1990] conclusions, no evidence was found to indicate that the bank's interest rates on loans not supported with audited statements are significantly higher than those charged on loans with audited statements.



BIBLIOGRAPHY

Baker, William M., "How Non-GAAP Financial Statements Affect Loan Officers and Borrowers," The Journal of Commercial Bank Lending May 1990), pp. 23-30. Barrett, G.V. and B.M. Bass. “Cross-Cultural Issues in Industrial and Organizational Psychology”, Handbook of Industrial and Organizational Psychology, Edited by M.D. Dunnett (Chicago, Rand McNally, 1976). California State Banking Department, Annual Report of California State Banking Department (Sacramento, CA: 1996). Chow, C., M. Shields, and V. Chan, "The Effects of Management controls and National Culture on Manufacturing Performance: An Experimental Investigation" Accounting, Organizations and Society (1991), pp. 209-226. Chow, C., V. Kato, and M. Shields, “National Culture and the Preference for Management Controls”. An Exploratory Study of the Firm-labor Market Interface”, Accounting, Organizations and Society (1994), pp. 381-400. Financial Accounting Standards Board, "Qualitative Characteristics of Accounting Information,' Statement of Financial Accounting Concept Nos. 2 and 4 (Stamford, Conn.: FASB, May 1980). Griswold, Wendy, Cultures and Societies in a Changing World (Thousand Oaks, CA: Pine Forge Press, 1994). Hollander, Morris, I., "Know Your Borrower and His Accountant," Banking Today (June 1987), pp. 14, 16. Lincoln, James R. and Arne L. Kalleberg, Culture, Control, and Commitment: A Study of Work Organizations and Work Attitude in the United States and Japan (Cambridge, UK: Cambridge University Press, 1990). Mair, Joy E., "Some Advice on Trusting Today's Small Borrower: Don't," American Banker (October 21, 1991), p. 4. Nair, R. D. and Larry E. Rittenberg, "Alternative Accounting Principles for Smaller Businesses: Proposals and Analysis," Small Business Financing (Robert Morris Associates, 1987), pp. 78-97. O'Dell, Judith H., "What if You're Presented with Financial Statements Prepared Using OCBOA?" The Journal of Commercial Bank Lending (December 1991), pp. 44-47.



SEC ENFORCEMENT ACTIONS IN THE AREA OF

BILL AND HOLD TRANSACTIONS

RYERSON, III, FRANK E. UNIVERSITY OF MONTEVALLO

[email protected]

MICHAEL E. STEPHENS UNIVERSITY OF MONTEVALLO

A significant number of SEC investigations involving financial reporting and a large number of cases coming before the AICPA Professional Ethics Executive and Quality Control Inquiry Committee concern some form of revenue recognition issue. While a number of these involve accounting for large complex transactions, many of them simply deal with inappropriate accounting for routine sales transactions. Some of the more common methods used to misstate revenues are improper sales cutoff, bill and hold transactions, side agreements, shipments to controlled destinations, fictitious transactions and misuse of the percentage-of-completion accounting method. A close examination of these types of irregularities may provide the accounting profession with insights that could lead to improved accounting and auditing standards and help reduce the number of misstated financial statements caused by inappropriate revenue recognition. For that reason, this paper investigates the misuse of the bill and hold method of revenue recognition. This investigation was conducted by reviewing the Securities and Exchange Commission’s (SEC) Accounting and Auditing Enforcement Releases (AAERs). The review identified a total of nine AAERs citing the inappropriate use of the bill and hold method. This paper describes the major problem areas identified by the SEC and specifies the critical revenue recognition issues associated with bill and hold transactions.

REVENUE RECOGNITION CRITERIA

The SEC, in AAER No. 846, stated that financial statements contained in commission filing must comply with Regulation S-X, and therefore must conform to Generally Accepted Accounting Principles (GAAP). In specifying what it considers to be GAAP, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Concepts No. 5, (CON 5), entitled “Recognition and Measurement in Financial Statements of Business Enterprises” states that revenue should be recognized when it is both realized (or realizable) and earned. Paragraph 83 of CON 5 states that revenue is realizable when a product is “exchanged for cash or claims to cash” and revenue is earned “when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues.” Paragraph 84(a) states that revenues from manufacturing and selling activities are commonly recognized at time of sale, usually meaning delivery. Thus, in the normal situation, revenue is recognized when the products are completed and delivered to the customer. However, in the case of a bill and hold transaction, the customer commits to purchasing the products but the seller retains possession until the buyer requests shipment. While this type of sales arrangement is not a violation of GAAP, past auditor experiences indicate that the risk is high that the seller may be attempting to manipulate revenue in such situations because no shipment has occurred. Therefore, the auditor should be skeptical about accepting such revenue as legitimate and accordingly should ascertain how and why a company maintains that the bill and hold method is justified. In addition, the SEC has concluded that GAAP does not allow bill and hold transactions without the purchaser having a compelling business purpose for requesting delay in delivery. Perhaps the greatest single source of guidance the SEC has provided auditors in the area of bill and hold transactions is found in AAER No. 108.



ACCOUNTING AND AUDITING ENFORCEMENT RELEASE NO. 108

On August 5, 1986, the SEC issued AAER No. 108. In that release the SEC set forth a number of conditions a purported bill and hold transaction must meet before it can be considered for revenue recognition. These conditions are as follows:

(1) The risks of ownership must have passed to the buyer; (2) The customer must have made a fixed commitment to purchase the goods, preferably

reflected in written documentation; (3) The buyer, not the seller, must request that the transaction be on a bill and hold basis. The

buyer must have a substantial business purpose for ordering the goods on a bill and hold basis;

(4) There must be a fixed schedule for delivery of the goods. The date for delivery must be reasonable and must be consistent with the buyer’s business purpose (e.g., storage periods are customary in the industry);

(5) The seller must not have retained any specific performance obligations such that the earning process is not complete;

(6) The ordered goods must have been segregated from the seller’s inventory and not be subject to being used to fill other orders; and

(7) The equipment must be complete and ready for shipment.

The SEC went on to say that while these conceptual criteria are important, they are not a check list and a transaction meeting all of them might still fail to meet the requirements for revenue recognition. The Commission also believes those responsible for the financial statements should consider these six additional factors set forth in AAER No. 108.

(1) The date by which the seller expects payment, and whether it has modified its normal billing and credit terms for this buyer;

(2) The seller’s past experiences with and pattern of bill and hold transactions; (3) Whether the buyer has the expected risk of loss in the event of a decline in the market

value of the goods; (4) Whether the seller’s custodial risks are insurable and insured; (5) Whether APB Opinion No. 21, pertaining to the need for discounting the related

receivable, is applicable; and (6) Whether extended procedures are necessary in order to assure that there are no exceptions

to the buyer’s commitment to accept and pay for the goods sold, i.e., that the business reasons for the bill and hold have not introduced a contingency to the buyer’s commitment.

The next section of this paper presents the results of the investigation into the misuse of the bill and hold transactions. As noted earlier, this investigation was conducted by reviewing the SEC’s AAERs for evidence of misuse.

MISUSE OF BILL AND HOLD TRANSACTIONS The review of the SEC’s AAERs uncovered a total of nine AAER’s citing the inappropriate use of the bill and hold transactions. While an in-depth reporting and analysis of these AAERs is beyond the scope of this paper, this section does list them and provides a description of the violation. • AAER No. 47 - overstated revenues by improperly recording bill and hold transactions as sales. The

goods were held by the seller because the seller declined to ship them rather than as a result of the customer requesting that the goods be held. The sellers action to hold the goods was due to the fact that the customer’s accounts with the seller were not sufficiently correct.



• AAER No. 108 - Overstated revenues by recording on the bill and hold basis sales which should not have been recognized as revenue because the sales were conditional on the occurrence of future material events. The SEC also noted that the bill and hold arrangements used significantly departed from the company’s reported revenue recognition policy; i.e., that revenues were recognized when product units were shipped and installed. Some of the inappropriate sales cited were actually consignment transactions or shipments of products on a demonstration basis with no-charge to the “customer”.

• AAER No. 196 - Overstated income due to the improper recognition of revenue for six bill and hold transactions. The sellers normally recognized revenue upon receipt of an order and shipment of the respective goods. In the case of the six bill and hold transactions revenue was recognized upon receipt of a distributor’s order for a dollar amount of goods, prior to the distributor having specified the goods to be shipped or the shipment of any goods, which in some cases did not occur for over one year after the revenue was recognized. In addition, the seller held and commingled with its inventories goods which it treated as having sold and the risks of loss and the rights of ownership on these goods did not pass to the distributor at the time the seller recognized revenue.

• AAER No 215 - Similar to the complaint filed in AAER No. 196, the seller in this case violated its own policy of recognizing revenue only upon shipment of product by recognizing revenue at the time the invoice was sent to the customer, which was prior to shipment of the goods. Furthermore, the goods were not segregated from other inventory nor were they specifically identified. The seller also bore the expense of storing the goods until shipped and remained responsible for any loss, obsolescence or damage which occurred prior to shipment. The SEC also concluded there was no business purpose for structuring the transaction in this way.

• AAER No. 817 - Overstated revenues and understated losses by recognizing revenues from purported bill and hold transactions. In this instance the seller recognized revenue on goods that had not yet been completed and the earnings process was, therefore, not complete. Even if the goods purportedly sold had been completed, the recognition of revenue would have still been improper because no exchange had taken place because the sellers transaction had failed to meet virtually all of the conditions set forth in AAER No. 108 for bill and hold transactions. For example: the buyers did not request the bill and hold basis; there was no fixed schedule for delivery; the ordered goods had not been segregated and many customer orders were cancelable or vague in their terms.

• AAER No. 834 - Overstated revenue and earnings by recording the purported bill and hold transactions as sales even through the conditions for recognizing revenues on such transactions had not been met.

• AAER No. 971 - Overstated revenues and profits by recording and concealing fraudulent and premature sales through a variety of means including having customers sign false “ship-in-place” (bill and hold) request letters.

• AAER No. 1160 - Overstated revenues by recording approximately sixty transactions as bill and hold sales on the last day of the quarter. The revenues were not recorded in accordance with GAAP because the earnings process was neither complete or virtually complete nor had an exchange taken place.

• AAER No. 1197 - In an intentional scheme to manage earnings, the company overstated revenues by improperly recording purported bill and hold transactions. The sales recorded as bill and hold sales were for goods that were neither billed nor shipped to customers, and, in some cases, did not exist or were not completely manufactured.

CONSIDERATION FOR AUDITORS AND CONCLUSIONS

In January of 1995 the AICPA issued Practice Alert No. 95-1 to remind auditors of conditions that can be indicative of increased audit risk with respect to improper and unusual revenue practices. Among the various revenue practices noted in the alert was “Sales billed to customers prior to delivery and held by the seller (“bill and hold” or “ship in place” sales).” The importance of such revenue recognition issues to auditors was reinforced by the AICPA in November of 1998 when they issued Practice Alert No. 98-3 on revenue recognition issues to supercede Alert No. 95-1. Alert No. 98-3 again spelled out certain issues requiring special consideration on the part of auditors, including bill and hold transactions. The AICPA stated that in order to reduce the risk of improper revenue recognition, the audit needs to be planned and executed with an appropriate degree of professional skepticism. In the planning of the



audit the auditor needs to obtain a sufficient understanding of, among other things, the client’s sales policies and its accounting policies and procedures related to revenue recognition. It is essential that this include an understanding of a client’s policies with respect to acceptable terms of sale and an evaluation of when revenue recognition is appropriate given those terms. In considering the appropriateness of recognizing revenue or sales to distributors the auditor should determine that the customers has accepted the product and the risks and rewards of ownership have been transferred. The AICPA also notes that a proper understanding of a client’s business, its accounting policies and procedures, and the nature of its transactions with customers is also useful in assessing the extent of experience or supervision required of personnel assigned to audit revenue transactions. Certain unusual or complex sales contracts may require more experienced engagement personnel. More specifically, with reference to this paper, the auditor was warned to exercise caution when bill and hold sales exist. These should be examined to obtain an understanding of the transaction’s business purpose to evaluate whether revenue recognition is appropriate. To further reduce audit risk on purported bill and hold transactions, the auditor should consider using confirmations to corroborate the terms of the agreement and inquire about the existence of any oral modifications or undocumented “side-agreements.” The auditor should also consider the business purpose of the transaction from both parties’ perspectives and evaluate responses to inquiries with appropriate professional skepticism. In summary, because bill and hold transactions depart from the normal convention of recognizing revenue at the time of delivery, the nature of the reason for the delayed shipment is the critical element for consideration. If the buyer has made an absolute commitment to purchase the goods, but is unable to accept immediate delivery, perhaps due to a temporary lack of storage space, then the transaction is generally considered a sale. In conclusion, this review of AAERs revealed that certain bill and hold transactions were clearly not sales, whereas with others, the decision was not so obvious. However, once such transactions are identified the primary audit objective is to ascertain that the transaction has substance. Because they occur with relative infrequency, they should be viewed with extreme skepticism. Supporting evidence should clearly indicate that the buyer has a compelling business reason to request the delay in shipment. The auditor should also consider obtaining a signed statement from the client’s customer asserting to the reason for the request for delay in shipment. In addition, confirmation of the client’s assertion of the quantity of bill and hold goods on hand at fiscal year-end is recommended.



REFERENCES American Institute of Certified Public Accountants (1995). Practice Alert No. 95-1, Revenue Recognition

Issues, Professional Issues Task Force of the SEC Reactive Section. American Institute of Certified Public Accountants. (1998). Practice Alert No. 98-3, Revenue Recognition

Issues, Professional Issues Task Force of the SEC Practice Section. Financial Accounting Standards Board, FASB Concepts Statement No. 5, Recognition and Measurement in

Financial Statements of Business Enterprises, Original Pronouncements, Vol. 2. Securities and Exchange Commission (1989). SEC Accounting Guide, Chicago: Commerce Clearing

House, Inc. Securities and Exchange Commission (1999). Essential SEC Rules for Business, CCH Electronic Library,

October 1999, Chicago: Commerce Clearing House, Inc. Securities and Exchange Commission (1999) SEC Enforcement Division,

http://www.sec.gov/enforce.htm>



SMALL BUSINESS ACCOUNTING INFORMATION SYSTEMS DILEMMAS: HOW MUCH IS TOO

MUCH? HOW MUCH IS NOT ENOUGH?

Glidden, Kimberly L. Moorhead State University

[email protected]

The rapid decline in the cost of computers and the proliferation of inexpensive software has given many small business owners the opportunity to utilize accounting information systems for the first time. Owners are faced with an array of software which may or may not be the best information systems solution for their businesses. Often, owners are also at a disadvantage in the marketplace. They have kept manual bookkeeping systems for years, and may not be qualified to choose the accounting information system that best fits their needs, let alone to choose the hardware on which it will operate. Owners who have utilized automated systems are often attached to custom systems built especially for them and cannot fully grasp the potential or the growth in functionality that has occurred in recent years.

This paper uses two companies to illustrate small business concerns faced by two separate business owners who run different types of businesses. One owner runs a $15 million manufacturing concern, while the other runs a $300K electrical contracting operation. The manufacturing owner experienced an unexpected business upturn due to increased market demand for his new product. He wanted to purchase software in order to create access to very detailed manufacturing information, and wanted new accounting software only if it was required. He was comfortable with the system in place, even though it was completely outdated, because it had been "state of the art" when he had customized it 10 years ago. The second business owner had created a manual bookkeeping system following the pattern of one he had seen. He was uninterested in paying anyone to do his invoicing or vouchering - he merely wanted to proceed with his simple system. In the second year of operation, he took on a partner. This increased the volume of transactions substantially; however, the two were still wary of automating any of the accounting systems.

This paper will illustrate the decision making process used to create automated accounting information systems solutions for each of these concerns. Several factors must be considered when actively seeking a new solution in a small business, such as owner acceptance, owner time valuation, systems support, owner understanding, and availability of internal company resources. In addition, potential warning signs, such as size of investment in the solution vs. potential return, complexity of the solution vs. owner ability to utilize the solution effectively, and lack of owner commitment to the selected solution will be emphasized.

Prior to the mid-1990's, small business owners had been unable to benefit from the potential productivity gains offered by personal computers. In many cases, the technology was cumbersome and difficult to utilize effectively without the assistance of an individual who had received in-depth information systems training. In addition, the lack of functionality required by small business made it difficult for owners to find compelling reasons for purchasing new software.

As personal computing power expanded, so did the willingness of small business owners to reevaluate the potential impact that incorporating financial systems into their businesses might have. Software companies began to write simpler programs for the masses, and small business owners began to look at the possibilities implementing software may have on small business efficiency.

Different approaches may be taken when implementing information systems solutions. This paper will detail the decision making process for selecting accounting information systems for two small business concerns of different type and size. Several factors must be considered when actively seeking a new solution in a small business. These include owner acceptance, owner time valuation, systems support, owner understanding, and availability of internal company resources. In addition, potential warning signs, such as size of investment in the solution vs. potential return, complexity of the solution vs. owner ability to



utilize the solution effectively, and lack of owner commitment to the selected solution will be discussed. Case#1: Recreational Products (name changed), a manufacturer of fiberglass recreational vehicles, was created in answer to the market demand for a new type of vehicle. The owner had previous fiberglass experience and sought to apply his knowledge to achieve success through manufacturing a new type of vehicle. Demand in the first 4 years of business had risen steadily and profitably. The company was experiencing problems common to small businesses in growth mode, such as backorders, inventory run outs, and production scheduling difficulties. Recreational Products had an aged financial reporting system with manufacturing capability installed in the early 1980's. Software updates hadn't been installed once the company entered the 1990's, and the system became increasingly archaic. An individual with financial expertise was hired to take over the Finance function, and also became primarily responsible for the search to "prove out" the ability of the old manufacturing/financial system vs. the capabilities of the new systems in the market. There wasn't an information systems professional on staff; the owner contracted out all information systems maintenance to a third party. Step one in the decision making process is to Define Current Business Processes. To accomplish this, Recreational Products gathered contributors together and asked each person separately to describe the various functions and computer screens used daily. Each brought samples of reports required to complete their daily tasks. At this stage, no one questions whether or not the jobs are value-added to the company. A list is compiled of the specific reports used, the data needed on the reports, and possible formatting options for new reports. If a contributor immediately identifies extraneous data present on the existing reports, it is not listed as a requirement.

Once the finance person had this data, a chart of requirements was created and routed through the personnel who attended the system requirements meeting to allow contributors the opportunity to view the document and make and necessary changes. This document would serve as a blueprint to evaluate existing functions, but it did not address desired functionality not present in the current system. The contributors would then brainstorm about "nice to have" items. Contributors would name a type of data, or a report they'd like to see, and the reason each believed it would benefit the company, and that would also be listed on the chart of requirements. Once the brainstorming session was completed, the requirements chart would be the sum total of the organizational hopes for software/hardware functionality. The finance person then began the second step in the process, which was to Benchmark Against Competitors. Small businesses are unique in that they don't have large networks where interaction takes place. Often, like businesses are geographically diverse, and, in our case, the niche market of this small business owner meant he competed against much larger companies with extensive information systems resources. Rather than try to shoot in the dark to find the best application software for his needs, the finance person used a list of all the competitors in the niche market and their phone numbers. Each competitors information systems manager or accounting manager was contacted and asked questions from a short questionnaire, including:

1> What is your current financial/manufacturing system software? 2> How long have you been using this software? 3> Are you happy with the functionality and response time of your current software and

hardware? 4> Why? Why not? 5> If you purchased prewritten software, what was the name and phone number of the vendor? 6> How long will it be until you purchase new hardware/software to run your

manufacturing/accounting functions? Once the questions were answered, the responses from the fifteen manufacturers were evaluated to

discern positive responses to software and hardware performance. Not surprisingly, many of the manufacturers were using some type of "homegrown" software to run their businesses. Many of the personnel spoken to were increasingly dissatisfied with the functionality of this type of software, citing the inability of the user to create and modify reports, the dependence on information systems personnel for programming changes, and the lack of current functionality within the dated programming. Personnel stated they were beginning the process of evaluating new software choices, and were very hopeful that a new system would be implemented as a result of that process. The most beneficial outcome of the benchmarking process were the responses of the personnel who had implemented systems that did not meet the specific requirements of the niche market they reside in. The opportunity presented by this was to avoid a poor managerial decision through the experience of others.



Once the survey of others was complete, the results were listed in chart format for comparison purposes and the group was reunited in a meeting for step three, Search for Software/Hardware Solutions. It was in this step that the owner began to be impatient. It had been three months since the initial decision to evaluate solutions had been made - he questioned why nothing had yet been decided. One of the challenges faced by personnel who implement software in small businesses is the need to resist the movement towards immediate action in the decision process. Owners of small businesses are used to immediate decisions in a small chain of command with rapid, if not immediate, implementation results. The finance person was asked to speed the process, and did so by renewing effort to find the distributors (resellers) of the purchased products that looked promising in order to schedule demonstrations. In step three, ground rules should be set surrounding the long-term budget for the project. This should include two parts. Part one should detail the initial cash outlays for the software, hardware and consultant support required for implementation of the system in its entirety. Part two should detail each expense required to maintain the system over at least the next two years. Without a budget, the company may find that it was able to afford the initial installation of the system; however, the upkeep and maintenance upgrade costs may be unaffordable in the long run. In this case study, the finance person did not establish budgets beyond the initial implementation system costs, and that became detrimental in the long run. Demonstrations for the owner of the different software packages found in the survey were scheduled through the distributors who sold the packages. In addition, a demonstration was also scheduled for the existing installed software package updated for the releases that Recreational Products had not installed. In this step, it is most important that the demonstration lack few flaws and that each demonstration be given to the contributors who will be utilizing the new system. Contributors should be encouraged to ask questions. This will enable the demonstrator to prove out the functionality of the proposed system and ease potential fears surrounding the software change. In this case study, the owner witnessed a very poor demonstration from the existing software representative, and a very polished demonstration with a fully functioning software program from a new software company. In that instant, the polished demonstration sold the owner. The owner was unconcerned with the complicated nature of the system; he was merely concerned that he installed the state of the art system into his business. Following the demonstration phase, the process enters step four, Evaluating Software/Hardware Options. In this step, everyone should come together with the original chart of system requirements as a basis for the discussion. If possible, demonstration copies of each program should be set up in development for the contributors to try out functionality at their leisure. This will enable contributors to make a more informed decision based on their own trial of the software functionality. Each person must re-evaluate their original premise, and decide whether or not the proposed systems meet, exceed or fall below their expectations. In addition, during the initial portion of this step, evaluators are encouraged to amend their original premise to add items or options viewed in any demonstration which they believe will enhance their ability to do their jobs. At this stage, requirements should not be ignored, nor should any requirements be weighted more heavily than others. The process merely requires the participants to objectively evaluate whether or not the proposed software system completes the need in a method that falls short, meets, or beats expectations. Once the software is evaluated on functionality, individual requests for price proposals should be issued to vendors who meet or exceed expectations.

Following the preparation of the proposal requests, step five, Evaluate the Vendor Proposals will take place. Vendor proposals are usually priced in sections for implementations. Common areas for prices to be individually listed include software price, server hardware, user hardware (quoted per person), user licenses, network charges (if your building is not wired for LAN use), consultant charges per hour, and expense charge per diems per day. Vendor proposals should include an estimate of yearly maintenance charges once the system is up and running as well. These include charges by the software manufacturer for new releases, and charges by the consultants to install and maintain your system if you do not have an information systems person on staff.

In the evaluation process, the functionality of the software is used as a baseline for comparison. Each software package is ranked on its ability to meet the functional requirements. If an area of the proposed software package is severely deficient in meeting the needs of a functional area within the business should be discarded from the decision process in this step. In addition, each package should be evaluated within the scope of the personnel currently employed by the business. Ensure that the software can be operated confidently by the personnel who are in their jobs, and weigh their experience levels



carefully in your decision. Finally, the cost/benefit analysis of the new package must be a factor in the decision making

process. A software package may solve a business problem; however, if the costs of purchasing, implementing, training and maintaining the system over the long run outweigh the benefits of the functionality gains, the small business owner must reject the decision to purchase new software. This is especially true if the business faces no regulatory or competitive need to upgrade systems. In the cost benefit analysis, process changes, workarounds, partial systems solutions and other methods of creating value should be explored.

In step six, Select and Implement the Solution, the small business owner profiled purchased a system with high functionality, many industry specific modifications, and custom written programs that required modifications each time one of the major software packages had a revision. The hardware was installed immediately. The test software was installed one month later, and the owner was impatient to see results from the large investment. Initially, the financial software and the manufacturing software were set to be implemented together; however, lack of personnel commitment throughout the organization left the finance person alone on the project. The finance systems were brought up alone in January, with plans to implement the integrated manufacturing system by the end of the following year.

At this juncture, it became clear that the company had not evaluated internal processes that might impede the progress of the use of the manufacturing software. The company owner questioned the process and decisions made by teams constantly, and refused to show faith in personnel involved in the implementation and use of the software. Decision implementation was riddled with issues in manufacturing - a relatively simply bill of materials (250 different parts) kept the manufacturing personnel in a state of preferring the status quo rather than moving towards technology to manage the product. Lack of project "championing" by the owner of the corporation, continued "foot dragging" and "bad-mouthing" of the project by those in charge of manufacturing were a drag on the project that hadn't been experienced during the successful financial system implementation. Consultants were employed to enable help with the project and bemoaned the lack of progress in the manufacturing area at each visit - the potential simplicity of the implementation was marred by the unwillingness of the manufacturing personnel to participate in the process.

Although the process is sound, small business owners have an additional dilemma. Should they purchase a system that meets their needs totally, or meets only some of their needs? In this case, the small business owner had nothing but the best intentions. A proper process for searching and finding an information system solution for his business was executed; however, did he aim for too much system? The information system chosen consisted of three parts - one software was a manufacturing accounting software written for the masses, the second software integrated with the first through custom programming to provide increased use of the databases in the first and the third contained the financial accounting functionality. The custom program itself fit the business perfectly and was specifically written for the business by someone from the industry. The small business owner felt safe because the software was already installed in similar businesses. However, the comparison was invalid, because the competitors were much larger, had a greater quantity of information systems resources, and a much larger administrative staff to handle the inputs required for effective system utilization. This owner had no systems professional on staff; therefore, participants on the implementation team were often unsure how to proceed to populate the system with the data it needed to operate. In addition, the purchase of three software packages to meet his manufacturing need left him with the purchase of three yearly maintenance packages and multiple software upgrades each year. The size of the ongoing investment wiped out potential manufacturing gains from reduced inventory management costs. The complexity of the software left the owner unsure of its capabilities, and unable to understand how it really functioned. In order for a small business solution to be effective, the owner must have a basic understanding of how the software accomplishes its task in order to be supportive of the project to others. A lack of understanding will mean the owner is unable to defend his decision to himself, and he may then be unable to be supportive of the decision in public because of it. Ultimately, even though the owner followed the correct process, the lack of recognition of software complexity, lack of internal resources, and failure to complete a cost/benefit analysis meant completion of this project would be difficult. Currently, the owner is continuing the battle to install the software because of the initial investment; however, without the required internal changes, the implementation team faces an uphill struggle. Case #2 Electrical Contractor, LLC (name changed), a small electrical contractor, was a one-



person business in the first two years of operation. In the third year, a co-owner was named, and the company created twice the paperwork each month due to the addition of the co-owner. In the first two years of this business, the owner wrote checks for disbursements once a month, and invoiced his customers weekly. The initial owner did not pay himself in the first two years, preferring instead to amass capital for investment in equipment within the business. A manual bookkeeping system developed in year one recorded transactions in three journals - sales, receipts, and disbursements. In addition, a list of outstanding receivables at the end of each month was developed. When the co-owner was named, a decision was made to pay each of them weekly. In addition, it was agreed that taxes would be withheld and remitted to the proper taxing authority monthly. Disbursement checks were written twice monthly, and invoices were sent out upon completion of work. One co-owner worked and mailed invoices to customers; the second was responsible for the disbursements and invoicing his customers. Although the manual bookkeeping system worked properly, the co-owners were dissatisfied with the timing of the reporting. In many cases, accounts receivable aged and they weren't aware of the problem until the bookkeeper was finished with the ledgers two or three months following month end. Each of the owners desired more "real-time" information on the cash account, and wanted more detailed reporting on sales and disbursements. The second case is a pure example of "How much is too little?" In today's business environment, even small businesses cannot afford to be without current, accurate financial reports. The smallest business can profit from the installation of a personal computer and financial software to better manage the business. In this case, the co-owners jointly decided it was time to find software to give them more financial information. A consultant was hired to find an inexpensive, simple solution to their management problems. Using the same steps defined in the first small business process, the consultant began with step one, Define Current Business Processes. The processes were easily defined as financial information functionality. In addition, the consultant determined that inventory functionality might be required at a later date if the business should grow. Identifying potential requirements is necessary to have a complete chart of requirements no matter what size business is considering a software purchase. The consultant then proceeded to step two, Benchmark Against Competitors. Because the business was small ($300K revenue), service-oriented and located remotely, the business had no real competitors. In step three, Search for Software/Hardware Combinations, a list of small business software was compiled using industry magazines and the consultant obtained trials copies to evaluate each for functionality. The software listing also contained several types of small business financial software in case the industry software was too complicated. The consultant narrowed the list of software to three selections to demonstrate for the owners in step four, Evaluate Hardware/Software Options. The owners were shown how transactions would be completed within the system and given samples of reports that could be generated from the system once installed. The strengths and weaknesses of each software package were demonstrated and examples given of the ways requirements were met or exceeded. Following the demonstration phase, the owners worked with the consultant again in step five, Evaluate Software/Hardware Options. Even though the owners were not proficient in the use of personal computers and software, it was important to familiarize them with options and to have them participate in the decision process. Ultimately, it would be the owners operating the software, and they needed to be aware of the choices to make an informed decision for their business. The consultant can suggest why one software may seem more suited to the application than another one, but only the owner should be allowed to make the choice.

Lastly, the group completed step six, Select and Implement the Solution. The owners determined that the following solution would solve many of the reporting issues the business faced as it expanded. Each owner would continue to compile their own invoices, using, or not, the personal computer at their disposal. The bookkeeper would enter all of the invoices, receipts, disbursements and payroll checks into the one of the computers weekly, and print out profit and loss reports monthly. In addition, aged receivable lists would be generated weekly after posting current invoices and receipts and given to each of the owners. Monthly statements with finance charges could now be generated as well, reducing the time spent on collection calls by the owners. The simplicity of the business in case 2 calls for a simple solution. Each of the owners was taught to run reports from the primary financial computer, or to request them from the bookkeeper as needed. Each was pleased with the improvement in turnaround time for reports and collection of receivables



improved, and was fully committed to using the system as a tool in operating the business. The key to success in the second case was the owner commitment to change and the willingness to remain simple. An application software that managed inventory resources for electrical contractors could have been implemented; however, it would have cost them additional time in input, or additional investment in bookkeeping assistance. The owners were clear in their expected outcomes - they had completed the cost/benefit analysis and had invested only in what they could reap a reasonable return from. In conclusion, small business owners must be attentive to expected outcomes, supportive and well versed in the chosen solution, and confident that return on the information system investment will reap benefits that exceed the costs in the long term. Ultimately, failure to monitor expenses vs. benefits during the project may cause the owner to choose a system that is difficult to implement and maintain.



STUDENT HOMEWORK EFFORT AND THE

INTRODUCTORY FINANCIAL ACCOUNTING COURSE

McEacharn, Michelle

University of Louisiana at Monroe [email protected]

ABSTRACT

Considerable research has been directed toward identifying the factors that influence student

performance in the introductory financial accounting course. The influence of factors such as aptitude test scores, cumulative grade point averages, outside work and home activities, previous accounting courses or experience, and gender have been investigated to determine the significance of these factors on student performance. In some studies, student motivation and effort have been considered. However, student effort, as evidenced by homework effort, has not been directly addressed. This research was directed toward identifying the significance of homework effort in a student’s performance in the introductory financial accounting course. Homework effort was found to significantly influence the student’s performance on individual examinations, as well as the student’s overall performance on quizzes and final course grade.

INTRODUCTION

Many accounting educators adhere to the belief that “Accounting is learned best through the end of a pencil” and have often expressed this belief to their students. Most often, the implication of this expression is that the student will learn accounting better and perform better in the course if a conscientious and consistent effort is made in the area of homework. Research has been done that attempts to define the characteristics that result in better performance in the introductory accounting course. Eskew and Faley (1988) found several factors to be significant in determining student performance in the introductory financial accounting course, including such factors as SAT scores, high school grades, and previous high school accounting experience. Doran, Bouillon, and Smith (1991) also found that measures of academic performance such as ACT scores, cumulative grade point average, and high school accounting experience had a significant impact on the success of the student in the introductory accounting courses. If, as accounting educators often remark, accounting is learned best through the end of the pencil, then the argument should be made that, regardless of inherent ability as evidenced by academic performance measures, more effort on the part of the student will result in better performance. Eskew and Faley (1988) did consider student effort in their research but the attribute used to measure effort was the number of quizzes taken by the student. The number of quizzes taken in a course may reflect the effort of the student in attending class but does not necessarily indicate the amount of effort extended by the student in trying to learn the material. Some research has been directed toward the impact of effort in a general educational setting (Fad and Ryser, 1993) and in the managerial cost accounting course (Ibrahim, 1989). Wooten (1998) also considered the impact of student effort in a structural model developed to compare traditional versus nontraditional students in introductory accounting classes. Wooten measured effort through class attendance, homework attempted and study guide usage and found effort to be a significant determinant of performance. This research attempts to contribute further to this body of research and determine whether student effort with respect to homework is a positive contributor to performance, without regard to inherent ability or other such contributing factors.



RESEARCH QUESTIONS AND METHODOLOGY The purpose of this research is to determine whether homework effort contributes positively to student performance in the introductory financial accounting course. Homework effort can be easily measured by the number of assignments completed (or not completed) during the course. For many students, the ultimate measure of performance is represented by the final grade earned in the course. However, it is intuitively logical that those students who put forth more effort should perform better on a daily basis as measured through quiz grades, on a periodic basis as measured by individual examination scores, and overall as measured by the final (comprehensive) examination score. Therefore, the following questions are posed by this research. Research Question 1: Does student homework effort positively impact individual examination scores

of students in the introductory financial accounting course? Research Question 2: Does student homework effort positively impact final examination performance

for students in the introductory financial accounting course? Research Question 3: Does student homework effort positively impact quiz grade performance for

students in the introductory financial accounting course? Research Question 4: Does student homework effort positively impact the final grade students earn in

the introductory financial accounting course?

Examination scores, quiz grades, final course grades, and homework completion data were derived from four sections of the introductory financial accounting course taught over a three-semester period (Spring 1998, Fall 1998, and Spring 1999). One instructor taught all four sections of the course, the format of the course was not significantly changed during the three-semester time frame, all course sections were morning classes offered on a three-day a week schedule, and the same text and testing process was used in each section. Course information related to a total of 125 students was obtained and consisted of only those students who actually completed the course, regardless of final grade. Basic information related to the research data is presented in Exhibit 1.

EXHIBIT 1: BASIC COURSE AND STUDENT DATA Student Classification: Classification: Freshman Sophomore Junior Senior Graduate Number/(Percentage): 10 (8%) 63 (50.4%) 29 (23.2%) 19 (15.2%) 4 (3.2%) Student Major: Non-Business Acct CINS Eco/Fin Mgt/Mrkt GenBus MBA Number 31 18 33 7 22 12 2 Percentage 24.8% 14.4% 26.4% 5.6% 17.6% 9.6% 1.6% Grade Distribution (90% = A, 80% = B, etc.): A B C D F Number 17 43 40 21 4 Percentage (out of 125) (13.6%) (34.4%) (32%) (16.8%) (3.2%) Missed Homework Distribution (Average of 31 assignments required each semester):

Number of Assignments Missed Number of Students Percentage Missed No Assignments 12 9.6% Missed 1 or less 26 20.8% Missed 3 or less 51 40.8% Missed 5 or less 76 60.8% Missed more than 5 49 39.2% Missed more than 10 26 20.8% Missed more than 15 7 5.6%



Each course had the same basic set of requirements. There were three regular exams. The first exam covered the accounting process (e.g., recording transactions, adjusting and closing entries), financial statements, and merchandising operations. The second exam covered asset-related topics, such as accounting for uncollectible receivables, inventory methods, and depreciation. The third exam covered debt and equity topics, including payroll accounting, present value concepts and bonds, and corporate accounting for stocks, dividends, and treasury stock. The final exam was comprehensive and covered all of the material addressed in the course. Quizzes were given periodically, with at least ten quizzes given in each course. Students were required to turn in homework assignments at the beginning of each class period and homework was due on virtually every class day except the day of exams. Homework was not graded for accuracy but was graded for effort and completion. The students were not awarded points for completing homework but were penalized on each applicable exam grade for unsatisfactory homework effort. Students were permitted to miss one assignment per unit exam without penalty. After that, each unsatisfactory assignment or missing assignment resulted in a one-point deduction from the applicable exam grade. The impact of this penalty has been removed from the exam grades for purposes of this research study.

RESEARCH RESULTS AND DISCUSSION For purposes of analyzing the data, students were divided into groups dependent upon the level of homework effort exhibited, measured by the number of assignments missed, and compared with the remaining students. With respect to the first research question, the results of the analysis provide evidence that homework effort has a positive impact on individual exam performance. Students who missed one or fewer homework assignments performed significantly better on the first exam (p < .001), the second exam (p = .09) and the third exam (p = .02). This is consistent with the inference that students who exert greater homework effort are more prepared for the exams. The additional homework preparation should lead the student to understand the material more fully during the class lectures and provide a consistent building of the thought and learning process. Three comparisons were made to investigate the impact of homework effort on quiz performance for the second research question. Comparisons were made at various levels of homework effort, including comparisons of students who missed two or fewer assignments, four or fewer assignments, and nine or fewer assignments. In every case, homework effort had a strong positive effect on quiz performance (p < .001) in all comparisons that were made. Even for those students who missed a fairly significant number of homework assignments (e.g., 7), quiz performance was significantly higher for students who exerted more homework effort. Generally speaking, quizzes are given to entice the student to prepare on a daily basis and be prepared for the class lecture. Homework effort is a considerable contributor to the student’s daily preparation. The results of the research did not reveal a statistically significant positive relationship between homework effort and final exam performance for the third research question. Comparisons were made for students who missed two or less (p = .64), four or less (p = .12), and nine or less (p = .21) homework assignments and none of the comparisons revealed a statistically significant positive relationship. These results were discouraging but there could be some underlying reasons for the results. The policy was implemented in each of the four sections that a student could substitute the final exam score for the lowest exam grade. This policy could have influenced the results of this analysis. First, those students who did not exert as much homework effort and scored lower on one or more of the individual exams may have been required to put forth considerable more study time for the final exam in order to get this substitution. Second, there may be some reason to believe that students who are fairly “set” in their grade for the course may not prepare as hard for the final exam. For example, a student with an 85 average in the class would likely have to score very high on the final to raise the average to the next letter grade but can likely score fairly low and maintain the current letter grade average. In this case, students may not be motivated to study as hard for the final exam and, instead, concentrate on finals which can “make a difference.” It seems possible that many of the students who prepared throughout the term by exerting strong homework effort may fall into this category. Regardless, the results do not provide evidence of a positive impact of homework effort on final exam performance.



For the fourth research question, the research results provide evidence of a statistically significant positive relationship between homework effort and overall student performance. Again, several comparisons were made. Students who missed two or less homework assignments (p = .04), four or less assignments (p < .001), and nine or less assignments (p < .001) had significantly higher overall grades than those students who did not exert equivalent levels of effort. The previous effort extended by the student resulted in better performance on individual exams and quizzes that should and will influence the overall grade in the course. However, for the student’s benefit, the overall grade in the course is influenced by the extent of effort. Students who exert even some effort (e.g., missing 8 or 9 assignments) will perform better overall than students who miss more assignments. This could provide the instructor with some evidence to use in motivating the student to increase their level of effort, even if the student starts off with less attention and effort than others do. Exhibit 2 provides a summary of the research results.

EXHIBIT 2: RESULTS OF ANALYSIS

Comparison of Individual Exam Performance

Number of Assignments Missed Count Mean Std Dev t-statistic p-value Exam 1: 1 or less 88 81.4 10.86 2 or more 37 72.7 13.03 3.56 *** <.001 Exam 2: 1 or less 60 76.6 13.07 2 or more 65 73.7 11.55 1.32 * .09 Exam 3: 1 or less 61 74.1 13.14 2 or more 64 69.0 14.63 2.06 ** .02

Comparison of Quiz Performance

Number of Assignments Missed Count Mean Std Dev t-statistic p-value Comparison 1: 2 or less 41 86.9 8.19 3 or more 84 74 14.46 6.39 *** <.001 Comparison 2: 4 or less 62 85.2 8.88 5 or more 63 71.5 15.02 6.22 *** <.001 Comparison 3: 9 or less 96 83 9.66 10 or more 29 62.6 15.3 6.76 *** <.001

Comparison of Final Exam Performance

Number of Assignments Missed Count Mean Std Dev t-statistic p-value Comparison 1: 2 or less 41 77.4 51.33 3 or more 84 78.3 10.30 -2.37 .64 Comparison 2: 4 or less 62 79.2 12.09 5 or more 63 76.8 10.58 1.16 .12 Comparison 3: 9 or less 96 78.4 11.58 10 or more 29 76.6 10.71 .799 .21

Comparison of Final Grade Performance

Number of Assignments Missed Count Mean Std Dev t-statistic p-value



Comparison 1: 2 or less 41 81.5 10.07 3 or more 84 78.2 9.55 1.75 ** .04 Comparison 2: 4 or less 62 81.9 9.21 5 or more 63 76.5 9.69 3.22 *** <.001 Comparison 3: 9 or less 96 80.7 9.49 10 or more 29 74.4 9.43 3.14 *** <.001 * Significant at the .10 level ** Significant at the .05 level *** Significant at the .01 level

CONCLUDING COMMENTS This research has shown that homework effort has a significantly positive impact on the individual exam performance, quiz performance, and overall performance in the introductory financial accounting course. These results should provide instructors of the course with evidence that can be used to express the importance of homework effort in ensuring higher performance in the course. This may also lend some support to requiring students in these courses to turn in homework rather than merely suggesting homework problems for completion. More research in the area should be pursued. The lack of significance in the extent of homework effort and the resulting performance on the final exam may be a particularly interesting area of future research. One inference may be made that homework effort influences short-term preparation and does not necessarily result in better retention of material. Differences in student classification (e.g., freshman versus sophomore) or in learning style of the student may influence the importance of homework effort to performance. Additionally, differences may exist in the importance of homework as a result of the level of accounting learning (e.g., introductory versus advanced) or the type of learning (e.g., a technically-oriented intermediate accounting versus conceptually-oriented auditing course). In either case, the results of this research suggest that the importance of homework effort on student performance should be further investigated. Students would be the ultimate benefactors of the additional research.



REFERENCES Doran, Bouillon, & Smith (1991). “Determinants of Student Performance in Accounting Principles I and

II.” Issues in Accounting Education, Spring 1991, 74 – 84. Eskew and Faley (1988). “Some Determinants of Student Performance in the First College-Level Financial

Accounting Course.” The Accounting Review, January 1988, 137 – 147. Fad and Ryser (1993). “Social/behavioral Variables Related to Success in General Education.” Remedial

and Special Education, 1993, 25 – 35. Ibrahim (1989). “Effort-Expectations and Academic Performance in Managerial Cost Accounting.”

Journal of Accounting Education, 1989, 57 – 68. Wooten (1998). “Factors Influencing Student Learning in Introductory Accounting Classes: A Comparison

of Traditional and Nontraditional Students.” Issues in Accounting Education, May 1998, 357 – 373.



STUDENT PERCEPTIONS OF THE IMPORTANCE OF ORAL COMMUNICATION IN THE

ACCOUNTING PROFESSION

Ameen, Elsie Sam Houston State University

[email protected]

Chow, Simeon Audits and Surveys Worldwide

[email protected]

Jackson, Cynthia Northeastern University

[email protected]

ABSTRACT

A survey was administered to students enrolled in introductory accounting classes at six universities to measure their perceptions of the oral communication requirements for the accounting profession. The results indicate that students perceive accounting as a profession with very little oral communications requirements.

INTRODUCTION “Researchers have hypothesized that individuals choose occupations based partly on society’s

stereotypical representation of that career” (Cory 1992, 2). Society’s stereotype for accountants is that they are number-crunchers devoid of personality (Sundem 1994). Therefore, students may choose to major in accounting because of the mistaken belief that it deals only with numbers. Students do not perceive oral communication as a part of the skill set for accountants.

However, the accounting profession has changed dramatically in the last decade. Oral communication skills have become much more important for success in the accounting profession. Lau and Rans (1993) found that communication is ranked as one of the most important skills for success in accounting. A "knowledge of accounting is of little use if a person cannot communication effectively" (Stanga and Ladd 1990, 180).

In 1975, Daly and McCroskey assessed student perceptions of various careers. They found that accounting was perceived as an occupation with low oral communication requirements. Their study is almost 25 years old. The subjects were not business majors. Therefore, the purpose of this study is to determine whether students still perceive accounting as a profession with little oral communication requirements; especially, given the emphasis now placed on communication skills in the accounting profession and in many university accounting curricula.

RESEARCH METHODS

A survey, which was administered to students enrolled in introductory accounting classes at six universities, was used to obtain the data for this study. Students completed the survey voluntarily and anonymously. They were asked to indicate the amount of oral communication required by each of 25 occupations using a 7-point Likert scale (1 = requires almost no oral communication; 7 = requires a great deal of oral communication). A total of 735 usable surveys were completed.



RESULTS

Student’s perceptions of the communication requirements for various professions are ranked

ordered by mean rating in Table 1 below. Accountants were ranked just above systems analysts and well below stockbrokers. As shown, the perceived communication demands for accountants are in the lower quartile of our professional list.

Table 1: Ranking Order of Professions

Professions Orderr

Mean

t-test

(p value)

Farmer/rancher 1 2.76 .21 Artist 2 2.84 .00

Computer programmer 3 3.04 .00 Tax return preparer 4 3.67 .11

Systems analyst 5 3.79 .88 Accountant 6 3.79 .00 Stock broker 7 5.02 .04

Bank loan officer 9 5.16 .14 FBI agent 9 5.25 .31

Nurse 10 5.32 .83 Buyer for retail store 11 5.33 .30

Police Officer 12 5.39 .02 Management trainee 13 5.54 .21

Advertising 14 5.63 .30 Physician 15 5.68 .00 Human

resources/personnel 16 5.87 .17

Industrial negotiator 17 5.97 .39 Social worker 18 6.03 .00

Psychologist/psychiatrist 19 6.19 .01 Salesperson 20 6.34 .72

Public school teacher 21 6.36 .80 Professor 22 6.37 .78

Trial attorney 23 6.39 .08 TV newscaster 24 6.46 .13

Politician 25 6.52 Valid N (listwise) 668

Because each student rated each profession, a pair-wise t-test between adjacent ranked profession categories was performed. That is, we tested whether the mean rating of profession with rank order i was significantly lower than the mean rating of profession with rank order i+1. We see that students rated the communication demands of accountants significantly lower than that of a stockbroker and, of course, all occupations listed below stockbroker in Table 1.

We next test whether perceptions of communication requirements are a function of factors associated with the respondent. That is, do certain types of respondents have different perceptions? Because major is selected by the respondent, we treat that factor as fixed and the gender and class of the respondent as random. Further, we dichotomize the major into whether the respondent chose accounting or not. Therefore, we consider a three-factor model where factors GENDER and CLASS have random factor levels while factor MAJOR has fixed factor levels. The mixed ANOVA model is: Yijkm = � … + MAJORi + GENDERj + CLASSk + (MAJOR x GENDER)ij +

(MAJOR x CLASS)ik + (GENDER x CLASS)jk +



(MAJOR x GENDER x CLASS)ijk + � ijkm

Table 2 presents the ANOVA table for the above random three-factor model.

Table 2: Tests of Between-Subjects E Table 2: ANOVA Table Dependent Variable: Accountant

Source Type IV Sum of Squares

Degrees of freedom

Mean Square

F

Signifi- cance

Hypothesis 4.593E-02 1 4.593E-02 .009 .935 MAJOR Error 6.623 1.358 4.878 Hypothesis 5.839 1 5.839 6.925 .931 GENDER Error 1.677E-02 1.989E-02 .843 Hypothesis 6.899 3 2.300 .262 .858 CLASS Error 6.813 .775 8.793 Hypothesis 1.930 1 1.930 .741 .547 MAJOR *

GENDER Error 2.603 1 2.603 Hypothesis 17.767 3 5.922 2.288 .390 MAJOR *

CLASS Error 3.438 1.328 2.589 Hypothesis 2.960 3 .987 .343 .912 GENDER *

CLASS Error .278 9.667E-02 2.876 Hypothesis 2.603 1 2.603 1.043 .308 MAJOR *

GENDER * CLASS

Error 1635.390 655 2.497

As noted by the F-statistic for all main effects and interactions, there is no significant factor effect evident. That is, students’ perceptions of the communication requirements for accountants are not dependent on major chosen, gender, or year in school.

IMPLICATIONS AND CONCLUSIONS

Much attention has been given to the importance of oral communication in the accounting profession recently. Many universities now require accounting students to complete a public speaking course and many teach business communications classes. These measures are designed to enhance the skills of those students who have already declared accounting as a major. However, these results suggest that these measures are not significantly impacting students’ perceptions of the oral communication requirements for the accounting profession. It appears that more emphasis needs to be placed on changing the stereotypical representation of the accounting profession in the academic environment and ultimately in society in general. Perhaps, we need to focus on presenting accounting as the communication of financial information. Accounting educators in introductory classes need to be encouraged to emphasize the importance of oral communication to the accounting profession. Understanding the role of communication in the accounting profession will allow students to make more informed decisions about their majors earlier in their college careers. The earlier this decision is made, the less likely students will experience the “sunk cost” feeling; the feeling that they have invested too much time to change their majors.



REFERENCES Cory, S.N. (1992). “Quality and Quantity of Accounting Students and The Stereotypical Accountant: Is There a Relationship?” Journal of Accounting Education, Volume Ten, 1-24. Daly, J. A. and J. C. McCroskey (1975). “Occupational Desirability and Choice as a Function of Communication Apprehension.” Journal of Counseling Psychology, Volume Twenty-Two, Number Four, 309-313. Lau, R. and D. L. Rans (1993). “They Can Add But Can They Communicate?” Business Forum, Summer, 24-26. Stanga, K. G. and R. T. Ladd (1990). “Oral Communication Apprehension in Beginning Accounting Majors: An Exploratory Study.” Issues in Accounting Education, Fall, 180-194. Sundem, G. (1994). “Scholarship in Four Dimensions.” CA Magazine, April, 39-44.



STUDENT PERCEPTIONS ON THE IMPORTANCE OF COURSE SYLLABII

Rubenfield, Allen J.

Clark Atlanta University

Nagle, Brian H. Duquesne University

Pandit, Ganesh M.

Clark Atlanta University

ABSTRACT

The topic under examination in this paper is the perception of students regarding faculty syllabi. The motivation for the study is the result of the different perspectives that faculty have about the importance of their syllabus and the purpose that it serves. The study seeks to obtain the input of students who use the syllabus. We measure their perceptions about different aspects of the typical syllabus and the students’ overall expectations of its utility. The authors believe that this study may enhance the syllabus construction process by identifying student needs with respect to the syllabus. The study uses a questionnaire wherein the students are asked to indicate the importance of several dimensions of a syllabus on a scale ranging from 1 (not very important) to 5 (very important). The students were also asked to rank these dimensions relative to each other on a scale from 1 (least important) to 7 (very important). Further, the questionnaire looked at the differences in perceptions of graduate and undergraduate students.

INTRODUCTION

In recent years, researchers and educators have continued to struggle with the issue of what one can do to improve education at all levels. In higher education, many aspects of the relationship among administrators, faculty and students have been discussed. Educators have argued vehemently over such things as resources needed, tight or loose academic standards, remedial education, and the responsibility for the quality (or the lack of quality) of education. In the confines of the higher education itself, research has looked at what can be done to improve the relationship among the many groups involved and enhance the students’ educational experience. One such issue dealing specifically with the faculty-student relationship is the significance of the course syllabus, which is what we examine in the current research. Much has been written about the importance of syllabus, its content and its purpose. Many institutions hold faculty seminars on the syllabus, establish minimum requirements of what goes into a syllabus and even publish guidelines for their faculty members to follow. On the one hand, it is argued that a syllabus is a formal contract between the faculty member and the student; therefore it should be written in great detail. On the other hand, it is argued that a syllabus is just a set of flexible guidelines to start a course out and give it some direction. Faculty syllabi seem to show different forms. For example, there is a one-page format that is practically devoid of any information other than the faculty member’s office phone number, address and office hours. There are also very elaborate documents that contain minute details about every aspect of the course, thus making the syllabus longer than some textbooks.

The authors seek to study the perceptions and opinions of students regarding what a syllabus should be and what they expect to get out of it. The objectives of this research are to identify (1) the sections in the syllabus that students find the most or least important and (2) whether differences exist between graduate and undergraduate students as to their perceptions of the importance of the syllabus.



While the study is limited in scope, we hope that the insights provided by the study will enhance the construction of the syllabus and improve its utility as an educational tool.

MOTIVATION FOR THE STUDY

The motivation for this study was the result of the different perspectives among faculty members as to the importance of a course syllabus and the purpose that it serves. On one end of the spectrum are faculty members who view the syllabus as a contract between them and the student. On the other end are faculty members who view the syllabus as a document to be handed out to the students on the first day of class. With the accreditation environment that permeates higher education today, documentation of our course structure has become a critical issue. The implicit assumption is that the syllabus contains at least a minimum amount of important information regarding a course and consequently, many institutions have adopted specific guidelines regarding the syllabus content.

These guidelines have been established largely by college and university administrators, often with little or no input from the parties most involved in using the syllabus, namely, faculty and students. This is ironic given the fact that the students are the ones who are expected to receive any benefits that may accrue from the syllabus. Therefore, the current study seeks to obtain the input of the students who will be using the syllabus by measuring their perceptions about different aspects of a course syllabus and their expectations about its overall utility. The authors believe that the current study may enhance the syllabus construction process by identifying students’ perceived needs with respect to the syllabus.

METHODOLOGY

This study used a questionnaire to obtain the students’ responses as to their perceptions about the usefulness of course syllabi received by them. The students were asked to indicate the importance of several dimensions of the syllabus as shown in Figure 1. The scale ranged from 1 (not important) to 5 (very important). Further, the students were also asked to rank these same dimensions relative to each other, with 1 being the least important and 7 being the most important. The dimensions chosen for the study were those that were expected to have he greatest impact upon the students. In addition to the perceived importance of various dimensions of the syllabus, the students were asked to provide information on other items of interest that have been listed in Figure 2. The questionnaire was administered to one hundred and forty undergraduate and graduate students of business. Results of the survey are presented in the following paragraphs.

Figure 1

Perceived Importance of Syllabi Contents

List of Assignments and Due Dates

Grade Determination and Grading Scale

Office Hours

List of Course Topics

Course Objectives

Teacher's Statement of Student Expectations

Statement of Academic Dishonesty Policy

Figure 2

Students' Perceptions of Other Aspects of the Course Syllabi



Flexibility built into the syllabus

Frequency of referring to syllabus during the semester

Thoroughness with which the syllabus is read at the beginning of the semester

Perceived importance of the syllabus in communicating teacher expectations

Likelihood of referring to the syllabus regarding an administrative matter in the course

Availability of the syllabus at the first class session

Perceived importance of strict adherence to the syllabus

DESCRIPTIONS OF THE DATA AND FINDINGS

Tables 1 and 2 display a summary of the responses obtained from both undergraduate and graduate students. Based on the results of the survey, the following preliminary conclusions can be drawn with regard to the syllabus content and the related issues. As seen in Table 1, in general, the graduate students attached a somewhat higher level of importance to all the factors with the exception of office hours. Both groups of students noted that a listing of assignments and their due dates was the most essential piece of information in the syllabus. This was not surprising especially for the graduate students who like to and often need to plan their work ahead of time. The second most important factor for both sets of students was the grade determination and grading scale. Obviously, grades were important to the students since grades indicate the relative performance and achievement level of each student. Among the other factors, the undergraduate students gave high importance to office hours, an indicator of accessibility to the instructor and list of course topics.

The greatest disparities between the graduate and undergraduate students were in the importance of knowing the course objectives and the faculty expectations of the students. The former group of students placed a higher importance on these two dimensions when compared to the latter group. One possible explanation for this finding may be that graduate students are often older, more mature and working. Therefore, they may prefer to know, in advance, what is required of them. This perhaps highlights the desire on the part of the graduate students to be overachievers.

Table 1

Perceived Importance of Syllabi Contents

Undergraduate Graduate

List of Assignments and Due Dates 4.696 4.725

Grade Determination and Grading Scale 4.343 4.425

Office Hours 3.970 3.750

List of Course Topics 3.765 3.850

Course Objectives 3.480 3.950

Teacher's Statement of Student Expectations 3.471 4.150

Statement of Academic Dishonesty Policy 2.049 2.375



The statement relating to policy regarding academic dishonesty rated very low in importance among both undergraduate and graduate students. Apparently, most students considered themselves academically honest and did not need to be reminded of any policy statement regarding academic honesty, or they were going to simply disregard the statement on the syllabus as being inconsequential. As more and more colleges and universities require statements relating to cheating on their syllabi, it appears that from the student’s perspective, such statements have little or no impact. Table 2 shows the responses of the students on certain other items of interest with respect to the course syllabi. Among these items, flexibility built into the syllabus was the most important factor for the undergraduates. The graduate students gave relatively less importance to this factor. One possible reason for this finding may be that undergraduate students take a much larger course-load as compared to the graduate students and remain occupied constantly with the multiple assignments and tests from different courses. Hence, they may prefer to have some leeway with respect to how each course is handled by the respective instructors. As opposed to that, graduate students are frequently working students who may prefer rigid adherence to the syllabus so that any changes in the syllabus may not affect their day-to-day schedules. This is further supported by the finding that when compared with the undergraduate students, the graduate students in the sample gave higher importance to strict adherence to syllabus. Also, they indicated a greater likelihood of referring to the syllabus regarding an administrative matter in the course.

Table 2 Students' Perceptions of Other Aspects of the Course Syllabi

Undergraduate Graduate

Flexibility built into the syllabus 4.408 4.000

Frequency of referring to syllabus during the semester 4.255 4.500

Thoroughness with which the syllabus is read at the beginning of the semester

4.108 4.425

Perceived importance of the syllabus in communicating teacher expectations

4.088 4.500

Likelihood of referring to the syllabus regarding an administrative matter in the course

3.990 4.175

Availability of the syllabus at the first class session 3.980 3.925

Perceived importance of strict adherence to the syllabus 3.363 3.475

The graduate students in the sample seemed to read the syllabus more thoroughly and referred to it more frequently throughout the term than the undergraduates do. Also, they placed much greater importance on the role of the syllabus in communicating the teacher’s expectations to students. This may be because the graduate students are required to prove their academic abilities in a variety of ways that include tests, research papers and presentations. Therefore, they may find it necessary to know, at all times, what is expected of them at various points during the semester. Both groups of students attached equally high importance to the availability of the syllabi for the first class session.

CONCLUDING REMARKS The research described in this paper is very limited and preliminary with respect to students’ perceptions of the course syllabus. The authors hope that the investigation into the design of a syllabus is only the beginning of a lengthy research process. The survey instrument can be improved by adding more factors, and the survey can be greatly expanded to include students from non-business background as well as students from different institutions with varying sizes. While the syllabus may be very important to the interested parties, it must go beyond being just a document if one is going to reach the students and enhance their educational experience at least in the



classroom. The syllabus must communicate something about the faculty. It must assist the faculty members in making a first impression and catching the students’ interest. The syllabus definitely has to be tailored to fit the students’ needs; but the faculty member plays an important role in making the syllabus more useful to the students by designing it thoughtfully.



GOING ON SABBATICAL?: RECENT CHANGES IN THE FOREIGN EARNED INCOME EXCLUSION

FOR U.S. CITIZENS LIVING ABROAD

Blythe, Stephen American University of Sharjah, United Arab Emirates

[email protected]

ABSTRACT

Income earned abroad by U. S. citizens may be excluded from American federal income tax pursuant to Internal Revenue Code Sect. 911. Accordingly, the professor on sabbatical may qualify if he can establish a tax home in the foreign country and can satisfy either the physical presence test or the bona fide residence test. For foreign income earned in 1999, the amount of the exclusion is $74,000; however, the exclusion will be increased to $80,000 for 2002 and thereafter.

THE FOREIGN EARNED INCOME EXCLUSION The Foreign Earned Income Exclusion (“FEIE”) benefits qualifying U.S. citizens earning income in foreign countries by excluding the first $74,000 of such income from American federal income tax. The exclusion will increase to $76,000 in 2000, to $78,000 in 2001, and to $80,000 for years 2002 and beyond. (IRC, 1996) If housing is provided to the foreign-based U.S. employee, part of the value of such housing may also be excluded from taxation. (Lee, 1997)

JUSTIFICATION OF THE FOREIGN EARNED INCOME EXCLUSION The FEIE is codified in the Internal Revenue Code, Sect. 26 (United States Code, Title 26, Sect. 911). (IRC, 1996) In 1996, the Clinton Administration attempted to repeal the FEIE, but failed. (Fischer, 1996) In response to the recommendation to Congress to repeal the exclusion, Congress was inundated with an unusually strong lobbying effort by international business firms to keep the FEIE. (Hughes, 1996) One of the most vocal groups called themselves the “Section 911 Coalition”; their motto was “Americans Abroad = U.S. Exports = U.S. Jobs.” They cited facts to Congress which were impressive, e.g., that nearly 40 percent of America’s Gross Domestic Product results from exports of goods and services. They cited U.S. Dept. of Commerce statistics that every $1 billion in U.S. exports creates or sustains 17,000 man-years of direct domestic employment; the U.S. exported $701.2 billion worth of goods and services in 1994, which translates into nearly 12 million American jobs. They also presented data substantiating that a correlation exists between the number of Americans working overseas and the level of U.S. exports. (Id.) Other justifications include: U.S. business is made more competitive because it is able to more easily recruit employees for overseas positions, since the employees will have a financial incentive to work abroad to cut their tax liability, if the foreign country has an income tax rate less than that of America; U.S. overseas investment and foreign trade is thereby increased; the more Americans working abroad, the less the U.S. trade deficit will be; it helps to overcome the unfair economic hardship of American employees who may be forced to move overseas, often into areas with a lesser quality of life and with a high cost of living; and, exports are promoted because American firms are able to place their salespersons into the field where foreign markets are.(Papahronis, 1982)



HISTORY OF THE FOREIGN EARNED INCOME EXCLUSION The FEIE was first enacted by Congress in 1926. The statute excluded all foreign earned income for any citizen residing outside the United for more than six months from U.S. federal income tax. At the time, the exclusion was criticized as an unnecessary benefit to expatriate Americans who were already protected from double taxation by the foreign tax credit. However, Senator Reed, a proponent of the legislation, defended the FEIE by stating that it would help our foreign trade and would place all Americans working abroad in a position of equality. (Evans, 1997) Since 1932, the FEIE has not applied if the income emanates from theU.S. government or an agency of the U.S. government. Therefore, foreign service officers and related government employees will not receive the benefit of this exclusion; the rationale seems to be that these individuals do not need an incentive to go abroad to work because such assignments are naturally to be expected in the course of their employment. The FEIE was incorporated intact into the Internal Revenue Code of 1954, but was redesignated as Sect. 911 for the first time. Those alleging that all of their overseas income was excludable were still required to file a return. (Sobel, 1985) In the 1960’s, the Kennedy Administration proposed that the FEIE be limited to those Americans working in lesser developed countries. However, the House Ways and Means Committee did not adopt this distinction. Accordingly, the exclusion continued to apply to all foreign earned income, regardless of the degree of economic development of the foreign nation. (Sobel, 1985) However, the Committee modified the law to deny the FEIE to any taxpayer who earned income from sources within the foreign country of residence, filed a statement with the authorities of that foreign country contending that he was a nonresident, and asserting that he was not subject to income tax as a resident of that country; thus, the U.S. citizen who would attempt to qualify for the benefits of the FEIE “cannot have it both ways,” i.e., cannot attempt to avoid foreign taxes by denying foreign residency, while at the same time attempting to enjoy the FEIE by claiming foreign residency. (Sobel, 1985) Over the years, many attempts have been made to repeal the FEIE, but Congress seems to always return to the rationale that the exclusion is necessary for the promotion of foreign trade and to serve as an incentive for Americans to work abroad. (Kurlander, 1983)

QUALIFYING FOR THE FOREIGN EARNED INCOME EXCLUSION To qualify for the FEIE, the professor working in a foreign country will have two primary requirements:

1. He/she must establish a foreign tax home. The term “tax home” means, with respect to any individual, such individual’s home for purposes of determination of traveling expenses while away from home. An individual shall not be treated as having a tax home in a foreign country for any period in which he/she has an abode within the United States. (IRC, 1996)

2. He/she must pass the physical presence test or the bona fide resident test. a. The “physical presence” test requires that the American professor must have,

during any period of 12 consecutive months, been present in a foreign country or countries during at least 330 full days in such period. (IRC, 1996) To comply with this test, the professor on a one-academic-year sabbatical (i.e., nine calendar months) may want to arrive at his foreign destination early in order to be present there for at least 330 days.

b. The “bona fide resident” test requires that he/she must have become a legal resident of the foreign country. Attainment of bona fide resident status offers the very convenient advantage of being able to travel to and from the U.S. without having to worry about the number of days one is abroad, as in the physical presence test. However, the person must be able to demonstate that he/she went abroad with the intention of becoming a legal resident of the foreign country. (Henry, 1983) Furthermore, he/she should be able to present to the Internal Revenue Service documentation (e.g., his/her passport containing a residency visa issued by the foreign country, or a residency card issued by the foreign country) substantiating attainment of foreign-residency status.



CRITIQUE OF THE FOREIGN EARNED INCOME EXCLUSION Through the years, advocates of tax reform have often criticized the FEIE as an unnecessary windfall to American expatriates. (e.g., Papahronis, 1982; Sobel, 1985; Peroni, 1997; Shay & Summers, 1997) The U. S. Treasury loses billions of dollars each year due to the FEIE. (Papahronis, 1982) No reputable study has definitively proven that the FEIE serves as an incentive to lure Americans to foreign jobs, or to keep them there once they assume them. (Sobel, 1985) Another criticism is that the FEIE will not offer any financial incentive in the first place, unless the country the person is working in happens to have an income tax rate that is lower than that of the United States. Many countries of the world have income taxes; in those countries, therefore, the presence of an income tax will dilute the tax savings that will otherwise occur. A country like the United Arab Emirates, with a zero income tax rate, is indeed exceptional. If most countries had tax rates as low as the United Arab Emirates, the overall impact of the FEIE would be far greater than it is. (Evans, 1997) Another criticism is that the FEIE distorts the marketplace by luring labor into foreign tax-havens in order to take full advantage of the tax savings. (Sobel, 1985)

CONCLUSIONS

Many Americans, including professors, seem to be unaware of the impressive financial incentive offered by the FEIE if they are interested in foreign employment. In order to take advantage of this financial incentive to the maximum possible extent, the professor considering an overseas sabbatical should look for a position in a country with a low income tax rate; of course, an even better decision would be to locate in a nation with no income tax whatsoever, e.g., the United Arab Emirates. A fundamental requirement is that the person claiming the FEIE show that his tax home is in a foreign country. Additionally, the professor must pass either the physical presence test or the bona fide resident test. The professor on a one-year sabbatical, in order to qualify under the physical presence test, should plan to be in the foreign country for at least 330 full days; this might mean going abroad early in order to have the requisite number of days. Alternatively, the professor can become a bona fide resident of the foreign country; evidence of bona fide residency would be a foreign resident visa, or perhaps a foreign resident card. Once qualified, the professor can exclude up to $74,000 of his foreign earned income in the calendar year 1999. The exclusion will increase to $76,000 in 2000, to $78,000 in 2001, and to $80,000 in years 2002 and thereafter.



REFERENCES

Evans (1997). “The Foreign Earned Income Exclusion: Policy and Enforcement.” Virginia Journal of International Law, Volume Thirty-Seven, Summer 1997, 891-917. Fischer (1996). “Tax Reform and 911.” Fischer Report, August 1, 1996. Henry (1983). “Visit Abroad, Professor, and Pay No Income Tax.” University of Cincinnati Law Review, Volume Fifty-Two, 1983, 700-759. Hughes (1996). “U.S. Ditches Plan to Abolish Tax Breaks.” South China Morning Post, March 20, 1996. IRC (“Internal Revenue Code”) (1996). United States Code, Volume 26, 1996. Kurlander (1983). “The Foreign Earned Income Exclusion: Redefining the Exception For Amounts

Paid by the United States under I.R.C. Sect. 911.” Cornell Law Review, Volume Sixty-Eight, 1983, 592-616. Lee (1997). “Will the Renunciation of U.S. Citizenship Still Be Worth Some Tax Savings?: An

Analysis of the Recent Reform on the Taxation of Expatriates.” Santa Clara Law Review, Volume Thirty-Seven, 1997, 1063-1072. Papahronis (1982). “Taxation of Americans Abroad Under the ERTA: An Unnecessary Windfall.”

Journal of International Law and Business, Volume Four, Autumn 1982, 586-600.

Peroni (1997). “Back to the Future: A Path to Progressive Reform of the U.S. International Income Tax Rules.” University of Miami Law Review, Volume Fifty-One, July 1997, 975-1010. Shay & Summers (1997). “Selected International Aspects of Fundamental Tax Reform Proposals.” University of Miami Law Review, Volume Fifty-One, July 1997, 1029-1073. Sobel (1985). “United States Taxation of Its Citizens Abroad: Incentive or Equity.” Vanderbilt Law Review, Volume Thirty-Eight, January 1985, 101-160.



THE ADOPTION TAX CREDIT AND EXCLUSION: POLICY CONSIDERATIONS AND BEHAVIORAL

IMPLICATIONS

Smith, Sheldon R. Brigham Young University-Hawaii

[email protected]

ABSTRACT This paper reviews the adoption tax credit and exclusion that exist under current U.S. federal tax law. Some of the ironies, complications, or frustrating situations that can occur from these tax laws are reviewed. Tax policy suggestions are given and possible behavioral implications are discussed.

INTRODUCTION In 1996, legislation was enacted which allows for a tax credit for adoption expenses incurred by a taxpayer and also allows for an exclusion from gross income for individuals who have adoption expenses paid or reimbursed through an employer adoption assistance program. One can easily imagine some of the arguments for and against this type of legislation. Supporters of the legislation might cite the social benefits of getting children out of foster care situations into permanent families that will provide stable, supportive environments. They might cite financial benefits to the government and taxpayers as welfare and foster care costs decrease with respect to adoptable children. They might cite political agendas making it wise to enact such legislation. Opponents might argue that adoption agency and legal fees will simply rise, taking away the tax benefit from the individuals who are adopting and giving these benefits to adoption agencies and lawyers. They might also argue that these tax benefits, if given to individual taxpayers, are just a windfall for many of them who might have adopted even without the tax assistance. While the contending arguments are important and should receive further attention and research, this paper does not address those issues. Instead, it addresses some policy issues relating to the ironies, complications, and difficulties that arise from the current law. Rather than prescribing specific policy, this paper outlines a set of principles that should be considered in future legislation. Some specific policy options are presented, but these are given for consideration, not as recommendations. Since tax policy has behavioral implications, some of the implications of these suggestions will also be discussed. Because both the credit and the exclusion are temporary measures (expiring after 2001), the policy considerations mentioned here deserve attention before future legislation is enacted which might extend these provisions. Although the remainder of the paper is written from a standpoint of changes that could be considered in future legislative policy relating to tax benefits for adoption, the over-riding discussion of whether adoption tax benefits are appropriate is not discussed. The next section of the paper gives an overview of the adoption tax credit and exclusion. It also summarizes some of the ironies, complications, and frustrating situations which can result from the current law relating to the credit and exclusion. It is followed by a section on tax policy issues and a conclusion.

ADOPTION TAX CREDIT AND EXCLUSION

The adoption tax credit allows an adoptive taxpayer a credit against taxes of up to $5,000 ($6,000 for adoption of a child with special needs) for expenses incurred in an adoption effort. The exclusion allows a taxpayer to exclude from gross income up to $5,000 ($6,000 for an adoption of a child with special needs) of amounts paid or reimbursed by an employer for an employee’s adoption costs under an adoption assistance program (IRS 1997, 1998).



The law defines what expenses qualify for the credit or exclusion, defines what constitutes an eligible child and a child with special needs, defines what criteria must be met for an employer’s adoption assistance program, and provides for some limits on both the credit and the exclusion. Both the credit and the exclusion have the $5,000 dollar limit already mentioned. Both also have an income limit–the credit and/or the exclusion are phased out for taxpayers with modified adjusted gross income (modified AGI) between $75,000 and $115,000. In addition, the credit has a limit based on an individual’s tax liability; it is nonrefundable but can be carried forward for up to five additional years. In addition the law also defines when the credit and the exclusion can be claimed. The timing rules are different depending on whether the adoption is a domestic adoption or a foreign adoption (IRS, 1997, 1998). Because of the types and number of qualifications and limitations on the credit and the exclusion, many ironies, complications, or frustrating situations can occur. A number of these have been discussed in papers by Smith and Tew (1999a, 1999b). The first paper discusses ironies of the credit–situations where the adoption credit can end up substantially different than a taxpayer’s expectations. A summary of these ironies follows: 1. Low-income families may be unable to take full advantage of the adoption tax credit. These

families are arguably the ones that need the greatest adoption assistance. 2. Although foreign adoptions may be more expensive than domestic adoptions, foreign adoptions

can result in less adoption credit, a longer time to claim the credit, or loss of a greater portion of the credit.

3. Adoption expenses which are reimbursed by an employer are not eligible for the adoption credit. A taxpayer may request employer reimbursement only to find out later the credit would have been a better option.

4. The adoption credit is a nonrefundable credit, so it is limited by a taxpayer’s tentative minimum tax. [Legislation near the end of 1998 removed this limitation for 1998 only. Additional legislation has been proposed to eliminate the limitation for future years also, but this legislation has not yet been enacted.] This limitation gives rise to multiple ironies: a. The income limits on the adoption credit will often mean very little, because the tentative

minimum tax limitation will be more restrictive than the income limits. b. Taxpayers with larger families may either require more years to claim the full credit or

may lose more of the credit as the carryforward period expires. c. Taxpayers who adopt two children may actually be able to take advantage of less credit

than those who only adopt one child, even though they “qualify” for two credits. d. Taxpayers who qualify for a larger credit because they adopt a child with special needs

may need a longer period of time to claim the credit or may end up losing some of it. The second paper discusses some of the implications of the exclusion for employers and employees. Several possible complications arise from the exclusion or from the coordination of the exclusion and the credit: 1. Although an employer does not have to withhold amounts for federal income taxes from adoption

assistance payments, even if they may be taxable, the reimbursements are subject to social security taxes, Medicare taxes, and federal unemployment taxes. Depending on state law, the reimbursements may also be subject to state income tax withholding. Whether these other taxes will be incremental for the employer and the employee depends on the employee’s salary level.

2. The tax forms lead a taxpayer through the calculations to determine the amount of the exclusion. However, if a taxpayer does not understand the law in advance, he/she may be surprised that some of the employer reimbursement becomes taxable. In addition to an unanticipated tax liability, this situation could also lead to penalties and interest.

3. As with the credit, situations could arise where multiple adoptions could actually lead to less exclusion than one adoption.

4. The exclusion can be granted through a pre-tax spending account option, funded either by the employer or the employee. Because amounts contributed to spending accounts must be designated in a prior year, because the timing of adoptions and adoption expenses is very uncertain, and because of the use-it-or-lose-it rules of spending accounts, this method could be very risky for a taxpayer.

5. In many cases, coordinating the credit and the exclusion can be very complicated. The complication increases if the taxpayer has a modified AGI in the phase out range, if multiple adoptions are involved, or if a spending account option is used for the exclusion. In these cases,



coordination of the credit and the exclusion and advance planning would be extremely difficult or even impossible, even for a tax professional.

These ironies and complications should be considered in any future tax policy deliberations regarding tax benefits for adoption. That way, the resulting law might be easier to understand, interpret, apply, and plan for.

TAX POLICY

Tax policy depends on social, political, and economic factors. Certainly the expected effects of proposed tax policies on government revenues must be considered. Sometimes, these factors may suggest competing solutions. Compromise or tradeoffs may then be necessary to craft tax legislation. The result may not always be the simplest, easiest-to-understand, or fairest solution. Some basic guiding principles could be applied in crafting legislation for adoption tax benefits. These principles assume that the social and political factors encourage providing such benefits. The principles do not specifically take the revenue implications into account. Therefore, these implications should also be considered separately. 1. The qualifications and limitation on any of these benefits should be easy to understand and apply,

allowing for adoptive taxpayers to understand the tax implications of their decisions before they are made. Don’t include qualifications and limitations that are easily understood but allow other sections of the tax code, which are not understood, to be more restrictive.

2. Once the targeted taxpayer group is defined and the desired policy objectives are determined, craft legislation that will cause targeted taxpayers to get the maximum benefits without a lot of effort, almost by default.

3. Encourage more companies to provide adoption benefit programs. Encourage businesses to provide greater adoption benefits, thus reducing the need for government resources. Make sure there is no situation where an employee would rather have the credit than the employer reimbursement and exclusion (in cases where they might be alternatives).

4. With respect to the amount of adoption tax benefits and the timing of those benefits, make sure that taxpayers who (1) adopt children with special needs are no worse off than those who adopt children without special needs, (2) already have some children before they adopt are no worse off than those who don’t have children, and (3) adopt multiple children are no worse off than those who adopt only one.

The following paragraphs discuss these issues and provide some specific ideas which can be considered. These ideas cannot all be implemented simultaneously; some are alternatives. The group of adoptive taxpayers, in general, is not sophisticated with respect to tax laws and application. In many, if not most, cases, individual taxpayers are not well informed enough to make choices relating to the credit and the exclusion based on an informed rational choice. Under current law, learning the basic qualifications and limitations of the credit and the exclusion can even be dangerous, because the interaction of the two or interaction with other sections of the tax code can cause complicated situations that are not understood by knowing the basics. Adoptive taxpayers generally do not even understand the importance of contacting their tax preparer before these decisions are made, perhaps because the limitations are seemingly straightforward. Therefore, they don’t get the advice that might have changed their decisions. In addition, these tax benefits are targeted to a specific, small segment of the population. Therefore, tax professionals and preparers will not deal with these issues on a regular basis and may not spend the necessary time to learn about these benefits and how they are applied if the rules are too complicated. One of the major complications to the credit is the tentative minimum tax limitation on nonrefundable credits. The alternative minimum tax (AMT) was established to make sure “high-income” taxpayers don’t end up without a tax liability because of preference items. However, the exemption amount for the AMT has not been indexed, and other AMT provisions have not been changed as other, related tax laws have been changed. Therefore, the AMT can now impact middle-class taxpayers, especially the provision dealing with nonrefundable credits. This situation is magnified in scope because of several recent nonrefundable tax credits that have been legislated. Examples include the child tax credit, Hope scholarship credits, the lifetime learning credit, and the adoption tax credit. Several ways exist to eliminate or mitigate the effect of the AMT on the adoption tax credit. One would be to completely eliminate the AMT or to substantially redefine it in terms of “high-income”



taxpayers. Although the revenue impact of this elimination might be substantial, almost every exemption, deduction, or credit legislated in recent years has its own income limitation or phase out amounts. Many of these phase out ranges are meaningless for some taxpayers because of the AMT. Even if the AMT were eliminated, these phase outs could still exist at “appropriate” levels, thus reducing the tax preferences claimed by those with income levels in the phase out range or above. Another proposal that would eliminate the impact of the AMT on nonrefundable credits is to allow nonrefundable tax credits to reduce a taxpayer’s tentative minimum tax. This provision would allow a taxpayer to reduce his/her tax down to zero but not below. Legislation was passed in 1998 which accomplished this proposal, but it was effective for 1998 only. Another possibility is to make some or all of the adoption tax credit refundable. Another version of this option would be to make it refundable, limited by the amount of social security tax withheld. This would be similar to the additional child tax credit for families with three or more children. Making part or all of the credit refundable for specific groups such as low-income taxpayers, those who adopt children with special needs, those who adopt multiple children, and those who already have children before they adopt would also provide ways to make sure some of the potential ironies do not occur. The adoption tax credit gives adoptive taxpayers a dollar-for-dollar benefit. However, an employer reimbursement does not give a dollar-for-dollar benefit, even if it qualifies for the exclusion, because it is subject to social security taxes and Medicare taxes. It may also be subject to state income taxes. From the employer’s perspective, the reimbursement has a cost additional to the actual payment because of the employer’s share of any incremental social security taxes, Medicare taxes, and federal unemployment taxes. If the law were extended so that employer adoption assistance payments were not subject to social security taxes, Medicare taxes, and federal unemployment taxes (and if states were persuaded to also honor the exclusion), these reimbursements would also provide a dollar-for-dollar benefit. This way, adoptive employees would have no incentive to use the credit before using the exclusion. The exclusion could be operationalized just like the exclusion for a medical insurance payment/reimbursement. The amounts paid for an employee by his/her medical insurance would not be subject to these additional taxes. In fact, this concept has an equity argument–those who adopt won’t have insurance to pay for the costs of getting a child like many of those who bear children naturally have. Exempting adoption assistance payments from these additional taxes might encourage businesses to offer such payments or increase the amount they are willing to offer, because they would have no additional taxes nor would their employees who adopt. In addition, if the income phase out range for the exclusion were increased, businesses might be further encouraged to offer adoption assistance, because fewer employees (of those currently in or above the phase out range) would be subject to income tax on the adoption payments. In fact, perhaps the dollar limit on the exclusion could be increased to encourage more support from private business. This increase could come either with or without a phase out of the adoption credit for an adoption that received more than $5,000 of exclusion. Another possible policy change is how the exclusion is phased out for the income limitation. Currently, an employee with a modified AGI of $95,000 who gets a $2,000 adoption reimbursement from his/her employer will only be able to exclude $1,000 (one-half of the amount reimbursed because modified AGI is one-half of the way from $75,000 to $115,000). Perhaps the phase out could be based on a proportion of the total dollar amount of the possible exclusion. Under this policy, the employee with $95,000 of modified AGI and a $2,000 reimbursement would still be able to exclude the entire amount because $2,000 is less than one-half of the total dollar limit of $5,000. This particular policy would benefit those employees with modified AGI between $75,000 and $115,000 who get an employer reimbursement less than the maximum dollar amount of the exclusion. Such a policy might encourage more employers to start offering at least some adoption benefits, even if they are less than $5,000 per adoption. This policy might also be significant since many employers who do offer adoption benefits do not offer as much as $5,000 per adoption. [This policy is similar to the new rules on excluding gain on the sale of a home. If a homeowner sells a home he/she has lived in for at least two of the last five years, he/she can exclude up to $250,000 of gain on the sale of the home. If the owner has only lived in the home for one year, he can exclude up to $125,000 of gain (one-half of the total possible exclusion) rather than excluding only one-half of the calculated gain.] A similar change could be made to the income limitation for the credit. This change could cause the phase out to reduce the total possible credit rather than reducing the calculated credit. This change would benefit those in the income phase out range who have less than $5,000 of unreimbursed adoption expenses. An increase in the income limitation phase out range for the credit could also be considered.



Most of the changes mentioned in this subsection would increase the loss in government revenues, either because of actual increases in tax credits or because of more and larger exclusions on otherwise taxable income. On the other hand, relaxed rules on the exclusion might lead to better employer adoption assistance programs and more use of the exclusion, leading to less need for the credit. The government loses less in revenue by offering an exclusion than it does by offering a credit. In addition, it is possible that increased savings in welfare and foster care costs because of more adoptions might actually offset, partially if not fully, the increased loss of revenues. However, the revenue implications would need to be studied carefully before serious consideration of any of these ideas. It is likely that Congress made the adoption credit and exclusion temporary so it could re-evaluate the benefits and costs of these programs to see if extending them or making them permanent is appropriate. However, if Congress waits until the end of 2001 to consider any extensions, employers may have a difficult time adjusting their benefit packages to match the law, especially if the extensions have any significant modifications. In addition, employers that do not currently offer these benefits may decide to wait until a more permanent law is enacted. They may not want to develop company benefit policies now that might need to change in two years. Much of our tax policy is designed to encourage or discourage certain behaviors. Since the adoption tax credit and exclusion are both designed to help adoptive parents pay for adoption costs rather than to reward them for adopting, there is probably not much chance of people adopting to “make money.” However, the types and amounts of tax benefits for adoption can significantly influence taxpayers’ ability to adopt because of the high cost of many adoptions. Adoption tax benefits may influence potential adoptive parents to adopt; they may influence adoptive parents to adopt again. They may influence potential adoptive parents to consider different, more expensive adoption routes. Therefore, taxpayer behavior may certainly be influenced by any adoption tax benefits available and the specific qualifications and limitations that are attached to the benefits. Although taxpayer behavior should be considered by those who legislate adoption benefits, it is also important to remember that the focus should be on the welfare of the children who are adopted–giving them permanent homes, loving families, and happy, healthy lives.

CONCLUSION

The current law allowing an adoption tax credit and an exclusion for employer adoption assistance payments can lead to ironic, complicated, and frustrating situations. This paper has reviewed the credit and exclusion and some of the ironies and complications. Principles which could guide future legislation in this area are then enumerated. Some detailed ideas for changing the credit and/or the exclusion laws are also presented. However, they are not given as recommendations but as ideas for consideration. Some related behavioral implications are also presented. The suggestions given here generally assume that tax benefits for adoption is an appropriate policy. This paper does not deal with all of the possible arguments for and against adoption tax benefits. Since those arguments have not been enumerated here, this paper is intended to be part of that discussion rather than a definitive statement of opinion.



REFERENCES

Internal Revenue Service (1997). Notice 97-9, 1997-2, Internal Revenue Bulletin, 35-41. Internal Revenue Service (1998). Publication 968, “Tax Benefits for Adoption.” January 1998. Smith, Sheldon R. and Glade K. Tew (1999a). “Ironies of the Adoption Tax Credit.” Tax Notes, Volume

85, Number 1, October 4, 1999, 83-89. Smith, Sheldon R. and Glade K. Tew (1999b). “The Tax Exclusion for Employer Adoption Assistance

Payments: Implications for the Employer and the Employee,” Proceedings, Decision Sciences Institute Annual Meeting, forthcoming.



THE CHANGING CONCEPT OF AUDITOR

INDEPENDENCE - PAST, PRESENT, FUTURE

Kausch, Darlene Andrews University

[email protected]

ABSTRACT The purpose of this paper is to trace the evolution and development of the concept of independence as applied to auditors from the early beginnings of the accounting profession in the United States to the present time. The rules of professional conduct with regard to independence have been influenced through the years in response to public concerns about the independence of auditors. Since the present is only a strange interlude between the past and future, by projecting historical trends, it is possible to perceive the probable shape of things to come.

INTRODUCTION In October 1997, the Independence Standards Board (ISB), a new private sector standard-setting body within the accounting profession, was established to deal with issues of auditor independence. The mission of the ISB is to establish independence standards applicable to audits of public entities in order to serve the public interest and to protect and promote investors’ confidence in the securities markets (ISB, 1998b). The objectives set out in the above-quoted document are to accomplish the mission by building on the current guidelines for independence while structuring a “conceptual framework” to implement a “principles-based” independence standard. The ISB will confront several complex issues throughout the conceptual framework project. For instance, how do you define independence? Currently, there is no universally accepted official definition of the term in the profession’s authoritative literature. Rather, there is an extensive array of specific interpretations of, rulings on, independence in the Code of Professional Conduct, as well as various rules and regulations promulgated by the SEC (Securities and Exchange Commission), which could be used to develop a general definition. The ISB must address the issue of appearance of independence versus fact of independence. The rationale for the importance of the appearance of independence has been part of the official description of audit independence since at least 1963, when Statements on Auditing Procedure were codified with auditing standards. This paper will study the historical development (Table 1) and the background of both the appearance of independence and the fact of independence. This should allow an understanding of the issues faced by the ISB as it begins its work on a new conceptual framework for auditor independence.

THE EARLY YEARS - FOCUS ON FINANCIAL INTEREST (1931-1959) Despite frequent references in professional literature to the independence of auditors in certifying financial statements, the word “independence “ had not yet appeared in the Rules of Professional Conduct, nor was there any rule specifically addressed to the subject prior to the stock market crash in 1929. Independence was regarded as a state of mind and a matter of character. The word “independence”, as professional accountants came to apply it to themselves, was generally assumed to mean integrity, honesty, and objectivity. So familiar was this concept of independence within the profession that it did not seem necessary to deal with it formally in the Code of Professional Ethics. The rules on misleading statements, contingent fees, and commissions from the laity were designed to buttress independence. However the subject of relationships with clients, which might impair independence, or appear to do so, had not yet been discussed (Carey, 1969).



After the stock market crash in 1929, when public attention focused on the accounting profession more sharply than ever before, the profession began to engage in some self-examination. At the 1931 annual meeting in Philadelphia, Frederick H. Hurdman, immediate past president of the Institute of Accounting in America, introduced the following resolution:

“WHEREAS the relations between a client, in the form of a corporation, and the auditor for that corporation should be one of entire independence, and WHEREAS it does not appear to be practicable for the auditor consistently to hold a dual relationship, as an auditor and executive of the corporation, and WHEREAS the public interest and confidence will best be preserved by a complete separation of these two functions, therefore be it RESOLVED, that the maintenance of a dual relationship, as director or officer of a corporation, while acting as auditor of that corporation, is against the best interests of the

public and the profession and tends to destroy that independence of action considered essential in the relationship between client and auditor.”

After considerable debate, an amendment was proposed that the last paragraph instead read: “RESOLVED, that the maintenance of a dual relationship, as director or officer of a

corporation, is in general against the best interests of the public and profession and tends to destroy that independence of action considered essential to the relationship between client and auditor.”

However, a substitute motion was proposed and passed that the resolution be referred to the committee on professional ethics, with instructions to report back to the annual meeting in 1932. Consequently, the profession had missed a chance to take a forward step voluntarily. But the fact that the proposal was made showed that some leadership was becoming conscious of a need to preserve the appearance of independence, as well as independence in fact (1969).

A year later the Securities Acts became law, and the Federal Trade Commission (FTC) on July 6, 1933, issued regulations including the rule on independence cited earlier, covering not only joint service as auditor and officer or director, but also financial interest of an auditor in a client corporation. The Federal Trade Commission’s first regulations under the 1933 Act provided that an accountant would not be considered independent with respect to any registrant in whom he had any interest, directly or indirectly, or with whom he was connected as officer, agent, employee, prompter, underwriter, trustee, partner, director, or person performing similar functions (1969). When the Securities and Exchange Commission was formed in 1934 and assumed administration of the two Securities Acts, it apparently was persuaded that the provision with respect to financial interest was a little harsh. In regulations issued in 1936 the rule was changed to proscribe “substantial interest”, direct or indirect. Interpretation of “substantial” caused some difficulty. In Accounting Series Release No. 2, issued May 6, 1937, it was stated that an accountant could not be deemed to be independent if he held an interest in a registrant that was significant with respect to its total capital or his own personal fortune. The criterion of a “significant” or “substantial” interest was held in a test case to be more than one percent of an accountant’s personal fortune (Carey, 1970).

The SEC’s rules on independence were to be tightened even more in the years ahead (Edwards, 1960). In 1934, after the SEC had acted, the profession was persuaded to adopt a resolution prohibiting a member from having a financial interest in a publicly financed enterprise of which he was the independent auditor. This was incorporated into the Rules of Professional Conduct as revised in 1940. In 1948 an amendment to this rule, either forbidding a member to serve as an auditor of an enterprise conducted for profit if he were also a director of such enterprise, or possibly requiring disclosure of the fact that he served as a director received very little support. This despite the fact that a SEC rule prohibiting such joint service had been on the books for 15 years. The growing concern in the United States about the question on independence raised by the SEC, and its rulings in specific situations, was evidenced in a statement adopted by the Council of the American Institute of Certified Public Accountants (AICPA) in 1947 - the same year in which the “Tentative Statement of Auditing Standards” was released (1970). Independence in fact received great emphasis in the “Tentative Statement of Auditing Standards”. Under the heading, “Independence in the Auditor’s Mental Attitude and Approach”, the statement said: “…The profession has gradually compiled …precepts and conditions to guard against the presumption of loss of independence. “Presumption” is stressed because insofar as intrinsic independence is synonymous with mental integrity, its possession is a matter of personal quality rather than of rules that formulate certain objective tests.”



The statement then cited five of the Institute’s rules of professional conduct designed to guard against the presumption of loss of independence: the rules on false or misleading statements, contingent fees, financial interest in a client’s business, commissions and brokerage from the laity, and occupations incompatible with public accounting (1970). The spokesmen for the profession were concerned by the tendency of the SEC to specify an increasing number of relationships which would result in an accountant’s being considered not independent –regardless of whether or not he was independent in fact. In 1952, a question was raised again within the profession as to the adequacy of the existing rule on independence, since it was limited to the question of financial interest and contained no guidance on the general concept of independence. However, the environment was not hospitable to change at that time (1970). In 1959, Andrew Barr chief accountant of the SEC, made a speech before the Ohio State University Institute on Accounting which attracted much attention. He referred specifically to the “double standard” in the profession’s ethical code - “permitting no substantial interest in a client with public distribution of securities, but only requiring disclosure of such an interest to private lenders.” He cautiously suggested also that prohibiting joint service as auditor and officer or director of the client might strengthen the code. This speech did not go unnoticed by the Institute’s committee on professional ethics (1970). DISTINCTION BETWEEN INDEPENDENCE IN FACT AND INDEPENDENCE

IN APPEARANCE (1960s) It had become quite clear to that committee that the Institute’s rule was obsolete, embarrassing, and possibly harmful to the smaller accounting firms. The rule permitted joint service as auditor and officer or director, and permitted auditors of closely held companies to have a financial interest in such companies, provided it was disclosed, while auditors of publicly financed corporations were not permitted either course of action by the SEC (1970).

In 1960, the committee on professional ethics vigorously advocated a new and comprehensive rule on independence, prohibiting any financial interest in any audit client – public or closely held—and joint service as auditor and officer or director of such a company. In 1961, after much debate and conflict, the rule was passed by a resounding majority of members of the profession and the profession adopted a new notion of independence. The newly adopted Institute rule said,

“A member or associate, before expressing his opinion on financial statements, has the responsibility of assessing his relationships with an enterprise to determine whether, in the circumstances, he might expect his opinion to be considered independent, objective, and unbiased by one who had knowledge of all the facts.” (1970). In 1963, the Committee on Professional Ethics published its groundbreaking Opinion No. 12,

which in effect introduced a new measure by which the appearance of lack of independence could be judged. The new rule stated that is was the auditor’s responsibility to avoid relationships, which “to one who had knowledge of all the facts” might appear to impair independence. Opinion No. 12 defined such relationships as those which to a “reasonable observer” who had knowledge of all the facts might suggest “conflict of interest” which might impair the auditor’s objectivity (1970). Independence in fact was an attitude of mind and to maintain public confidence in the objectivity of CPAs in expressing opinions on financial statements, it was imperative to avoid relationships, which might have the appearance of a conflict of interest. This reasoning led to the prohibitions against having a financial interest in and acting as an officer or director of audit clients. But the debate about “relationships” which might mar the appearance of independence had barely begun. However, in Opinion No. 12, the Committee was careful to stress that the rendering of professional services other than the independent audit would not suggest to a reasonable observer a conflict of interest. In management services and tax practice, so long as the CPA’s services were limited to advice and technical assistance, and a decision-making role was avoided, the Committee saw no likelihood of a conflict of interest arising. At the 1967 annual meeting of the Institute an entire session was devoted to discussion of the problem of “management advisory services” and its effects on auditor independence (Knight, Previts, & Ratcliffe, 1976). A special ad hoc committee had been established to study the problem. The committee found no evidence that the rendition of management services had impaired the independence of CPAs in



fact, but that some users of financial statements believed that such services created the appearance of lack of independence (Carey, 1970). While no definitive answers to the critics could be given at the present time, it was suggested that continual attention be given to the questions that had been raised.

EXPANDING NONAUDIT SERVICES AND INDEPENDENCE (1970s)

Since the enlarged scope of services offered by audit firms created significant concern about auditors’ independence, the 1973 revision of the Rules of Conduct focused primarily on promulgating rules that addressed the appearance of independence. The 1973 restatement attempted to provide more specific criteria to make this ethical construct operational. The code also included specific prohibitions. Auditors should not knowingly countenance misrepresentation of facts, and they should not subordinate their judgment to that of others. However, the code was not as forceful as it could have been. While clearly stating that it was critical to assess the integrity of management and to maintain the appearance of independence, the revision qualified both by stating integrity was difficult to assess and it was difficult for the CPA to appear always to be completely independent. The issue of independence was dealt with at length in the congressional hearings of the 1970’s, although no major legislation resulted (Previts & Merino, 1998). A key question on the hearing agenda was whether a firm that acted in an advocacy role to help a client with management or tax decisions could at the same time exercise independence in auditing the firm’s books as a “public watchdog” - particularly when the accountants had a strong financial self-interest in pleasing the client. Public concerns about the independence of the CPA had arisen from the growth of nonattest services. In June 1976, the Senate Subcommittee on Corporate Rights and Responsibilities considered the proposal for federal chartering of corporations as recommended by Ralph Nadar’s Corporate Accountability Research Group. Included in the Nadar Report was the recommendation that public corporations rotate auditors every five years to improve auditor independence. No federal legislation affecting public accounting directly resulted from these hearings (Olson, 1982).

Hearings conducted by Senator Metcalf in the Senate and by Representative Moss in the House became alarming to the profession. Begun in late 1975, the Senate Subcommittee on Reports, Accounting, and Management (Metcalf Subcommittee) investigated the possible regulation of accounting and auditing standards. In the December, 1976 initial report, entitled The Accounting Establishment, Senator Metcalf noted, “the alarming lack of independence and lack of dedication to public protection shown by the large accounting firms which perform the key function of independently certifying the financial information reported by major corporations to the public.” (Previts & Merino, 1998). In October, 1976, the full report of the House Subcommittee on Oversight and Investigations (Moss Subcommittee) called for auditors to be “neutral corporate financial reporters.” On June 16, 1977, Rep. Moss introduced HR 13175 that called for the regulation of public accounting firms through a “National Organization of SEC Accountancy” (NOSECA). The legislation would have required the registration of accounting firms who audited SEC clients and provided for disciplinary action by the NOSECA. The Commission of Auditor’s Responsibilities (Cohen Commission), organized in 1974, over two years before The Accounting Establishment was completed released its report in March, 1977. The Cohen report made 40 recommendations, many going far beyond current practice, but all stopping short of federal involvement as recommended in The Accounting Establishment. The Cohen report concluded that there was no evidence of a loss of independence in the performance of management advisory services by auditors for their audit clients. The 200 page Report of Tentative Conclusions proved most effective in countering the Metcalf staff study. Thus when Senate hearings began in April, 1977, Senator Metcalf had significantly moderated his recommendations for reform. The Metcalf subcommittee recommended that management advisory services not related to accounting should be discontinued. Specifically, management services related to accounting should be limited to the areas of computer and systems analysis. The report called for auditor independence in fact and appearance and supported the proposal for a self-regulatory body subject to SEC oversight and enforcement. The congressional investigations continued in 1978 with the second round of House subcommittee



hearings examining the self-regulatory measures instituted by the American Institute of Certified Public Accountants (AICPA) and the posture of the SEC in relation to public auditors (Previts & Merino, 1998). In his testimony before the subcommittee, SEC chairman Harold M. Williams reaffirmed his position on the importance of auditor independence. “If the profession cannot satisfy its obligation to maintain both the appearance and fact of independence, I suspect legislation is inevitable.” A major part of the AICPA self-regulatory plan was the creation of the Division for CPA firms. The Division consists of two sections, the Private Companies Practice Section and the SEC Practice Section. Together they have this purpose: “to strive for professional excellence in the manner in which CPA firms practice and to assure the public of quality of accounting and auditing services through an effective

peer review and continuing education program.” SEC Practice Section peer reviews are conducted under the direct supervision of an independent Public Oversight Board (POB). In 1979, the Public Oversight Board issued a report Scope of Services by CPA Firms, that dealt primarily with the issue of whether to limit the scope of services that may be furnished to SEC audit clients. The POB concluded “there are many potential benefits to be realized by permitting auditors to perform management advisory services for audit clients that should not be denied to such clients without a strong showing of actual or potential detriment.” COMPETITION AND EXPANDING SERVICES AND INDEPENDENCE (1980s)

Nonattest services continued to grow. The issue raised by the POB report of the expansion of services persisted. The need for guidance by the AICPA became more apparent. As a result in 1986, the Special Committee on Standards of Professional Conduct (Anderson Committee) recommended in its proposed “Standards of Professional Conduct” broad standards to determine what is consistent with professional conduct in the provision of nonattest services. Specifically in this area the proposed standards would require members to: “Determine whether, in their individual judgments, the nature or magnitude

of their services provided to an audit client over time might create, or appear to create, conflicts of interest in the performance of the audit function for that client.” (Shaub, 1988)

The investigation of the Accounting profession during the period from 1985 to 1988 by Rep. John Dingell, Chairman of the House Energy and Commerce Subcommittee on Oversight and Investigations, followed a succession of well-publicized incidents in which auditors issued an unqualified opinion shortly before the entity met with financial disaster. The subcommittee focused on several key issues that were not new. The key questions were: 1) Whether a firm that acts in an advocacy role to help a client can at the same time exercise independence in auditing the firm’s books as a public “watchdog” 2) Whether audit fee cutting and relaxation of rules on advertising and solicitation had decreased the quality of audits and whether the fierce competition for clients had encouraged auditors to bend the rules in marginal cases to retain a client 3) Whether SEC enforcement efforts had been tough enough and whether the agency relied too much on industry-sponsored organizations to set standards, monitor audit quality, and impose sanctions, and 4) Whether the self-regulatory process that had grown up in the accounting industry was effective. As a result of these hearings, the Auditing Standards Board issued ten new auditing standards which came to be known as the “Expectation Gap Standards”; indicating the expectation gap between the due diligence expected by the public and the diligence auditors are able and willing to accept. One example is audit responsibility for the detection of fraud in financial statements, which is a complex topic. Auditors take some responsibility but not as much as many users expect. This disparity leads to misunderstanding and lawsuits, even when auditors have performed well.

CHANGING ENVIRONMENT AND INDEPENDENCE (1990s)

In the early 1990s, CPA firms began providing many different nonaudit services to their audit



clients: investment banking assistance, strategic planning, human resource planning, computer hardware and software installation and implementation and internal audit outsourcing services. The question arose: Were these auditors still independent? Chairman Arthur Levitt, as well as senior SEC staff, warned the profession about making financial statement audits a loss leader to attract lucrative consulting engagements. In September 1996, the General Accounting Office (GAO) recommended the SEC consider new forms of auditor oversight, and three months later, Levitt said audit firms needed to continue to ensure “.…that audit quality was not compromised and that auditor performance continue to meet public expectations.” (Jenkins, 1999). The congressional hearings and proposals of the 1990s reflected what the popular press characterized as the “S&L backlash against accountants.” Another member of Congress, Rep. Ron Wyden, proposed legislation amending an earlier version of his 1986 bill to provide “early warning bells…from auditors… to prevent this kind of debacle from happening again.” Overall, the lengthy series of hearings addressed the role of independent accountants auditing publicly held companies under the provisions of the Securities Acts (Previts & Merino, 1998). Legislative and administrative actions during the post-Vietnam era contributed to a reshaped market for professional accountants’ services. At the same time new federal laws were coming into effect, the Federal Trade Commission was seeking to remove what it considered barriers to advertising and competition. The FTC’s actions would result in “price” competition among major firms over a maturing market for audit services and the perception that audits were a “commodity” to be used to gain access to the client base. Also, auditing services of firms became subject to forms of solicitation and price competition unknown in previous decades. Audit services were put up for bid and awarded commonly to the lowest bid, driving down the margin from this stream of service while lawsuits and public expectations for auditor performance continued to rise (1998). In the midst of this change, firms shifted their efforts from the “franchise” audit function to marketing a broader range of services. Nonattest services were subject to competition from non-CPA consulting firms, who were quick to complain that such services created problems, at least in appearance, about the independent role of the CPA firm in the auditor capacity, which was at the root of the service package being offered. In response the CPA firms argued that these services were another means of learning more about the client, enhancing the efficiency of the audit and reducing the “learning curve” costs of providing such services (1998). In March 1993, the Public Oversight Board published a report, In the Public Interest: Issues Confronting the Accounting Profession, in which it expressed concern for the independence and objectivity of the auditing profession. In addition the Board appointed an Advisory Panel on Auditor Independence to assess the dimensions of the problem and recommend steps to bolster the professionalism of the independent auditor. While the Panel concluded that there was no need for the SEC or AICPA to add to or amend the extensive existing body of rules and regulations relating to auditor conflicts of interest, there were important steps that should be taken in other ways to enhance the objectivity and strengthen the professionalism of independent auditors. Among the recommended steps was one that would emphasize to all professional staff that auditing is not just one of many services offered to clients. It is special! It involves a “public responsibility transcending any employment with the client.” (Advisory Panel on Auditor Independence, 1994). In October, 1997, the Independence Standards Board, a new private-sector standard-setting body within the accounting profession, was established to deal with issues of auditor independence. On February 18, 1998, the SEC issued Authorizing SEC Release (FRR-50) (ISB, 1998a). This release recognized the ISB as an official body “to provide leadership in establishing and improving auditor independence regulations applicable to the auditors of the financial statements of Commission registrants” (ISB, 1998). The official mission statement drafted by the ISB reads: “The mission of the ISB is to establish independence standards applicable

to audits of public entities in order to serve the public interest and to protect and promote investors’ confidence in the securities markets.” (ISB, 1998b).

The objectives set out in the above-quoted document are to accomplish the mission by building on the current guidelines for independence while structuring a “conceptual framework” to implement a “principles-based” independence standard. Other objectives of the Board are to be a resolution center for referrals on independence while acting as consultants to the profession for the same. They aim to allow for open discussion by the public as well as persons in the accounting field, on all issues, as they relate to



auditor independence (ISB, 1998a).

FUTURE ISSUES AND INDEPENDENCE (2,000s)

Constructing a conceptual framework is perhaps one of the most challenging tasks facing the ISB. However, with its development of a framework, the ISB promises to accomplish two very significant goals. The ISB will more easily develop future independence standards through reference to a single set of ideals and principles. ISB standards will garner greater credibility among the business community and investing public since a conceptual framework will explain the ideals and principles underlying the board’s decisions (Jenkins, 1999). The SEC saw the need for this type of board - self-regulatory with lots of public input, and oversight by themselves - as necessary because of the very nature of the issue - independence. They did not see the need for more regulations by themselves but self-regulation by the profession, with input from the public. On the one hand, the SEC is concerned that structural changes in the profession threaten auditor independence. On the other hand, the profession sees an arcane, labyrinthine, and frustrating set of rules and regulations that makes administration of independence costly and difficult. Moreover, the profession perceives auditor independence as so important for its success that it will take the necessary steps to protect it. Management advisory services and its relationship to auditor independence appears to be one of the areas of auditor functions that is drawing the most interest. Craig states that Richard Walker, SEC director, sees an environmental factor – the fierce competition among CPA firms to retain clients – as impacting auditor independence. Walker noted two forces that present new challenges to auditor independence: escalating competition to obtain and hold onto auditing business, and potential conflicts of interest as the major accounting firms offer “a literal supermarket of nonaudit services.” Nonaudit consulting now represents the fastest growing revenue source for many accounting firms. As firms continue to offer more services to their audit clients, the economic dependence between the two parties will expand, possibly resulting in conflicts of interest (1999). In fact, the board’s first statement affects these firms by requiring auditors to confirm their independence to a company audit committee or board of directors on an annual basis (ISB, 1998c). ISB Technical Director Richard Towers points out that existing SEC independence regulations assume that a single set of rules fits all firms regardless of their size. Given the changes facing the profession such as new firm ownership structures allowing non-CPA ownership and the technological advances allowing smaller firms to audit SEC companies, an independence conceptual framework must be applicable across many different situations and audiences (Jenkins, 1999).

The ISB is concerned that independence may be impaired by actions of a former firm member or remaining firm members during an audit of their former colleague. Another key concern is the presence of family relationships between firm personnel and the audit client. A key concern is whether there should be a “new and stronger differentiation” between auditors who work directly on a client engagement and those auditors the firm merely employs (1999). Still another is the ability of client management to hire and fire the auditors who review their work (Byrnes, 1999).

CONCLUSION There has been an official definition of audit independence since Generally Accepted Auditing Standards were first proposed in 1947 (Tentative Statement of Auditing Standards - Their Generally Accepted Significance and Scope). Essentially the same definition exists today in AU section 220 of the AICPA’s codification of auditing standards. The second general standard on independence requires that the auditor “must be without bias with respect to the client since otherwise he would lack that impartiality necessary for the dependability of his findings, however excellent his technical proficiency may be.” AU section 220 also states that independence requires “intellectual honesty” and a “judicial impartiality that recognizes an obligation for fairness not only to management and owners of a business but also to creditors and those who may otherwise rely (in part, at least) upon the independent auditor’s report, as in the case of prospective owners or creditors.” The official definition of audit independence equates the term with an attitude and approach of



objectivity (being unbiased, fair, and impartial) and integrity (being intellectually honest). There has also been an excellent foundation, at least for a conceptual framework, for several decades (Carmichael, 1999). Thus, the ISB has its work cut out for it. First, and perhaps foremost, the ISB must address the issue of appearance of independence versus fact of independence. The SEC strongly believes that appearance matters. Only a well-developed conceptual framework that demonstrates how the fact of independence can be established and monitored will change the SEC’s position. The beginnings of a conceptual framework are under way and will occupy much of the ISB’s time in the immediate future (Craig, 1999).

TABLE 1

DEVELOPMENT OF RULES ON INDEPENDENCE IN THE UNITED STATES

1931 RESOLUTION PROPOSED THAT AN AUDITOR WHO WAS ALSO AN OFFICER OR

DIRECTOR OF THE CORPORATION WAS NOT INDEPENDENT, REFERRED RESOLUTION TO COMMITTEE ON PROFESSIONAL ETHICS.

1932 RESOLUTION PROPOSED EXPRESSING DISAPPROVAL OF JOINT SERVICE AS

AUDITOR AND DIRECTOR OF A CORPORATION. MOTION DEFEATED. 1933 FEDERAL TRADE COMMISSION ISSUED REGULATIONS COVERING JOINT SERVICE

AS OFFICER OR DIRECTOR AND FINANCIAL INTEREST OF AN AUDITOR IN A CLIENT CORPORATION.

1936 SEC CHANGED RULE TO ANY “SUBSTANTIAL” FINANCIAL INTEREST IN A CLIENT

CORPORATION. 1940 RULES OF PROFESSIONAL CONDUCT PROHIBITED AN AUDITOR FROM HAVING A

FINANCIAL INTEREST IN A PUBLICLY FINANCED ENTERPRISE OF WHICH HE WAS INDEPENDENT AUDITOR.



1948 CONSIDERED AMENDMENT TO 1940 RULE EITHER PROHIBITING DUAL ROLES AS

DIRECTOR AND AUDITOR, OR REQUIRING DISCLOSURE OF THIS FACT. NO ACTION TAKEN.

1952 PROFESSION QUESTIONS ADEQUACY OF RULE ON INDEPENDENCE, BUT NO

CHANGE. 1960 NEW RULE PROHIBITING ANY FINANCIAL INTEREST IN ANY AUDIT CLIENT AND

JOINT SERVICE AS AUDITOR OR OFFICER OR DIRECTOR. 1979 QUESTION OF SCOPE OF SERVICES TO BE PROVIDED TO SEC AUDIT CLIENTS AND

STILL MAINTAIN INDEPENDENCE (MAS vs. AUDITING). 1986 ISSUE OF EXPANSION OF SERVICES vs. AUDIT FUNCTION CONTINUES VIA

ANDERSON COMMITTEE REPORT. 1989 ISSUED “EXPECTATION GAP AUDITING STANDARDS” IN RESPONSE TO GROWING

GAP BETWEEN EXPECTATIONS OF THE PUBLIC AND THE AUDITOR. END OF DINGELL COMMITTEE HEARINGS.

1990s SAVINGS AND LOAN FAILURES RESULT IN BACKLASH AGAINST AUDITORS.

RELAXATION OF THE RULES AGAINST ADVERTISING AND COMPETITION. 1997 ESTABLISHMENT OF THE INDEPENDENCE STANDARDS BOARD TO DEAL WITH

ISSUES OF AUDITOR INDEPENDENCE. 1998 INDEPENDENCE STANDARDS BOARD ISSUES ITS FIRST STANDARD REQUIRING

AUDITORS TO CONFIRM THEIR INDEPENDENCE TO A COMPANY AUDIT COMMITTEE OR BOARD OF DIRECTORS ON AN ANNUAL BASIS.

REFERENCES Advisory Panel on Auditor Independence. (1994). Report to the Public Oversight Board of the SEC

Practice Section, AICPA. New York, New York. Byrnes, Nanette. (1999). “Auditors and Clients Too Close for Comfort.” Business Week, Number Three

Thousand Six Hundred Seventeen , February 22, 1999, 92 . Carey, J. (1969). The Rise of the Accounting Profession from Technician to Professional 1896-1936. New

York: American Institute of Certified Public Accountants, Inc. Carey, J. (1970) The Rise of the Accounting Profession to Responsibility and Authority 1937-1969. New

York: American Institute of Certified Public Accountants, Inc. Carmichael, D. R. (1999). “In Search of Concepts of Auditor Independence.” CPA Journal, Volume Sixty-

Nine, Number Five, May, 1999, 38-42. Craig, J. L. (1999). “The CPA and Independence: Illusion or Reality?” CPA Journal, Volume Sixty-Nine,

Number Three, March 1999, 14-22. Edwards, D. J. (1960). History of Public Accounting in the United States. Michigan: Michigan State

University.



Independence Standards Board. (1998a) .”Authorizing SEC Release (FRR-50).” Database online. Available from http://www.cpaindependence.org/; Internet accessed 25 April 1999.

Independence Standards Board. (1998b). “Objectives and Mission.” Database online. Available from

http://cpaindependence.org/; Internet accessed 4 April 1999. Independence Standards Board. (1998c). “Statement No. 1 Independence Discussions with Audit

Committees. ISB Final Pronouncements.” Database online. Available from http://www.cpaindependence.org/; Internet accessed 4 April 1999.

Jenkins, J. G. (1999). “A Declaration of Independence.” Journal of Accountancy, Volume One Hundred

Eighty-Seven, Number Five, May, 1999, 31-33. Knight, Previts, & Ratcliffe (1976). A Reference Chronology of Events Significant to the Development of

Accountancy in the United States. Alabama: The Academy of Accounting Historians. Olson, W. E. (1982). The Accounting Profession Years of Trial: 1969-1980. New York: American

Institute of Certified Public Accountants, Inc. Previts & Merino (1998). A History of Accountancy in the United States. Ohio: The Ohio State University. Shaub, M. K. (1988). “Restructuring the Code of Professional Ethics: A Review of the Anderson

Committee Report and Its Implications.” Accounting Horizons, Volume Two, Number Four, December, 1988, 89-97.



THE CHANGING STRATEGY OF THE PUBLIC ACCOUNTING PROFESSION AND ACCOUNTING

EDUCATORS

Borke, John C. Uddin, M. Jamir

University of Wisconsin-Platteville

Technology, a competitive environment, deregulation, and higher expectations of clients caused the public accounting profession to reevaluate their future direction for the 21st century. In writing about the vision statement pronounced by the CPA profession, Melancon said,

“CPAs deliver value by communicating the total picture with clarity and objectivity. Certainly, that’s what we have traditionally been doing as a profession. But the vision statement moves us up the value chain, adding the following concepts: translating complex information into critical knowledge, anticipating and creating opportunities, and implementing or designing pathways to transform that vision into reality.”

In an earlier interview, Melancon said, “The bottom line is that the CPA will be nothing like what you’re probably used to. He/she will be a strategic business advisor, a trusted information professional who is comfortable with technology, and a member of senior corporate management, among other roles. In public practice, he/she will be providing new, market-driven services alongside more traditional services, such as audit and attestations. ‘The new CPA’, you might say, is almost a whole new profession.”

Kessler further contrasts the old CPA and the new CPA. The old CPA was a number cruncher; the new CPA is a number processor. The old was a recorder of historical information; the new is a forward-looking assurer of the integrity of real-time, customized data. The old was a traditional auditor and attestor of financial statements; the new is a trusted financial-services and business-strategy advisor. The old was a technician who worked with a pencil and calculator; the new is a savvy practitioner, comfortable with technology, who delivers electronic knowledge enhanced by his/her traditional training and experiences. The old CPA was a valued backroom employee, while the new CPA is a key decision-maker who contributes directly to the bottom line.

Accounting educators have always focused on preparing students both for public accounting and private accounting jobs. But in light of these changes in the public accounting profession’s direction, it is imperative that accounting educators should reevaluate their accounting education curriculum to determine and implement any changes needed to train future accounting students.

Nelson tells accounting students, “In addition to good system skills, you will need a broad liberal education….the ability to interact with diverse groups of people….and a sense of the breadth of ideas, issues, and contrasting economic, political, and social forces in the world….You will need strong writing, speaking, critical thinking, and interpersonal skills….you will also need state-of-the-art technical skills.”

Three features that have been suggested by Dietrick for incorporation into accounting programs that can provide students with the skills needed by the new CPA are a lyceum program, the use of cases, and internships. Other features that have been prominently mentioned include group activities and use of technology.

The primary purpose of this paper is to critically examine the undergraduate Accounting curriculums and teaching methods of selected comparable universities in the Midwest. This was accomplished by personally visiting the selected campuses and meeting with key academic instructors. The specific focus of the visits were to learn about the actions that campuses are considering implementing in their accounting curriculum in light of the new Vision Statement released by the CPA profession.

The secondary purpose of this paper is to determine specific actions that campuses are taking, if any, to develop core competencies as specified by the CPA profession. The following are those core



competencies, as stated in the CPA Vision Concept, are: Communications and Leadership Skills

Strategic and Critical Thinking Skills Focus on the Customer, Client and Market Interpretation of Converging Information

Technologically Adept

RESEARCH ACTIVITIES

The research began by developing a questionnaire that would serve as an anchor for discussions with at least one accounting professor at each selected university. Personally visiting the eight universities across the Midwest provided the chance to engage in more elaborate and detailed conversations rather than being limited by a pre-prepared questionnaire. This method also allowed the respondents (instructors) to ask questions and speak at length on specific issues. The personal visitations were more conducive to creating an atmosphere where we were able to exchange ideas.

Specifically, we discussed the mission, vision and competency statements of undergraduate Accounting programs. Furthermore, we learned of the universities’ undergraduate Accounting curriculums including the following: accounting core courses, elective courses, internships and sequence of courses taken by students at their institutions. We discussed the need for written “Core Competencies” for our accounting graduates and a means to measure these competencies. We also discussed at length the teaching methods used to develop critical thinking skills, communication skills, leadership skills, inter-cultural skills and ethical values.

RESULTS

Vision & Mission Statements. A majority of the respondents indicated that the Vision and Mission of the accounting programs should be clearly established and interpreted firmly by the institution rather than be construed by individual instructors. Furthermore, there is a consensus that the Vision & Mission should be changed only when there is a change in the global environment. Instructors also agreed that the Vision & Mission statements generally inspired motivation. In addition, it was agreed that they do help to a small degree in recruiting students for accounting programs. When asked about other tools used for recruiting students in Accounting programs, all the respondents identified the first accounting course to be the key criterion to recruiting students. Students who have a positive impression of and a good sense for accounting in their first course typically remain in the program. The other factors mentioned were: alumni presentations in the first accounting course, contact with parents of the prospective students, a good reputation of the institution, perception of the students after their first visit, and supply and demand in the job market.

Core Competencies for Undergraduate Accounting. Competencies are the skills that will provide students lifelong success. A majority of the respondents expressed that competencies are implied for their programs and that the accounting curriculum is structured based on competencies. Competencies are identified by the courses where a specific skill or skills will be learned.

When asked about the measurement of core competencies a majority of the respondents stated that feedback from the employer is the most accurate and relevant measurement. Other measurement criteria identified include professional exams, graduation testing (exit tests), passing of a core course, and competency-based grading.

It is widely recognized that technology is rapidly replacing traditional accounting skills. A majority of schools are reacting to this change by requiring that accounting majors take a lab course that teaches the application of accounting software. Today, students enrolling in accounting programs are computer-educated. It is the opinion of most respondents that requiring students to take a PC course is waste of time. They argue that accounting students should not be required to take any computer courses other than accounting lab. Instead, application of computers should be emphasized in the junior and senior level classes.

According to the research results, the first accounting course is recognized as the most important factor in recruiting students into the accounting field. Accounting educators believe that a user’s approach



in teaching the first accounting course does eliminate the negative image of accountants. However, a majority of respondents are using a balance between the user’s and practitioner's approaches in teaching their first accounting course. This approach facilitates the transition from elementary accounting to intermediate accounting. The bookkeeping aspect of the course is completely eliminated from the course.

The accounting profession also recognizes interpersonal and leadership skills as vital to becoming successful in the profession. The educators of the institutions visited believe that teaching methods and grading processes do facilitate acquiring these skills. However, they also support the learning of these skills through experience and maturity. A student’s participation level in class may be directly related to his or her level of interpersonal and/or leadership skills. Most of the respondents agree that a significant percentage of grades should be assigned to students' participation in the class. Moreover, junior & senior level students should be assigned case analysis that then should be presented in class.

The accounting profession does recognize that organizations are conducting business in a global environment. This requires appreciation of other cultures, working with diverse groups of people and understanding various economic systems and social environments. A majority of the respondents believe that accounting students should be required to take a cultural diversity awareness course. International economics and international business courses would also prepare students to work in a global environment. All of the interviewed instructors agree that simply completing accounting problems in foreign currencies is just not enough.

It is widely recognized that an internship is the most relevant experience that helps students to prepare for a job. It develops a type of partnership between the educational institution and employers in the market. All the respondents agreed that internships should be highly recommended but that it should not be a graduation requirement. Zero to six credit hour internships can be counted towards the graduation. It is also reported that finding summer internships is quite difficult for accounting majors. The following are some approaches mentioned for developing partnerships between educational institution and employers:

Invite employers to speak to students in class and in students’ organization Seek projects from local businesses for Junior and Senior level students

Set up regular students' visitation to businesses Provide student tax services to local people Keep in touch with alumni regularly

CONCLUSION On the basis of the research findings, the following recommendations were made to the Business and Accounting Department at the University of Wisconsin-Platteville.

1. The current Microcomputer Application course should include application of computerized accounting so that students are at ease in using spreadsheets and other applications in doing their computer assignments in other accounting courses.

2. Every accounting course including elementary accounting should have some assignments that involve collaboration.

3. Home assignments should emphasize critical thinking. 4. Students should be exposed to the global environment through a course to be taught by the

business faculty.



REFERENCES

CPA Vision Project (1998). Journal of Accountancy, December 1998. Dietrick, James W. (1999). “Three Suggestions for Professionalizing the Accounting Curriculum”, New Accountant, September 1999. Kessler, Stuart (1997). “Chair’s Corner”, The CPA Letter, November 1997. Melancon, Barry C. (1998). “The Changing Strategy for the Profession, the CPA and the AICPA: What

This Means for the Education Community”, Accounting Horizons, Vol. 12 No 4, December 1998.

Nelson, Irvin (1998). “What’s Happening in the Job Market”, New Accountant, March/April 1998. “The New CPA: An Interview with Barry Melancon, AICPA President & CEO” (1998). New Accountant, March/April 1998.



THE EFFECT OF AUDITOR INVOLVEMENT WITH PROJECTED FINANCIAL STATEMENTS ON LOAN OFFICERS’ LENDING DECISIONS FOR START-UP

COMPANIES

Swanger, Susan L. Western Carolina University

[email protected]

DeZoort, F. Todd University of South Carolina [email protected]

ABSTRACT

In the U.S., the advent of the Private Securities Litigation Reform Act of 1995 highlighted the importance of auditor involvement with forward-looking financial statements. This study investigates how different levels of auditor involvement with projected financial statements affects loan officers’ lending decisions for high risk start-up companies. We hypothesize that increased auditor involvement will lead to greater reliance on the auditor as measured by the perceived accuracy and achievability of projected statements, the likelihood of granting a loan, and acceptable interest rate for a start-up entity. Using a between-group design with three auditor involvement treatments (i.e., no involvement, compilation, and examination), 62 commercial loan officers completed the experimental materials. The results indicate that auditor involvement was associated with increases in both perceived accuracy and achievability of the financial projections. However, the extent of auditor involvement did not make a difference. Further, higher auditor involvement resulted in a greater likelihood of the loan being granted. We discuss the findings in the context of emerging audit and financial lending policy and practice.

INTRODUCTION

“Because forward-looking disclosures have been the subject of abusive claims, issuers have been unwilling to make them and auditors have been unwilling to risk association with them” (Andrews & Simonetti, 1996, p. 54).

The Private Securities Litigation Reform Act of 1995 represents an important step in U.S. tort reform. Specifically, the Act was designed to encourage companies to provide more forward-looking financial information for interested users and to provide auditors with protection to encourage their involvement in the process. Implicit in the research and policymaking literature is an assumption that auditor involvement, and increases in auditor involvement, will improve the credibility and reliability of the forward-looking financial information.

The purpose of this study is to evaluate the effect of auditor involvement with projected financial



statements on loan officers’ start-up company lending decisions. In the lending decision process, loan officers typically evaluate a wide range of information, including forward-looking information that is either provided by the client or generated internally by the loan officer. Based upon the perceived riskiness of the loan, a decision is made as to whether to grant the loan and the appropriate interest rate to be charged. While the loan applicant’s interests are to have the loan approved at the lowest possible interest rate, the loan officer is interested in balancing the interest rate and the risk of not collecting all or part of the loan (i.e., default risk). According to information theory, auditor involvement with financial information reduces the risk of making decisions based upon inaccurate information (Wallace, 1995). Thus, theoretically, loan officers should rely upon the expertise of auditors to help reduce the risk associated with the lending decision.

The current study contributes to the auditor involvement literature by examining for the first time if lending decisions are affected by differing levels of auditor involvement for a start-up enterprise where only projected financial statements are provided. This type of lending scenario involves an extremely high level of uncertainty because there are no previous operating results upon which to base a lending decision, and because of the major hypothetical assumptions underlying the projected financial information.2 From a research perspective, such a limited information set for decision-making is likely to produce an auditor involvement effect that is different than that demonstrated in earlier studies. In addition, our use of a start-up company allows us to isolate the variable of interest (i.e., level of auditor involvement with prospective financial information) and minimize the possibility of confounds associated with participants focusing on historical results rather than prospective financial information. From a practice perspective, this study introduces a previously unexamined market segment that is increasingly important to lenders because it represents both significant exposure and revenue potential (FDIC, 1998). Rosman et al. (1999, p. 38) highlighted the need to evaluate start-up companies in an auditing context because they “often differ greatly from mature companies (e.g., reliability of projected financial information).”

Consequently, we are motivated to evaluate this research problem on a number of fronts. While the literature reflects an interest in loan officers’ use of historical financial information in lending decisions and the effect of auditor involvement on those decisions (e.g., Bandyopadhyay and Francis, 1995; Johnson et al., 1983; Libby, 1979; Estes and Reimer, 1977), research on the use of forward-looking (or prospective) financial information is limited, dated, and has mixed results (Johnson and Pany, 1984; Strawser, 1994). For example, the extant literature on prospective financial information is limited because research efforts have been devoted to only one type of prospective information -- financial forecasts. However, other types of prospective financial information (e.g., financial projections and partial presentations) introduce higher levels of uncertainty that may lead to different decisions, different cognitive processes, and a greater need for auditor involvement to manage the increased risk. Strawser (1994, 553) noted this possibility when he stated that “it is possible that users may react differently to accountant involvement with financial projections (forecasts prepared assuming one or more hypothetical events) or presentation of only partial forecasted information.” This study's motivation also arises from recent accounting standards and regulation in the U.S. that date much of the extant prospective financial information literature. For example, the American Institute of Certified Public Accountants’ Guide for Prospective Financial Information (AICPA 1992), provides new presentation and reporting standards that, with the exception of Strawser (1994), have not been considered in previous studies. These new standards provide specific guidance on the form and content of prospective financial presentation, as well as guidance on fieldwork and reporting for external auditors. Finally, we are motivated by the mixed results found in previous studies related to auditor involvement and prospective financial statements. For example, Johnson and Pany (1984) found that auditor involvement with financial forecasts had little, if any, effect upon the lending decisions of commercial loan officers. Alternatively, Strawser’s (1994) results indicated that the probability of granting a loan was significantly higher when auditors performed an examination than when they performed a compilation or were not involved with the forecasted statements. Such varied results suggest the need for additional work under current standards and laws to amass empirical data as to whether different levels of auditor involvement with prospective financial information affects lending decisions. The results indicate that auditor involvement with projected financial statements is associated with higher levels of perceived accuracy and achievability of the projections. The results also provide evidence

2 The Federal Deposit Insurance Corporation (FDIC, 1998) estimates that approximately 53% of new businesses fail within the first four years.



that auditor involvement is associated with a greater likelihood that a loan will be granted. However, the findings consistently suggest that while auditor involvement with projected statements makes a difference in loan officers’ decisions and perceptions, the specific amount of involvement (i.e., compilation or examination) does not. Finally, the results indicate that auditor involvement makes no difference in the interest rate premium charged to the borrower.

These findings have a number of important research, practice, and public policy implications. First, the results expand our understanding of auditor involvement by focusing on the use of projected financial statements in the lending decision process, an area not previously addressed in the empirical research literature. Second, the findings provide evidence about the use of prospective financial statements as a tool used by loan officers in evaluating applicants from start-up entities. Such companies are inherently different from the types of mature companies commonly considered in the research literature and may motivate different decision processing (Rosman et al., 1999).

Third, the results suggest that increased auditor involvement with projected financial statements could provide a means for entrepreneurs to increase the likelihood that bank financing will be available. Fourth, for public accounting firms experiencing relative stagnation in accounting and auditing revenues (see Elliott, 1995; Berton, 1996), the results suggest that services related to prospective financial statements are valuable to clients and have potential to expand the base of accounting and auditing revenues. Finally, from a public policy standpoint, the results provide some evidence that commercial loan officers are familiar with the various levels of auditor service related to prospective financial statements. However, the participants indicated a lack of familiarity with current standards for presentation and reporting, suggesting a possible need for increased education and training in the area. The remainder of the paper is organized as follows. The second section provides background of the prospective financial information literature and develops the study’s hypotheses. The third section details the research method, followed by a presentation of the study’s results. The final section discusses the findings, limitations, and provides concluding thoughts.

BACKGROUND AND HYPOTHESES

Prospective Financial Information During the 1980s, the AICPA issued a number of documents highlighting interest in prospective financial statements (AICPA, 1985, 1986, 1989). For example, the AICPA’s “Statement on Standards for Accountants’ Services on Prospective Financial Statements,” (the Statement 1985) and “Guide for Prospective Financial Statements” (the Guide 1986) provided much needed guidance for prospective financial statement presentation and reporting. The Statement was later codified in the AICPA’s Codification of Statements on Standards for Attestation Engagements (SSAE) No. 1 (AICPA, 1989), and, in 1992, the Guide was updated. Together, SSAE No. 1 and the Guide provide detailed information about the different types of prospective financial information, as well as relevant presentation and reporting standards. The authoritative literature also provides auditors with specific guidance on procedures to be performed and opinions to be issued when dealing with alternative types of prospective information. The Guide makes several distinctions with regard to the different types of prospective financial information. In its broadest context, prospective financial information is any financial information that is futuristic in nature. Prospective financial information would encompass all of the following:

• Prospective financial statements -- formal financial statements that present future financial position, results of operations, cash flows, summary of significant assumptions, and summary of significant accounting policies.

• Partial presentations -- financial statements and/or schedules that relate to future periods

but lack one or more of the elements of prospective financial statements.



• Financial analyses -- financial presentations depicting a possible course of action or alternative courses of action (e.g., analysis of a potential project where the accountant makes the appropriate assumptions).3

Prospective financial statements consist of two types: forecasts and projections. A financial forecast presents the entity’s future financial position, results of operations and cash flows, based upon assumptions that reflect the expected conditions and actions to be taken. A forecast may be presented as a specific point estimate or as a range of values. A financial projection is similar to a forecast to the extent that it presents the entity’s future financial position, results of operations and cash flow, based upon assumptions that reflect the expected conditions and actions to be taken. However, a projection also incorporates one or more hypothetical assumptions into the presentation. For example, a company could present a forecast of next year’s operations based upon a continuation of the current operating structure and environment of the firm. However, if the company prepared prospective financial statements incorporating a major hypothetical assumption, such as expansion into international markets via construction of operating facilities in a foreign country, the prospective statements would be projections, not forecasts. Thus, a projection is more of a “what if” analysis and has a higher level of uncertainty associated with it than does a financial forecast. The Guide also specifies the various levels of auditor involvement with prospective financial statements. As with historical financial statements, the auditors may be engaged to provide differing levels of service. According to the Guide, the auditor may perform agreed upon procedures, a compilation, or an examination of the prospective financial information. In agreed upon procedures engagements, auditors perform and report on the specific procedures that have been agreed upon by the client and the recipient (or user) of the statements. In a compilation engagement, the auditor provides limited assurance regarding the presentation of the prospective statements and disclaims an opinion regarding the underlying assumptions. In an examination engagement, the auditor provides an opinion regarding the presentation of the prospective statements and the reasonableness of the underlying assumptions. Thus, the amount of work and the level of assurance for an examination are greater than for a compilation. Prior Auditor Involvement Research Prior research examining the lending decisions of commercial loan officers can be divided into studies that focused on the use of historical financial information and studies that focused on the use of prospective financial information. Historical Financial Information: In one of the earliest studies involving auditor involvement, Winters (1975) found that auditor association with unaudited compiled and reviewed financial statements increased bankers’ beliefs that the financial statements would be in accordance with generally accepted accounting principles. The findings also provided evidence indicating that auditor involvement increased bankers’ reliance on the financial statements and provided some assurance that the unaudited financial statements were not false or misleading. Other early experiments sought to capture differences in bankers’ lending decisions based upon differing audit reports. Estes and Reimer (1977) compared loan decisions based on qualified versus unqualified audit opinions. Their results revealed that bank loan officers were not significantly affected by an “except for” opinion on financial statements when the basis for the exception was otherwise disclosed in the financial statements. Similarly, Libby (1979) found no significant differences between lending decisions based on an unqualified opinion, a “subject to” opinion, or a disclaimer of opinion. Johnson et al. (1983) studied the impact of differing levels of auditor involvement on both the actions and perceptions of bank loan officers. A national sample of bank loan officers completed a simulated lending task where they were asked to consider a set of historical financial statements and background information for a commercial loan customer. Four levels of auditor involvement were used in a between-subjects design: no involvement, a compilation, a review, and an audit. The response variables

3 Pro forma presentations are specifically excluded from prospective financial information because they reflect historical amounts. Expired budgets are also excluded because the amounts are no longer prospective in nature.



were both “action” variables (decisions as to whether the loan would be granted and the associated interest rate) and “perception” variables (perceived accuracy and reliability of the statements). Although there was no significant difference in the action variables relating to whether the loan would be granted and the interest rate to be charged, the results indicated that audited financial statements were perceived to be of higher quality than compiled or reviewed statements or those with no auditor association. More recently, Bandyopadhyay and Francis (1995) used a sample of bank loan officers to evaluate differing levels of auditor association with historical financial statements. Using a within-subjects design, they manipulated the level of auditor association at three levels (compilation, review and audit), the type of security at two levels (debt covenants and collateral), and the provision of management advisory services by auditors at two levels (either provided advisory services or not). Their results indicated that increased auditor involvement not only increased the likelihood of a loan being granted, but also decreased the associated interest rate to be charged. Prospective Financial Information: The auditor involvement literature also contains a number of studies that have focused on the use of prospective financial information in lending decisions. Johnson and Pany (1984) investigated whether auditor association with financial forecasts affected the judgments of CPAs and bank loan officers. The CPA results revealed that auditor involvement was associated with a strong increase in perceived clerical accuracy and achievability of the forecasts. Alternatively, the banker results indicated that level of involvement did not affect lending decisions or perceptions of accuracy and achievability of the forecast. Strawser (1994) also evaluated whether auditor association with forecasts (as presented under the new standards) led to differences in perceptions and actions of bank loan officers. Using a lending task that included both historical and forecasted financial information, the results indicated that bankers perceive examination engagements to be beneficial in the decision-making process. The findings also suggested that the usefulness of examinations increased as the accountant’s knowledge about the entity increased. We extend the extant literature on auditor involvement by focusing on a lending scenario that involves a start-up company that has prepared projected financial statements. Because the company is a start-up organization, there are no historical financial statements and no previous operating results upon which the lending decision can be based. Thus, the importance of the prospective information is accentuated (Rosman et al., 1999). Further, the use of a financial projection (which incorporates a major hypothetical assumption) introduces a higher level of uncertainty and riskiness that is not present in a financial forecast. The use of projected financial statements and the effects of differing levels of auditor involvement have not been previously investigated. Collectively, the literature involving lenders clearly indicates that auditor association increases the perceived reliability of financial information (Winters, 1975; Johnson et al., 1983; Strawser, 1994; Bandyopadhyay and Francis, 1995). In particular, the empirical findings to date suggest that loan officers rely on the work of external auditors to reduce information risk to a more acceptable level.4 Such findings are supportive of information theory, wherein information is ascribed the attributes of noise, bias and fineness. Noise refers to errors in measurement, bias refers to one-sided misstatement, and fineness refers to the ability to capture the substance of the subject in such a way that it can be analyzed and compared (Wallace, 1995). Thus, from a theoretical standpoint, loan officers should rely upon the work of external auditors because of auditors’ competence, independence, objectivity and credibility, all of which work to reduce noise and bias and to increase fineness of information. Accordingly, increases in auditor involvement and the level of assurance provided (e.g., compilation versus review versus audit) should reduce the amount of information risk confronting the financial statement user. Extending this reasoning to the use of projected financial statements, we expect auditor involvement with projected financial statements to reduce information risk associated with lending decisions. Specifically, we hypothesize that this reduction in information risk will result in an increase in the perceived accuracy of the projected financial statements. Stated formally (in alternative form):

H1: Loan officers’ perceptions of the degree of accuracy of projected financial

4 Arens and Loebbecke (1997) suggested that lending decisions involve an integration of information risk and business risk. Information risk is defined as the risk that the information upon which a decision was made was inaccurate. Business risk is defined as the risk that a business will be unable to repay its loan because of economic or business conditions such as a recession, poor management decisions, or unexpected competition in the industry.



statements will increase as the level of auditor involvement increases.

The achievability of projected results can be threatened by a variety of factors, including changing business conditions, erroneous or unreasonable assumptions, and clerical and mathematical inaccuracies. While auditor involvement cannot reasonably be expected to affect the ability of loan officers to anticipate events beyond the control of management, it can effectively control the effects of unreasonable assumptions and mathematical errors on the achievability of the projected results. Thus, it is hypothesized that increases in auditor involvement will be associated with increases in the perceived achievability of the projected results. Stated formally (in alternative form):

H2: Loan officers’ perceptions of the degree of achievability of projected financial

statements will increase as the level of auditor involvement increases. We posit that the reduced information risk associated with increased auditor involvement will not only affect the perceptions of commercial loan officers, but their lending decisions as well. Specifically, we hypothesize that increased auditor involvement with projected statements will reduce information risk sufficiently to affect the likelihood of a loan being granted. Stated formally (in alternative form):

H3: Loan officers’ likelihood of granting a loan request after evaluating projected

financial statements will increase as the level of auditor involvement increases. In addition to deciding whether or not to grant a specific loan, loan officers often determine the appropriate interest rate to be charged on a particular loan. The interest rate premium charged (i.e., percentage points above the prime rate) is one measurement of the perceived riskiness of a loan. We posit that in situations where a loan is granted, increases in auditor involvement will affect the interest rate decisions of lenders dealing with projected financial information. Specifically, to the extent that information risk is reduced by increased auditor involvement, we expect lower interest rate premiums. Stated formally (in alternative form):

H4: The interest rate premium charged by loan officers after evaluating projected financial statements will decrease as the level of auditor involvement increases.

METHOD

Participants

The study’s sample comprised 62 commercial loan officers, representing 11 financial institutions located in the southeastern United States. Contact people at the institutions delivered the research materials and asked for participation. A total of 104 instruments were delivered to the various institutions and 73 were returned. Four participants failed a manipulation check question and were subsequently excluded from the analysis.5 In addition, seven participants were eliminated because they admitted being fixated on issues tangential to the primary case materials.6 The remaining 62 participants represent an adjusted response rate was 60%.7 The demographic results in Table 1 reveal that the average participant was 39 years old, had 15 years of banking experience, and 11 years experience in commercial lending activities. A majority (85%) 5 The manipulation check question at the end of the instrument asked the participants to indicate the CPA firm's level of involvement with the projected financial statements. 6 For example, some participants suggested their decisions depended on the availability of personal financial statements from the owner, while others indicated they would only grant the loan only if it had a Small Business Administration guarantee. 7 An evaluation of the participants' responses (e.g., thoroughness, substance of comments provided) indicated that they took the experimental materials seriously. Approximately half of the participants requested results of the study.



of the participants were male and represented financial institutions with total assets of at least $100 million (89%).

TABLE 1 Demographics

DEMOGRAPHIC ITEM N MEAN (standard deviation)

Age (years)

62

39

(7.90)

Banking experience (years)

59*

15

(7.63)

Commercial lending experience (years)

59*

11

(7.14)

% Gender - Female - Male

9 53

15% 85%

Education Level - Bachelor’s degree - Some graduate work - Graduate degree - Other

29 12 16 5

47% 19% 26% 8%

Institution size (total assets) - < $100 million - > $100 million

7 55

11% 89%

*Three participants did not provide information about banking or commercial lending experience.

Experimental Design & Materials The experiment involved a between-subjects design where the level of auditor involvement with projected financial statements was manipulated at three levels: no involvement (NONE), compilation (COMPILE), and examination (EXAMINE).8 Each participant received information about a hypothetical lending scenario developed from an actual business plan and loan application package used in practice at the time of the study. The scenario described a start-up company owned by one individual who wished to obtain bank financing for real estate, equipment, and working capital. Background information about the

8 Consistent with prior research (e.g., Strawser, 1994), we did not include agreed-upon procedures as a fourth level of auditor involvement because by definition, these procedures result from direct input by the user party.



proposed business, biographical and financial information of the owner, three years of projected financial statements, and industry average ratios were included in the packet.9 For the COMPILE and EXAMINATION groups, the appropriate auditors’ report (either a compilation or an examination report) was provided with the financial projection. No audit report was provided in the no involvement condition. Each participant was assigned randomly to one of the treatment groups. The research materials were developed in conjunction with lending professionals to ensure that, while information risk was high due to the start-up nature of the business and the lack of experience of the owner/operator, the lending scenario was realistic and the outcome was not predetermined by the extreme nature of the risk. For example, while the collateralization of loans minimizes information risk to some extent, the commercial lending literature clearly indicates that cash flows from operations of a business is the primary source of repayment and that liquidation of collateral is an undesirable and last resort for lenders (Jones, 1992). In addition, the specialized, single-purpose nature of the building and equipment that secured the proposed loan increases risk even further because it reduces the marketability of the collateral assets (Strischek, 1990).10

As with the previous auditor involvement literature (e.g., Johnson et al., 1983; Johnson and Pany, 1984; Strawser, 1994), the dependent variables in this study consisted of both action variables and perception variables. The action variables were GRANT, the likelihood that the participant would recommend (not recommend) that the loan would be granted, and RATE, the interest rate premium (percentage points above the prime rate) that the participant would charge the borrower. GRANT was measured using a 10-point scale anchored at zero with “definitely would not” and at 9 with “definitely would.” The scale was split at the midpoint so that a response in the zero to four range related to a loan denial decision, while a response in the five to nine range related to a loan granting decision. RATE was measured one of two ways. Participants who responded in the first question that they would grant the loan were asked to provide the interest rate premium (percentage points above the prime rate) they would charge on the loan. Participants indicating they would deny the loan were asked to provide the interest rate that they believed a competing financial institution would charge upon granting the loan. The perception variables were the likelihood that the projected financial results would be achieved (ACHIEVE) and the likelihood that the projections were free from clerical and mathematical errors (ACCURACY). ACHIEVE was measured using a 10-point scale anchored at 0 with “definitely will not” and at 9 with “definitely will.” ACCURACY was also measured using a 10-point scale anchored at 0 with “definitely not accurate” and at 9 with “definitely accurate.”

The instrument also contained questions about the participants’ reliance on various components of the case in making their lending decision. Specifically, the participants were asked about the extent of their reliance on the reputation and personal background of the applicant, the applicant’s financial strength, the reputation of the franchisor, and the projected financial statements provided. In addition, the loan officers were asked about their familiarity with different levels of auditor involvement and with current presentation and reporting standards for prospective financial statements. The entire instrument, including demographic questions, was designed to take approximately 15 minutes to complete. The summarized case materials are reproduced in the Appendix.

RESULTS

Descriptive Results

The results provide some evidence that commercial loan officers use projected financial 9 The specific ratios included in the case materials were selected based upon Dietrich and Kaplan (1982) and Spiller and May (1997). 10 Two commercial loan officers from separate financial institutions provided guidance in the development of the case materials to ensure they were realistic and appropriate for the participants. After pretesting with samples of loan officers and Ph.D. students, modifications were made to condense and summarize the information to minimize the time commitment of participants. The study's participants reported the case materials to be reasonably easy to complete (mean (sd) of 5.47 (1.06) on a 7-point Likert scale with 1 = “Very Difficult” and 7 = “Very Easy”) and realistic (mean (sd) of 5.01 (1.15) on a 7-point Likert scale with 1 = "Very Unrealistic" and 7 = “Very Realistic”).



statements in their lending decision-making processes. Measured on an 8-point scale (with 0 = "no reliance" and 7 = "heavy reliance"), the projected financial statements had a mean reliance score of 4.58 (sd = 1.52). This score indicates that the participants perceived that they used the projected financial statements when evaluating the lending decision. However, the reliance placed on the applicant’s reputation and background (mean = 5.20, sd = 1.40) and the franchisor’s reputation and financial strength (mean = 5.08, sd = 1.49) were significantly higher (p < .05) than the reliance placed on the applicant’s financial strength (mean = 4.69, sd = 1.91) and the projected financial statements.

For the familiarity questions, the participants indicated a high familiarity with the different levels of auditor involvement with prospective financial statements. Specifically, using an 8-point scale (0 = “completely unfamiliar” and 7 = “very familiar”), the loan officers produced a mean rating of 5.95 (sd = 1.63). However, the results also suggest that the loan officers were only moderately familiar (mean = 3.92, sd = 1.81) with the current AICPA reporting standards for prospective financial statements. Results of Hypothesis Testing For hypothesis testing, a multivariate analysis of variance (MANOVA) was run initially to test for auditor involvement differences across the study’s primary dependent variables. The results indicated that the level of auditor involvement made a difference across the four dependent variables (Wilks’ Lambda F = 2.38, p = .01, observed power = .89).11 In addition, separate analyses of variance (ANOVAs) were performed for each of the four dependent measures to identify specific differences. As indicated in Table 2, Panel A, the ANOVA for the dependent measure ACCURACY indicated that there were significant differences in the means across levels of service (F = 8.66, p < .001, observed power = .96).12,13 Tukey’s HSD comparisons of the treatment means (presented in Panel B) indicated that perceived accuracy of the projections for the NONE group was significantly lower (p = .001) than the perceived accuracy for the COMPILE and EXAMINE groups. However, no significant difference was found between the means for the EXAMINE and COMPILE groups (p = .20). Thus, the first hypothesis is supported in part by the strong increase in perceived accuracy when auditors are involved with the projected financial statements, although the specific type of involvement appears inconsequential or undetectable with this specific task and sample size.

TABLE 2 Results for ACCURACY

Panel A: ANOVA Results

Dependent variable (Hypothesis)

Degrees of freedom

Sum of squares

Mean square

F-value

p-value

ACCURACY (H1): Level Error Total

2

59

61

32.49 110.75

143.24

16.25 1.88

8.66

.001

R-squared = .23 Observed Power = .96 11 Power is the probability that the statistical test will lead to rejection of the null hypothesis (Cohen, 1977). Observed power is the power of the test when the alternative hypothesis is set based on the observed values. 12 The data were also evaluated using non-parametric procedures (e.g., Kruskal-Wallis and Mann Whitney-Wilcoxon). In all cases, the nonparametric results mirrored those reported using parametric procedures. 13 One-tailed p-values are reported due to the directional nature of the hypotheses.



Panel B: Cell Means (standard deviations)

INVOLVEMENT N ACCURACY

(H1)

NONE

22

5.64

(1.59)

* COMPILE

21

6.81

(1.36)

EXAMINE

19

7.37

(1.07)

* Per Tukey’s HSD comparison, the NONE group’s mean is significantly lower than the COMPILE and EXAMINE groups’ means (p < .001 for both comparisons).

The results for the ACHIEVE variable provide partial support for the second hypothesis. In

particular, the overall ANOVA results in Table 3, Panel A, indicate significant differences among the groups (F = 3.40, p = .02, observed power = .62). Tukey’s HSD follow-ups with the treatment means (presented in Panel B) indicated that the no involvement group’s mean of 4.00 was lower (p < .05) than the two auditor involvement groups means (COMPILE mean = 4.90; EXAMINE mean = 5.26). For both treatment groups, auditor involvement shifted the means across the threshold (at 4.50) from "will not be achieved" to "will be achieved." As with the accuracy variable, no significant difference was found between the COMPILE and EXAMINE treatments (p = .20).

TABLE 3

Results for ACHIEVE



Degrees of freedom

Sum of squares

Mean square

F-value

p-value

ACHIEVE (H2): Level Error Total

2

59

61

17.30 150.26

167.56

8.65 2.55

3.40

.02

R-squared = .10 Observed Power = .62




INVOLVEMENT N ACHIEVE

(H2)

NONE

22

4.00

(1.63) *

COMPILE

21

4.90

(1.59)

EXAMINE

19

5.26

(1.56)


As with the perception variables, the ANOVA results for the GRANT variable in Table 4, Panel A, indicate significant differences among the treatment means (F = 4.11, p < .01, observed power = .76). Tukey’s HSD comparisons of the group means (presented in Panel B) revealed that the NONE group’s mean of 4.14 was significantly lower (p < .05) than the COMPILE group’s mean of 5.28 and the EXAMINE group’s mean of 5.58. Again, the auditor involvement treatments resulted in the means shifting across the midpoint threshold from "would not recommend" to "would recommend." No significant difference (p = .40) was found between the COMPILE and EXAMINE groups.

TABLE 4

Results for GRANT



Degrees of freedom

Sum of squares

Mean square

F-value

p-value

GRANT (H3): Level Error Total

2

59

61

23.82 171.03

194.85

11.91 2.90

4.11

.01

R-squared = .13

Observed Power = .76




INVOLVEMENT N GRANT

(H3)

NONE

22

4.14

(2.01) *

COMPILE

21

5.28

(1.58)

EXAMINE

19

5.58

(1.43)


Despite the significant findings for the first three variables, the results provide no support for the fourth hypothesis related to interest rate. Specifically, the overall ANOVA results for RATE in Table 5, Panel A, indicate no significant differences among the means for the three levels of auditor involvement (F = .11, p = .45, observed power = .07). Follow-up comparisons of the treatment group means in Panel B reveal that the group means (NONE mean = 2.10; COMPILE mean = 2.03; EXAMINE mean = 2.12) were almost identical to one another. These findings are consistent with other studies using a similar interest rate variable (e.g., Johnson et al., 1983; Johnson and Pany, 1984; Strawser, 1994) and support the notion that interest rate decisions are institutional matters and not left to the discretion of an individual loan officer.14

TABLE 5

Results for RATE Panel A: ANOVA Results


Degrees of freedom

Sum of squares

Mean square

F-value

p-value

RATE (H4): Level Error Total

2

57

59

0.08 22.05

22.13

.04

.39

0.11

.45

14 Responses to the interest rate question also may have been affected by the absence of certain information that is normally present in an actual lending situation. Variations in assumptions about factors such as the prevailing prime rate and the level of compensating balances, although randomized across subjects, may have affected the outcome of this study and confounded the results. For example, Sami & Schwartz (1992) suggested that banks often use compensating balances as an adjustment to the stated interest rate in a lending relationship.



R-squared = .01 Observed Power = .07 Panel B: Cell Means (standard deviations)

INVOLVEMENT N RATE

(H4)

NONE

22

2.10 (.61)

COMPILE

19*

2.03 (.41)

EXAMINE

19

2.12 (.79)

* Two participants failed to provide a response to the interest rate question.

DISCUSSION AND CONCLUSION Despite the usual limitations inherent to this type of field experiment (e.g., use of an artificial task with summarized information, lack of participant incentive), the study’s findings contribute to the auditor involvement literature and provide some insight into the changing market for audit and assurance services. In particular, the results provide support for the notion that auditor involvement with projected financial statements for a start-up company franchise is associated with increased perceptions of accuracy and achievability of those projections, as well as an increased likelihood of a loan being granted. From a research perspective, these findings expand understanding of auditor involvement effects in a number of ways.

First, the focus on projected financial statements introduces a unique new task domain in the study of prospective information. The use of projected financial statements related to a hypothetical start-up company introduced a level of uncertainty previously unexamined in the auditor involvement literature. Although not generalizable to all types of lending decisions, Samolyk (1997) indicates that start-up companies are viewed as synonymous with small businesses in terms of lending processes and decisions. Thus, the results of this study could reflect the type of high risk lending (e.g. small business lending) that is becoming increasing prevalent in commercial bank lending. Specifically, the market segment used in this study is becoming increasingly important to lending institutions because it represents a "significant exposure and source of revenue for insured institutions." (FDIC, 1998). The FDIC (1998) further notes that competition is intense for these loans and that larger banks are expanding their efforts in this area because it provides relatively high returns and can initiate long-term profitable business relationships. From a research perspective, future research should continue to evaluate whether start-up companies lead to different decision processes and outcomes (as suggested by Rosman et al., 1999) for commercial lenders, auditors, and other users of financial information.

Second, the findings of this study provide additional evidence that lenders rely on auditor involvement with prospective financial information, demonstrating the value of auditor services in the area. However, contrary to Strawser (1994), this study’s findings suggest that when it comes to projected financial statements for a start-up company, the specific type of involvement does not matter. Instead, in



this context, loan officers appear concerned primarily with auditor involvement in general. Although alternative explanations exist, this finding may simply reflect the auditor's limited ability to reduce information risk for projected financial statements, given the heavy reliance on hypothetical assumptions. In this case, the result arises from the lenders' inability to perceive a difference in assurance between a compilation and an examination. Future research should continue to evaluate the perceived efficacy of alternative assurance services related to projected statements to improve understanding of users' needs in the area. The study also has several practical implications. For example, the results provide some evidence that commercial loan officers use projected financial statements in their lending decision-making processes. Such information appears to be particularly relevant to loan officers who are concerned with balancing the interests of the loan applicant (e.g., the applicant needs the loan to commence operations) and the interests of the lending institution (e.g., the amount of risk that the institution is willing to assume). It should be noted, however, that other factors (e.g., the reputation and personal background of the owner and the reputation and financial strength of the franchisor) were relied upon more heavily than were the projected financial statements. Nevertheless, the results suggest that entrepreneurs can significantly improve the chance of obtaining bank financing by submitting projected financial statements that have been compiled or examined by a CPA firm. For the public accounting profession, the evidence highlights the perceived value of auditor services. In the current environment of concern about the growth of assurance services, accounting firms could consider these results in their searches for viable service opportunities in their entrepreneurial practice divisions. From a public policy standpoint, the results suggest that commercial loan officers are not fully aware of certain aspects of the new reporting standards. The participants in this study indicated only moderate familiarity with the specifics of the presentation and reporting guidance embodied in the professional literature. Specifically, although the participants indicated a high familiarity with the different levels of auditor involvement with prospective financial statements, their familiarity with the presentation and reporting guidelines was relatively low. Thus, it appears that there may be a need for further education of issuers and users. While the evidence from the current and prior studies supports the value of auditor involvement with forecasts for existing businesses and projections for start-up franchise businesses, the stream of research is not yet complete. Future research may enhance our understanding of how auditor involvement affects lending decisions by focusing on the decision-making process itself. Further, there are other types of prospective financial information, such as partial presentations, and other types of services, such as agreed upon procedures, that have yet to be studied.



REFERENCES American Institute of Certified Public Accountants. (1992), Professional Standards, Volume 1. New York:

AICPA. _______. (1989), Statements on Standards for Attestation Engagements No. 1. New York: AICPA. _______. (1986), Guide for Prospective Financial Statements. New York: AICPA. _______. (1985), Statement on Standards for Accountants’ Services on Prospective Financial Statements.

New York: AICPA. Andrews, A.R. and Simonetti, Jr., G. (1996), “Tort reform revolution”, Journal of Accountancy,

September, pp. 53-55. Arens, A.A. and Loebbecke, J.K. (1997), Auditing: An Integrated Approach (7th Edition). Upper Saddle

River, New Jersey: Prentice Hall. Bandyopadhyay, S.P. and Francis, J.R. (1995), “The economic effect of differing levels of auditor

assurance on bankers’ lending decisions”, Canadian Journal of Administrative Sciences, Vol. 12, pp. 238-249.

Berton, L. (1996), “Accountants expand scope of audit work”, The Wall Street Journal, June 17, p. B1. Cohen, J. (1977), Statistical Power Analysis for the Behavioral Sciences (Revised Edition). Orlando, FL:

Academic Press, Inc. Danos, P., Holt, D.L. and Imhoff, Jr., E.A. (1989), “The use of accounting information in bank lending

decisions”, Accounting, Organizations and Society, Vol. 14, pp. 235-246. Dietrich, J.R. and Kaplan, R.S. (1982), “Empirical analysis of the commercial loan classification decision”,

The Accounting Review, Vol. 57, pp. 18-38. Elliott, R.K. (1995), “The future of assurance services: Implications for academia”, Accounting Horizons,

Vol. 9, pp. 118-127.



Estes, R. and Reimer, M. (1977), “A study of the effects of qualified auditors’ opinions on bankers’ lending

decisions”, Accounting and Business Research, Autumn, pp. 250-259. Federal Deposit Insurance Corporation (1998), “Will credit scoring transform the market for small-business

lending?” Federal Deposit Insurance Corporation website, www.fdic.gov/publish/regout/ro19972q/boston/sml_buns/sml_buns.htm.

Johnson, D.A., Pany, K. and White, R. (1983), “Audit reports and the loan decision: Actions and

perceptions”, Auditing: A Journal of Practice & Theory, Vol. 2, pp. 38-51. Johnson, D.A. and Pany, K. (1984), “Forecasts, auditor review, and bank loan decisions”, Journal of

Accounting Research, Vol. 22, pp. 731-743. Jones, S.L. (1992), “How to obtain a small business loan”, Economic Development Review, Spring, pp. 74-

77. Libby, R. (1979), “The impact of uncertainty reporting on the loan decision”, Journal of Accounting

Research, Supplement, pp. 35-57. Pincus, A.J. (1996), “The reform act: What CPAs should know”, Journal of Accountancy, September, pp.

55-58. Reinstein, A. and Hansen, R. (1992), “Incorporating attestation standards and prospective financial

information into the college curriculum”, Accounting Educators’ Journal, Vol. 4, pp. 124-142. Rosman, A.J., Seol, I. and Biggs, S.F. (1999), “The effect of stage of development and financial health on

auditor decision behavior in the going-concern task”, Auditing: A Journal of Practice & Theory, Spring, pp. 37-54.

Sami, H. and Schwartz, B.N. (1992), “Alternative pension liability disclosure and the effect on credit

evaluation: An experiment”, Behavioral Research in Accounting, Vol. 4, pp. 49-62.

Samolyk, K. (1997), “Small business credit markets: Why do we know so little about them?” FDIC Banking Review, Vol. 10, pp. 14-32.

Spiller, Jr., E.A. and May Jr., P.T. (1997), Financial Accounting (6th Edition). Houston, TX:

Dame Publications, Inc.

Strawser, J.R. (1994), “An investigation of the effect of accountant involvement with forecasts on the decisions and perceptions of commercial lenders”, Journal of Accounting, Auditing & Finance, Vol. 9, pp. 533-559.

Strischek, D. (1990), “Lending to quick lube shops”, The Journal of Commercial Bank Lending,

September, pp. 40-47. Wallace, W.A. (1995), Auditing (Third Edition), Cincinnati, Ohio: Southwestern College Publishing. Winters, A.J. (1975), “Bankers perceptions of unaudited financial statements”, CPA Journal, August, pp.

29-34.

APPENDIX SUMMARIZED CASE MATERIALS

SLED, Inc. Case Materials



You are a commercial loan officer of ABC National Bank, a regional banking institution. This morning you were visited by Sam Sullivan, representing SLED, Inc., a newly formed corporation. Sullivan has formed SLED, Inc. for the purpose of operating a Timely Tune franchise automotive service center. SLED, Inc. has requested financing from your bank for the acquisition of land, construction of a special purpose building, purchase of equipment and provision of working capital for the first three years of operations. The Loan Committee meets this afternoon and you must make a decision as to whether to recommend that this loan package be approved. Timely Tune is one of the two major, nationally known franchise operators of automotive service centers, with more than 500 franchise locations. A $25,000 franchise fee grants the exclusive right to operate a Timely Tune center within a specific geographic region for a term of 10 years. The franchise agreement also requires royalty payments of 7.5% of revenues and advertising fees of 9% of revenues. SLED, Inc. has requested loans totaling $340,965, which includes a $30,000 line of credit for the first 3 years of operations and $310,965 for the acquisition of a building and equipment that are estimated to cost $354,620. The loans will be secured by the assets of the company and will be guaranteed by Sullivan (that is, supported by his personal assets). Sam Sullivan is the President and sole stockholder of SLED, Inc., having contributed $100,000 for the initial capitalization of the company. Prior to today’s meeting you had never met Sullivan. You now know that Sam Sullivan, age 39, is an Air Force veteran and has over 10 years of experience in materials management, project development and strategic planning. He holds a Bachelors Degree in Business Administration from a local university. His credit report shows nothing unusual and his personal financial statement shows a net worth of nearly $100,000. Sullivan has provided you with projected financial statements of SLED, Inc. showing the projected results of operations, cash flows, and balance sheets for each of the next three years. The projected financial statements include a summary of significant accounting policies and assumptions used in the preparation of the projection. (No Auditor Involvement Treatment) SLED, Inc. has not employed an accounting firm to assess whether the projected financial statements have been prepared in accordance with standards established by the American Institute of Certified Public Accountants. The enclosed projected financial statements have been prepared by Sullivan and have not been compiled or examined by an independent certified public accounting firm. The projections are included herein, as well as certain ratios and industry averages for 1995 for comparative purposes. For the purpose of participating in this study, you may assume that the ratios are properly computed from the enclosed financial information. You may, of course, make other computations in answering the questions asked in this study, although it is not necessary that you do so. ** Case materials for the compilation and examination manipulations were identical to the no involvement scenario except that the appropriate auditor report was attached to the projected financial statements, and the italicized paragraph above was replaced with: (Auditor Compilation Treatment) SLED, Inc. has employed the services of a “Big Six” accounting firm to compile the projected financial statements that are included herein. A compilation engagement involves: assembly, to the extent necessary, of the prospective financial information; consideration of whether the assumptions or presentation are obviously inappropriate; and issuance of a compilation report in which the accountant expresses no conclusion or any other assurance. A copy of the compilation report is included with the projected financial statements. or (Auditor Examination Treatment) SLED, Inc. has employed the services of a “Big Six” accounting firm to examine the projected financial statements that are included herein. An examination engagement involves evaluation of: the preparation of the prospective financial information; the support underlying the assumptions; and the presentation of the prospective financial information for conformity with AICPA presentation guidelines, and issuance of an examination report. A copy of the examination report providing the accountants’ opinion is included with the projected financial statements.

SAMPLE QUESTION: 1. Circle the appropriate number on the following scale to indicate the likelihood you would (would not) recommend to the loan committee that your bank provide the requested financing to SLED, Inc.



Would Not

Recommend Would

Recommend

0 1 2 3 4 5 6 7 8 9

Definitely Would Not

Definitely

Would



THE EFFECTIVENESS OF ACCOUNTING LABS IN INTRODUCTORY ACCOUNTING CLASSES: AN

EMPIRICAL ANALYSIS

Dr. Nat R. Briscoe Northwestern State University

[email protected]

Dr. Terry W. Bechtel Northwestern State University

Ms. Melissa Aldredge

Northwestern State University

ABSTRACT The stated objective of accounting labs is to improve student learning and the retention of materials presented in introductory accounting courses. This technique stresses the concept of peer coaching through the use of upper division accounting students as mentors in the teaching process. The primary purpose of this study is to test whether this educational tool is an effective method for improving student performance on accounting exams. This issue is important to faculty and administrators to make the best use of limited academic resources. Students receiving lower grades on the initial introductory accounting exam were required to attend the accounting lab. The results of statistical analyses performed on subsequent exams relative to the first exam revealed the following: 1) the mean of the difference in the grades of those students attending the lab was significantly higher than those not required to attend and 2) there appeared to be a grade improvement trend for the semester for those attending while this trend was not evident for those not attending. The implications of these results for accounting education are discussed.

INTRODUCTION Test scores provide information to both students and instructors. In the main, the better students are the ones that act on exam results and seek help from their instructors. The students who do not do well on an examination in many cases continue on as before the examination, perhaps with the hope of “muddling through.” This behavior is likely the manifestation of a number of possible factors including, but not limited to, poor study habits, time constraints due to work, family, or social obligations, or inadequate preparation for class. Some instructors behave like the students. That is, the examination results do not alter the instructor’s behavior. This is perhaps attributable to a laissez faire attitude rationalized by such statements as, “The students are adults” and “My door is always open.” The manifestation of the above noted behavior by both the students and the instructors is a significant dropout and failure rate in the introductory level accounting courses. The stated objective of accounting labs is to improve student learning and retention of materials presented in introductory accounting courses. This technique stresses the concept of peer coaching through the use of upper division accounting majors as mentors in the teaching process. It is believed that undergraduate students will seek help from other students before coming to their professors. Also, professors are often not available to their students or are too busy to address the mundane problems associated with introductory accounting courses. The primary purpose of this study is to test whether this educational tool is an effective method for improving student performance on accounting exams. This issue is important to faculty and administrators



to make the best use of limited financial and academic resources.

BACKGROUND

Accounting labs are used to assist students in introductory accounting courses. They are usually staffed with upper division accounting students. It has been shown that peer coaching can be an extremely effective way for people to learn (Cunningham and Honold, 1998 and Showers and Joyce, 1996). By using students to teach students, several benefits are gained; 1) the student can avoid direct contact with the professor, which can sometimes be intimidating, 2) there is a stop gap between the student and the professor, 3) students often feel more comfortable asking help from another student. Additionally, this concept of horizontal teaching has been effective in teaching administrators, educators, and executives (Hyman, 1990 and March, Peters, and Adler, 1994). Therefore, there is precedent for using peers to coach or teach students, and this aids the upper division students as well. These labs do consume academic and financial resources. It is for this reason that this study was done. If the costs of these labs outweigh the benefits derived from them, then the resources used should be channeled elsewhere. Conversely, if the labs are shown to be effective, then the costs can be justified.

METHODOLOGY Students in five sections of an introductory accounting class taught by three instructors were used in the study. They were segregated into treatment and control groups based upon their performance on the first examination given in the course. Those students scoring below a “C” on the first test were placed in the treatment groups and were required to spend at least two hours each week in the accounting lab. The two-hour requirement was chosen as it was considered to be the minimum time necessary to complete a typical accounting homework assignment. The balance of each class, the control groups, was not required to attend the lab. Additionally, the treatment groups were required to complete the homework assignment on the upcoming chapter prior to the lecture on that chapter. The homework was not evaluated on correctness, but on the effort put forth by the student.

Upper division accounting majors with grade point averages above 3.0 (on a 4.0 scale) staffed the accounting lab. They were instructed to answer all questions and work through all problems with the students and to offer assistance as needed. The students in the treatment group were told that they should consider the time spent in the lab each week as an additional assignment. Also, they were informed that, should they not attend the lab, their overall grade in the course would be lowered one percentage point for each assignment not completed.

The second examination was administered to both the control and treatment groups using normal classroom procedures. Another accounting faculty member who had no knowledge of the students’ group classification graded the tests.

The hypothesis tested was: Ho: Ut = Uc Ha: Ut > Uc Where: Ut = The population mean of the difference in the examination scores comparing the first and second examinations for students in the treatment group. Uc = The population mean of the difference in the examination scores comparing the first and second examinations for students in the control group. If the treatment, i.e., requiring lab attendance, is beneficial, the changes in the examination scores of the students in the treatment group should be statistically different from, and greater than, the changes in the examination scores of the students in the control group. The differences in the examination scores for both groups were calculated, and a one-tailed t-test for the difference in means of two independent samples



was used to investigate the hypothesis.

RESULTS

The means in the pooled sample on the second test were significantly lower than the means on the first test for the control group, -12.6421, while the means on the two tests for the treatment group remained almost constant, -0.1176. This decrease was expected due to the increased difficulty level of the material on the second examination as compared to the more fundamental material covered on the first examination.

Mean Meann Difference Std.Dev. n Difference Std.Dev. df t-statistic p value

Instructor A 31 -12.9355 13.1198 22 -0.0909 12.8542 51 3.5413 0.0004

Instructor B 19 -33.8947 11.8645 13 -15.4615 11.5659 30 4.3601 0.0001

Instructor C 45 -3.4667 22.0089 16 12.3125 20.9276 59 2.4937 0.0077

Pooled Sample 95 -12.6421 20.9822 51 -0.1176 18.535 144 3.7143a 0.0001b

CONTROL GROUP TREATMENT GROUP TEST RESULT

TABLE 1Results of One-tailed t-test

a=Z-test used due to the larger sample sizes. Alpha error (one-tailed test) = .02. b=Alpha error (one-tailed test) = .025.

The one-tailed t-test of the difference in means of the two groups revealed that the treatment group mean was significantly different and greater than the mean of the control group (p < .001). Therefore, the null hypothesis was rejected. This suggests that the accounting labs may an effective tool for increasing grades in introductory accounting classes.

DISCUSSION AND CONCLUSIONS

This study investigated the effectiveness of accounting labs in introductory accounting classes.

The results of the statistical analyses performed revealed the following: 1) the mean of the difference in grades of those students attending the lab was significantly higher than those not required to attend and 2) there appeared to be a grade improvement for those attending while this trend was not evident for those not attending.

As university resources become constrained, it is important that faculty and administrators make the best use of these limited financial resources. The results of this study suggest that the accounting lab does provide effective assistance to students in introductory accounting courses. Therefore, the funds necessary to finance the labs should be provided either through the university budgets or through lab fees collected from the students in these classes.

A further implication of this research is that the peer coaching helps to enhance the students’ ability and desire to learn. That students are able to get assistance from their contemporaries allows them to avoid direct contact with their professors. Many times the professors are unavailable or are unwilling to work one-on-one with students. This vehicle, the accounting lab, provides the help and reinforcement that students need early in their accounting program.



SELECTED REFERENCES

Cunningham, Ian and Linda Honold (1998). “Everyone Can Be a Coach.” HR

Magazine, June 1998, 63-66. Hyman, Ronald (1990). “Peer Coaching: Premises, Problems, Potential.” Educational Leadership, Volume 56, Number 1, September 1990, 52-57. March, Judith, Karen Peters, and Heidi Adler (1994). “Peer Coaching: Empowering Teachers while Accomplishing Management Goals.” HR Magazine, Spring 1994, 44-63. Showers, Beverly and Bruce Joyce (1996). “The Evolution of Peer Coaching.” Educational Leadership, Volume 53, Number 1, March 1996, 12-17.



THE EFFECTS OF PEER INFLUENCE ON TAXPAYERS' COMPLIANCE DECISIONS

Maroney, James J.


Rupert, Timothy J.


ABSTRACT

Prior studies have demonstrated an association between taxpayers’ compliance decisions and the compliance pattern of their peers. While these studies have found such an association, they have not been able to address the question of how the measure of peer influence affects taxpayers’ reporting decisions. For example, is there a direct effect, an indirect effect, or is the measure of peer influence merely correlated with other variables affecting taxpayers’ compliance decisions? This study contributes to the existing literature by not only examining the effects of peer influence on taxpayers’ compliance decisions, but by exploring potential explanations for how peer influence may affect these compliance decisions. The results suggest two major findings. First, taxpayers’ noncompliance behavior (understating the tax liability on a personal income tax return) increased as the number of their peers that understate their tax liability increased. Second, taxpayers who had previously received self-employment income had a larger number of peers that understated their tax liability than participants who had never received self-employment income.

INTRODUCTION Over the last two decades, the tax gap (the difference between the tax actually owed by taxpayers and the tax reported and collected) in the United States has skyrocketed to the point that its current magnitude is estimated to be as high as $100 billion per year (Guttman 1996). The sheer magnitude of this amount has attracted many researchers to investigate the cause of this noncompliance. One result of this increased interest is the emergence of a stream of research attempting to discover the factors that enter the taxpayer’s decision about compliance with the tax law. While factors such as probability of audit and severity of penalties are perhaps the most intensively researched influences, some attention has also been given to the compliance patterns of peers. While prior studies have demonstrated an association between taxpayers’ compliance decisions and the compliance patterns of their peers, they have not been able to address the question of how the measure of peer influence affects taxpayers’ reporting decisions. It is possible that peer influence has a direct effect or an indirect effect on compliance. Further, it is possible that the previously used measures of peer influence are merely correlated with other variables affecting taxpayers’ compliance decisions. The present study contributes to the existing literature by not only examining the effects of peer influence on taxpayers’ compliance decision, but by exploring potential explanations of how peer influence may affect these compliance decisions. To examine the effects of peer influence on taxpayer compliance behavior, survey data were gathered from 122 part-time adult accounting students. Additional demographic and attitudinal date were gathered from the participants in order to explore how peer influence affects tax compliance behavior.



LITERATURE REVIEW AND HYPOTHESES

Peer influence has long been recognized as a potential factor influencing the propensity for deviant behavior (Voss 1964; Jessor et al. 1968; Kaplan et al. 1987; Simon and Robertson 1989). In applying deviant behavior theories to tax evasion, Weigel et al. (1987) suggest several possible roles for peer influence. Social norms that stress the importance of individual wealth as one measure of success may facilitate tax evasion. In contrast, such behavior may be inhibited by norms of groups which disapprove of tax evasion. Weigel et al. suggest that further examination is needed to determine the relative importance of these roles of peer influence. The researchers who have empirically examined the impact of peer compliance further specify this influence with the assumption that it can be either direct or indirect. Peers can directly influence the compliance of a taxpayer by sharing methods of noncompliance. Vogel (1974) indicates that for his sample of Australian taxpayers, nearly sixty-five percent receive their only return preparation assistance from friends and relatives. Vogel concludes that his preparation assistance may also be accompanied by knowledge of successful techniques of noncompliance. This same type of influence can be seen with U.S. taxpayers. In their summary volumes of compliance research, Roth, Scholz, and Witte (1989) discuss a Westate (1980) finding that occupational groups quickly mandate to new employees how to report their income so as not to draw attention to either the new employee’s return or their own. As evidence of this, Rollins (1985) describes the arrangements domestics and their employers often make in order to evade the taxes for which both would be responsible without such an arrangement. Additionally, the IRS has announced plans to target a group of police officers from a large city after finding a high percentage of noncompliance for income from second jobs on a sampling of these returns (Tax Notes Nov. 12, 1990, p. 818). A more commonly hypothesized effect of peer compliance is an indirect influence on the taxpayer’s chosen position. This indirect influence on taxpayer compliance is most often posited to take the form of norms. Spicer (1986) suggests that norms concerning compliance act to change the benefits and costs in the decision to comply or not, often leading taxpayers to adopt the strategy, “If you cooperate, I’ll cooperate; if you defect, I’ll defect” (Spicer 1986, p. 16). Groenland and Van Veldhoven (1983) suggest a similar phenomenon among occupations. While it may not be a direct influence as in the sharing of noncompliance techniques, taxpayers in the same occupational group may develop similar attitudes about the tax system, including acceptability of noncompliance, since they may have experienced similar impacts of the tax law. When empirically investigating peer influence, researchers have operationalized peer influence in a number of different ways. However, these studies have consistently found peer influence to be an important factor in explaining compliance behavior. For example, Scott and Grasmick (1981) asked their sample of taxpayers from the Oklahoma City area to respond to a statement regarding the fear of others losing respect for them if they were discovered evading taxes. The result of their survey indicated that those who were more fearful of the disapproval of their peers were more likely to comply with the tax law.

Other survey studies have examined a more indirect operationalization of peer influence by asking about acquaintance with noncompliers. Two of these studies (Vogel 1974, Spicer and Lundstedt 1976) have examined the effect of being acquainted with other noncompliers. Vogel (1974) found that those taxpayers who report that they know someone who evades taxes are more likely to believe that they could successfully evade taxes. In addition, these taxpayers have a more negative attitude toward the tax system. Spicer and Lundstedt (1976) examine the relation between the number of perceived noncompliant peers with which the respondent is acquainted and likelihood that he/she will noncomply. In their regression analysis, Spicer and Lundstedt found a positive relationship between the number of evaders known and the score on a tax resistance scale.

By far the most common means of measuring the impact of peer influence on tax evasion involves an estimate of the number of noncompliers out of a given number of adults with whom the respondent is most familiar. Grasmick and Green (1980), Grasmick and Scott (1982), and Wallschutzky (1984) all found that the more tax evaders the respondent knew, the more likely the respondent would evade taxes.

These previous studies that used a survey methodology to investigate the effect of peer influence all measured compliance by asking respondents the likelihood that they would comply in the future. In contrast to this approach, several other studies have used an experimental methodology. For example, Hite (1988) presented her sample of prospective jurors with hypothetical scenarios in which they were presented



with an additional source of taxable income (i.e., $1,000 cash earnings from an extra job or $1,000 barter income). Hite hypothesized that descriptions of a compliant friend would promote compliance among subjects while descriptions of noncompliant friends would promote noncompliance. Thus, to operationalize peer influence, the scenarios included a statement that a close friend had also had the same type of income and had decided to either report it (compliant peer condition) or not report it (noncompliant peer condition). When comparing the amount that subjects indicated they would report in the hypothetical scenarios, Hite found no significant difference between the amount reported by subjects in the compliant peer condition and the amount reported by subjects in the noncompliant peer condition.

Similarly, Kaplan et al. (1986) included an examination of peer influence on taxpayer compliance in their experimental study. Subjects (introductory accounting students) were given a hypothetical scenario describing a taxpayer who had cheated on his tax return and thereby saved $1,600 in taxes. Using the notion of social norms to represent one type of peer influence, the authors operationalized this variable by dichotomizing the degree of consensus in society regarding such noncompliance. To represent high consensus, the scenario included the statement, “the frequency of tax evasion in the U.S. is great and becoming still greater. The type of evasion tactic noted in this case is especially common.” In contrast, the low consensus condition included the statement, “the percentage of American people who cheat on their taxes, in any material fashion, is very small. The type of evasion noted above is especially infrequent in use.” Kaplan et al. found that the level of consensus did not have a significant effect on the subjects belief that they would also evade taxes if they found themselves in the same circumstances.

In the present study, we build on the previous literature to examine the effect of peer influence. Like many of the survey studies, we measure peer influence by determining how many acquaintances the taxpayer knows who overstate their deductions or understate their income. However, unlike the previous survey studies, we do not relate this measure with a measure of intended future compliance. Instead, we relate the measure of peer compliance with actual compliance decisions made on prior tax returns. With these measures of peer influence and compliance, we test the following hypothesis:

H1: Taxpayer compliance behavior is associated with the tax compliance behavior of peers. As noted above, the previous literature on peer influence has found mixed results. While those

studies that have used a survey methodology have generally found a relation between peer influence and compliance decisions, the studies that have used an experimental methodology have not found such a relation to exist. Given these conflicting results, an understanding of those taxpayers who are most likely to be influenced by a strong peer influence is important. One group of taxpayers that the IRS has focused attention on has been self-employed taxpayers (Zeidner 1991). The present study extends previous research by determining whether those taxpayers who have previously received self-employment income have a greater number of peers who have understated their tax liability than taxpayers who have not received self-employment income. H2:Taxpayers who have previously earned self-employment income have a greater number of peers who have previously understated their tax liability than taxpayers who have not previously received self-employment income.

METHOD

Part-time adult students enrolled in introductory accounting, intermediate accounting, or auditing classes at a private urban university participated in this study. Demographic data gathered from the participants suggest that they were experienced taxpayers, rather than student subjects with little or no experience with tax returns. Specifically, only one of the 122 participants indicated that he/she had never filed a federal tax return. Approximately 76 percent of the participants reported that they normally prepare their own return, while the remaining participants indicated they used a paid preparer or received help from a friend or relative. Other demographic data, summarized in table 1, also suggest that these participants were experienced taxpayers. The majority of participants (65 percent) earned an average annual income between $25,000 and $50,000. Eighty-four percent had worked for six years or more, with 51 percent having worked more than 11 years. Sixty-one percent of the participants were female and 39 percent were males. Finally, the median age group was 25-34 years old.



Table 1 Demographic Data for Participants

(n = 122)

Percentage of Participantsa

Average Income

No Response 3 Less than $10,000 3 $10,000 - $14,999 3 $15,000 - $19,999 7 $20,000 - $24,999 6 $25,000 - $34,999 41 $35,000 - $50,000 24 $50,000 and over 13

Years Worked

No response 1 1 – 3 8 3 – 5 7 6 – 10 33 11 and over 51

Age Under 25 11 25 – 34 61 35 – 44 22 45 – 55 7

Gender Female 61

Male 39 a

Totals may not add to 100 percent due to rounding. Task and Procedures - Participants were first asked to complete a hypothetical tax judgment case that required the participants to provide the following items for a hypothetical taxpayer: the perceived fairness of taxing three specific components of income (salary, self-employment income and unemployment compensation); the perceived fairness of the hypothetical taxpayer’s overall tax burden; and the amount of self-employment income reported. After completing this case, the participants were asked to complete a questionnaire which gathered information about their prior tax compliance behavior, the prior tax compliance behavior of their peers and also various demographic and attitudinal data. To gather data about the participants’ prior tax compliance behavior, the participants were asked “In the past five years, have you ever understated your income on your federal income tax return?” and “In the past five years, have you ever overstated your deductions on your federal income tax return?” A dichotomous variable called “Tax Compliance Decision” was developed from these two questions and was coded 1 if a participant responded yes to either question, and 0 otherwise. The resulting variable (Tax Compliance Decision) was used as the dependent variable in testing Hypothesis 1.



To determine the tax compliance behavior of the participants’ peers, the participants were asked “Of your five closest friends, how many do you believe understate their income and/or overstate their deductions?” The potential choices ranged from 0 to 5 friends, with the resulting variable (Peer Compliance) used as the independent variable in testing Hypothesis 1 and the dependent variable in testing Hypothesis 2. The independent variable used to test Hypothesis 2 was a dichotomous variable developed from the participants’ response to the question “Have you ever earned self employment income?” This variable was coded as either 1 if the participant responded yes, or 0 if the response was no. In addition to providing responses about their own tax compliance behavior and that of their peers, the participants completed a questionnaire that elicited demographic information as well as attitudes and beliefs about the tax system and the government. Most participants completed the instrument in 20 minutes. To ensure that the participants did not feel pressure for demand effects, they were ensured that their anonymity would be preserved and that they could withdraw from the study at any time.

RESULTS

Analysis of Hypothesis 1 - The first hypothesis posits a positive association between the participants’ tax compliance behavior and the tax compliance behavior of their peers. This association is examined through the development of a logistic regression model, where the participants’ prior tax compliance behavior (Tax Compliance Decision) serves as the dependent variable and the tax compliance behavior of the participants’ peers (Peer Compliance) serves as the independent variable. As previously described, Tax Compliance Decision is a dichotomous variable coded 1 if the participant had either understated income or overstated deductions on their federal income tax return over the past five years, and 0 if they had not. Peer Compliance is the participants’ response to the following question: “Of your five closest friends, how many do you believe understate their income and/or overstate their deductions?” The potential responses range from 0 to 5 friends. The resulting logistic regression is: Tax Compliance Decision = b0 + b1Peer Compliance + e (1) The results, presented in table 2, provide strong support for H1 since Peer Compliance is significantly positively associated with the Tax Compliance Decision (p < .0001). Thus, the results indicate that as the number of a participant’s closest friends that have understated their tax liabilities increases (decreases), the likelihood that the participant has understated his or her tax liability also increases (decreases). Table 3 further illustrates the strength of this relation by comparing the participants’ tax compliance behavior to the number of peers who have previously understated their tax liability. For example, table 3 shows that of the 27 participants who do not have any close friends who have understated their tax liability, 15% of these participants have previously understated their own tax liability. However, for the 47 participants who have three or more friends who have understated their tax liability, 58% of these participants have previously understated their own tax liability. Thus, the tax noncompliance behavior for these participants is approximately four times greater than that of the participants who do not have any close friends who have understated their tax liability.



TABLE 2

Logistic Regression Results for Tax Compliance Decision

(N = 122) Variable

Coefficient

Wald

Significancea

Intercept (b0) -1.68 20.37 .0001

Peer Compliance (b1) .50 13.88 .0001 Model chi-square = 15.91, p < .0001 a All significance levels are one-tailed except for the intercept.

b

The Tax Compliance Decision Variable is coded 1 if the participant had either understated income or overstated deductions on his or her federal income tax return over the past five years, and 0 if he or she had not

TABLE 3 Comparison of Participants’ Tax Compliance Behavior to

The Tax Compliance Behavior of their Peers (N = 122)

Number of Peers Understating their Tax Liability

Percentage of Participants Understating their Tax Liability

Number of Participants

0 15% 27 1 25% 20 2 29% 28 3 58% 26

4 - 5 57% 27 Analysis of Hypothesis 2 - Since H1 finds a strong positive association between the participants’

tax compliance decisions and those of their peers, it is important to understand which groups of taxpayers are most likely to have a strong peer influence. H2 extends earlier tax research by examining whether taxpayers who have received self-employment income know a greater number of peers who have understated their tax liability than taxpayers who have not received self-employment income. Table 4 summarizes the mean number of peers who have understated their tax liability for each of these two groups. As indicated by table 4, the mean number of peers for taxpayers who have previously received self-employment income is 2.74, and it is 1.81 for taxpayers who have never earned self-employment income. To examine whether these two means are significantly different, a t-test was performed. The results of the t-test are consistent with H2 and indicate that the mean number of peers who have understated their tax liability is significantly greater for the group of taxpayers who have previously received self-employment income (p < .01).



TABLE 4 Comparison of Mean Number of Peers Who have Understated their Tax Liability between

Taxpayers with and without Prior Self-employment Income (N = 122)

Group Mean Number of

Peersa

Standard Deviation Number of Subjects

Prior Self-employment 2.74 1.81 34

No Prior Self-employment 1.81 1.43 88 a

The difference in the mean number of peers who have understated their tax liability between the two groups is significant (p < .01).

Additional Analysis - While H2 examines one factor that is significantly associated with the

variable that measures the strength of peer influence, other demographic and attitudinal data gathered from the participants may also be associated with this variable. To further understand the effect of peer influence on tax compliance behavior, an exploratory analysis was performed which examines the correlation between the measure of peer influence and the various demographic and attitudinal data gathered from the participants. Results of this analysis indicate that the age (p = .004, two-tailed test) and average income (p = .001, two-tailed test) of the participants were significantly positively correlated with the peer influence variable. In addition, a dichotomous variable coded 1 if the participant had previous training in tax (e.g., a tax class), and 0 otherwise, was also significantly positively correlated with the variable for peer influence (p = .005).

In contrast to the significant positive correlations for the demographic variables, a number of the attitudinal variables were significantly negatively correlated with the variable for peer influence. For example, the participants’ perceived fairness of the tax laws (p = .004, two-tailed test) and their perceived influence over the tax laws through the voting process (p = .011, two-tailed test), were significantly negatively correlated with the measure of peer influence. This indicates that as the number of the participants’ friends that understated their tax liability increased, the participants’ perceived fairness of the tax system and belief that they could influence the tax system through the voting process, decreased. Further, the frequency of voting in elections was also negatively correlated with the measure of peer influence (p = .021, two-tailed test). Implications of these findings are discussed in the conclusion section of the paper.

CONCLUSIONS

The primary purpose of this study is to investigate the effects of peer influence on taxpayers’ compliance decisions. The study provides two primary findings. First, taxpayers’ compliance decisions were positively associated with the tax compliance behavior of their peers. Thus, the participants’ noncompliance behavior (understating the tax liability on a personal tax return) increased (decreased), as the number of their peers that understate their tax liability increased (decreased). While we found an association between the measure of peer influence and the participants’ tax compliance behavior, this association does not necessarily imply causation. Thus, an important opportunity for future research is to further examine how peer influence affects taxpayers’ compliance decisions. An improved understanding of this relation has the potential for increasing the collection of tax revenue if Congress is able to develop tax policies and programs designed to mitigate the potential detrimental effects of peer influence. A second primary finding is that taxpayers who had previously received self-employment income had a larger number of peers that understated their tax liability than participants who had never received self-employment income. Additional analysis indicates that the measure of peer influence is also associated with several demographic and attitudinal variables. For example, as the age, average income and tax



training for the participants increases, the number of peers that understate their tax liability also increases. Conversely, as the participants’ perceived fairness of the tax system and belief that they could influence the tax system through the voting process decreases, the number of peers that understated their tax liability increases. These findings, particularly the negative correlation between the measure of peer influence and attitude towards the tax system, suggest ways in which tax policy makers may be able to address the detrimental effects of peer influence. For example, Congress may be able to develop programs and strategies which enhance taxpayers’ beliefs that they can influence the tax system. For example, the internet may provide Congress with an effective means to solicit feedback from their constituents on proposed tax policy. This expanded use of the internet may have the effect of developing more positive attitudes toward the tax system and may mitigate the detrimental effects of peer influence. Thus, this avenue of research provides an important opportunity for future tax researchers. There are several limitations of this study, which although they may limit the generalizability of the findings, also provide significant opportunities for future research. First, while the participants in this study were experienced taxpayers, they were from a single urban university. To strengthen the generalizability of our findings, future researchers should examine the issues addressed in this study with a broader range of taxpayers. A second limitation of this study relates to previous research (Elffers et al., 1987) which has shown that taxpayers may be reluctant to accurately reveal their actual tax evasion behavior. Thus, some participants in this study may have been reluctant to disclose their actual tax evasion behavior. However, to mitigate this potential concern we ensured the participants that their anonymity would be preserved and that they could withdraw from the study at any time. A final limitation of this study relates to the methodology used to gather the data for this study. We used a survey method since this method provided us with a means to obtain data on taxpayers’ actual tax compliance behavior. However, a weakness of survey methodology is that it is difficult to infer causality or direction from the data. While we found an association between the measure of peer influence and the participants’ tax compliance behavior, this association does not imply causation. Thus, the measure of peer influence may not be directly causing taxpayers’ noncompliance behavior, but may be merely correlated with other variables affecting this behavior. Future researchers should use other research methodologies (e.g., an experimental methodology) in order to strengthen our findings regarding the relation between peer influence and taxpayers’ compliance behavior.



REFERENCES Grasmick, and Green (1980). “ Legal Punishment, Social Disapproval and Internationalization of Inhibitors of Illegal Behavior.” Journal of Criminal Law and Criminology, Volume Seventy-One, Number Three, 325-335.

Grasmick, and Scott (1982). “Tax Evasion and Mechanisms of Social Control: A Comparison with Grand

and Petty Theft”. Journal of Economic Psychology, Volume Two, 213-230.

Groenland, and Van Veldhoven (1983). “Tax Evasion Behavior—A Psychological Framework.” Journal of Economic Psychology, Volume Three, 129-144.

Guttman (1996). “IRS Updates Estimates on Individual Tax Gap. ” Tax Notes, Volume Seventy-One, 857-

858.

Hite (1988). “An Examination of the Impact of Subject Selection on Hypothetical and Self-reported Taxpayer Noncompliance.” Journal of Economic Psychology, 1988 Dec, Volume Nine, Number Four, 445-466.

Jessor et al. (1968). “Expectations of Need Satisfaction and Drinking Patterns of College Students.”

Quarterly Journal of Studies on Alcohol, 1968, Volume Twenty-nine, Number One-A, 101-116. Rollins (1985). “ Between Women: Domestics and Their Employers”. Philadelphia: Temple University

Press. Spicer (1986). “ Civilization at a Discount: the Problem of Tax Evasion.” National Tax Journal, Volume

Thirty-Nine, Number One, 13-20. Spicer and Lundstedt (1976). “Understanding Tax Evasion.” Public Finance, Volume Thirty-One, Number

two, 295-305. Vogel (1974). “ Taxation and Public Opinion in Sweden: An Interpretation of Recent Survey Data.”

National Tax Journal, Volume Twenty-Seven, December 1974, 499-513. Voss (1964). “ Differential Association and Reported Delinquent Behavior: A Replication.” Social

Problems, Volume Twelve, Number One, 78-85. Wallschutzky (1984). “Possible Causes of Tax Evasion.” Journal of Economic Psychology, 2:187-211. Westat Inc. (1980). “A Research Design for the Study of Individual Income Tax Compliance”. Study for

the Internal Revenue Service, Rockville, Md.: Westat, Inc. Zeidner (1991). “Lower Audit Rate Doesn’t Mean Less Scrutiny.” Tax Notes, Volume Fifty-Three, 1001-

1002.



THE GENDER DIFFERENCE IN THE DURATION OF FACULTY EMPLOYMENT IN THE NEW YORK

STATE

Joan M. Magratten Pace University

[email protected]

ABSTRACT

Despite individual differences, society does not expect differences in performance that are predictable by group membership, where group membership is based on a characteristic of birth rather than acquired skill, according to Leinhardt et at. (1979). Brazelton (1998), however, asserts that if one or more causes of any disparity can be identified, the potential to alter the situation exists. This paper investigates whether there was any gender differences in the average duration of employment for the accounting faculty teaching at institutions of higher learning. The paper also looks at any possible differences in the employment duration of accounting faculty between public versus private institutions and between those that hold terminal degrees versus those that do not. The sample consists of 56 schools that have accounting program(s) in the state of New York.



THE GRINCH WHO STOLE POST-RETIREMENT BENEFITS

English, Richard Augustana College

[email protected]

ABSTRACT

This paper will discuss an actual case involving a unionized employer that eliminates post-retirement medical benefits. The company argues that the reduction is permitted by the contract. The retired employees argue that they had given up increases in their retirement pay to guarantee their medical benefits for life.

The introduction will trace the history of the employer and provide some background on the company/union relations. The paper will also discuss some reasons why the company would want to eliminate post-retirement medical benefits. The problems will be examined from both employer and employee perspectives.

The case involves ethics, management, accounting, finance and legal implications. The case also contains an endnote section.

“I think the guy who owns the company is the Grinch who stole Christmas” was the comment of State Senator Karen Muenster on hearing that the John Morrell Company filed a lawsuit on December 18, 1991 to be allowed to reduce or eliminate post-retirement healthcare benefits. (Trautmann 12/22/91)

INTRODUCTION

For a major part of the 20th Century the John Morrell & Company was the largest employer in Sioux Falls, SD. Throughout the last half of the century the town grew from 40,000 to 100,000. Morrell employed about 3,000 people during these years. Other major employers now include Citibank and a hospital, both with over 3,000 employees. But in its early history, the meat plant was the major employer with the best paid jobs and best retirement benefits. A job with Morrell was “so desirable that job applicants had to know somebody inside to be hired.” (Schmidt 9/11/94) One lady took her husband’s job when he died and stayed twenty-eight years so she could support her family. The plant was built in 1909 and was basically a vertical disassembly plant. Animals were brought to the top floor - up a ramp under their own power. They would be killed there and processed into various products. The products came down the line in progressively smaller units to drop to the next lower floor until they were packaged and shipped from the first floor.

Although South Dakota is a “right to work state” (meaning a person cannot be forced to join a union) the Morrell plant was unionized in 1936. In general, the union/management relations were good, although there was a bitter strike in the 30's to get the union established.

In the 70s the meat packer was acquired by United Brands. It was operated as a relatively independent subsidiary. The company found increased competition from Iowa Beef Processing (IBP) and other packers that had much more modern plants. United Brands found the business generally unprofitable and threatened closure, even as they sought out a purchaser for the business. The Morrell Division was accounted for as a discontinued operation on financial statements for two years. Later, they “un-discontinued” the accounting for the division thus having to include Morrell’s results in the operations of the United Brands Company. A year later the division was sold to Smithfield Products, a large meat packer from the East Coast.



HEALTHCARE – THE PROBLEM: John Morrell & Company had provided medical coverage for their employees and retirees since at least the 1950s. The coverage did not appear to even be a matter of interest in contract negotiations for several contracts. Although the wording related to retiree Health Medical-Surgical (HMS) changed from the 1973 to 1976 contracts, the company continued to pay for retiree HMS. Morrell sent a letter to the union on July 12, 1979 stating that “the company intends to announce that effective September 1, 1979, the company will extend the following benefit programs to retirees currently covered by a company HMS and who have retired prior to September 1, 1979. (U.S. District Court).” In fact, the company continued the coverage. During legal strikes, the company continued striking workers HMS benefits only if they paid for them. However, the company continued to provide benefits to retirees throughout the strike at company expense. So, it came as a shock to the retirees when notice of the lawsuit was sent to them only a week before Christmas. John Morrell & Company initially filed suit against the United Food and Commercial Workers’ Union in December 17, 1991. The suit was to allow the company to change and reduce post-retirement healthcare benefits for workers who retired before April 2, 1989. Alternatively the suit sought a court order to require the union to negotiate changes in retiree health benefits. The company lawyer stated that the benefit changes were “relatively minor” and in line with rising national health costs. He asserted that the 1985 contract allowed changes in benefits for retired workers. The changes would include a premium of $18 per month for the retiree and $18 per month for the spouse plus higher deductibles. (Trautmann 12-22-91)

The union members felt they had contracted for the benefits for life. The workers gave up pension money in return for what they thought were guaranteed benefits. In earlier contracts, it was a requirement that retirees take a joint and survivor annuity in order to cover their spouse and dependents. If they only took a single life pension the medical coverage ended at the end of the month of the death of the retiree. A joint and survivor annuity, because it covers two lives, provides a smaller monthly payment. One example (Exhibit One) shows the information sheet of one person who retired at age sixty in 1985. He retired then to ensure his pension benefits under the union contract. “I took a lesser pension, so I could cover my wife. Now if we lose the insurance, why should we have taken less pension?” (Schmidt 7-12-93) He took about $35 per month less to cover his wife. After losing benefits, he would have to spend about $300 per month out of his $498 pension payment for healthcare insurance to cover both him and his wife. The company insurance had also covered pharmaceuticals. Their current insurance and Medicare do not. In the dissenting opinion of Judge Heaney, he stated, “Upon the death of a retiree who elected joint survivorship benefits, Morrell informed the surviving spouse that health benefits would continue until the spouse died or remarried.” (8th US Court of Appeals) At the trial several Union members testified they had been told that health benefits would be for life. One union member testified, “I was told (by management) that I would have the benefits for the rest of my life… If I left the percentage in there for my wife, she would receive benefits for the rest of her life…” (US 8th Circuit Court of Appeals) In addition, one person testified he tried to take a one life annuity when he retired. His supervisor told him to take the joint and survivor annuity because he would get HMS for both him and his wife and “the only way you can lose that health insurance is if the company went belly up and went broke.” However, the Assistant Manager for Benefits for Morrell in Sioux Falls, testified that “it was our standard practice to advise that their pensions were guaranteed and fixed, but their (HMS) benefits were not.” (8th US Circuit Court of Appeals) The employees who retired early did not have Medicare benefits and many had become uninsurable at reasonable rates or at any cost. (Schmidt 7-12-93)

On June 24, 1993, Judge Richard Battey of the U.S. District Court ruled that Morrell could reduce or eliminate healthcare benefits for 3,300 retired employees. He stated there was nothing in the half-dozen contracts with workers that guarantees healthcare benefits for life. (Schmidt 7-12-93) He concluded that the retirees are not entitled to the same benefits they negotiated when they worked in the plant. One employee retired in March of 1989 at age fifty so that he could guarantee his benefits. According to the judge, the guarantee ran out when the contract expired.

In October of 1994, the US 8th Circuit Court of Appeals upheld Judge Battey’s ruling even though the company had provided post-retirement healthcare benefits for more than forty years. The vote was 2-1. The two stated that the union “had not proved the benefits were promised for life.” The third judge disagreed strongly, stating there were two possible reasons Morrell never told the union “it retained the right to terminate retiree health benefits at the end of a collective bargaining agreement. First, Morrell knew it had no right to do so… Second, Morrell knew that its assertion of such a right after more than forty



years of give and take bargaining involving the issue would trigger a work stoppage.” (8th US Circuit Court of Appeals) Three months later the company notified retirees that they would no longer have health benefits.

QUESTIONS

1. Does John Morrell & Company have a responsibility to retirees that is different than current

employees? 2. Provide in terms of rights and justice arguments why healthcare benefits can be eliminated. 3. Provide in terms of rights and justice arguments why healthcare benefits cannot be eliminated. 4. What arguments could be made for or against continued coverage of retirees?

LEGAL ASPECTS: The United Food and Commercial Workers Union and John Morrell & Company had been parties to Master Agreements—the collective bargaining agreements (CBA) made with other major meat packers. They used what is called “pattern bargaining.” The United Food and Commercial Workers Union would negotiate an agreement with one company and the rest would follow the pattern. This was convenient for the companies because it equalized labor costs, benefits and working conditions. It kept everyone competitive. Contracts between Morrell and the UCFW “contained an Appendix F which detailed the health benefits (US District Court). The courts (both the District Court and the US 8th Circuit Court of Appeals) spent a great deal of time exploring the history of HMS in these contracts. The earliest quoted contract is one terminating August 31, 1964, that states, “The HMS benefits… shall continue to be made available to present covered retirees who have been carrying such insurance…” and that “all retirees who are carrying such insurance coverage as of December, 1967, shall be furnished such insurance thereafter at company expense.” (US District Court) In this 1973 CBA continued the language including retirees. However, the 1973 contract included a duration clause, that stated the HMS “will remain in effect for the duration of the agreement.” There was an additional change in the 1976 CBA. The contract omitted reference to “all retirees currently furnished HMS coverage.” (US District Court) Note that ERISA was passed in 1974. Also, the court noted that the Allied Chemical and Alkali Workers of America, Local Union v. Pittsburg Plate and Glass Co., Chem. Div., 404 US 15792 S.CT 383.30L.Ed.2d 341 (1971) held that retired workers were not part of the bargaining units. UFCW had not been elected as representing the retirees and Morrell did not have to recognize them as representing retirees. The court infers this omission was intentional.

The 1979 CBA contains clauses similar to 1976 in that employees retiring under the 1979 CBA had to take joint and survivor annuity to cover a spouse after the retiree’s death. It also included a duration clause limiting coverage to retirees retiring after September 1, 1979. In addition, the company sent a letter to the union stating that “the company has taken the position that it has no legal obligation to bargain with the Union with respect to the benefits of past retirees.” As stated earlier, they intended to cover past retirees as a matter of policy. (US District Court) The union testified it understood what the company’s position was. The 1982 and 1985 CBA’s continued the definitions of covered employees and the duration clause. ERISA puts employee benefit plans under a different category than pension plans. They are also treated differently. ERISA subjected pension plans to very strict vesting requirements. The court found the welfare plans to have costs that are “unpredictable” and therefore hard to accrue. (US District Court) The court also pointed out that rights under a labor contract do not generally extend beyond the term of the CBA. Although the parties can contract to extend those rights if they do so “unambiguously.” (US District Court) The court found that ERISA did not prohibit the company from making changes or eliminating benefits. It found that the CBA’s “unambiguously provide that the HMS plan would remain in effect for the duration of the CBA.” The court also found that Morrell’s coverage of retirees was a matter of policy that could be changed. The US 8th Circuit Court of Appeals agreed on a 2 to 1 vote. The dissenting judge issued a strongly worded opinion. Basically he said the company and the union had a bargain and that the company refused to be held to its bargain. Morrell did not attempt to refute testimony that they had



promised lifelong benefits. The company and the union in fact bargained for retiree benefits and it was only because of economic reversals that the company wanted out of the bargain. (8th US Circuit Court of Appeals)

THE ACCOUNTING PROBLEM: In December of 1990, the Federal Accounting Standards Board (FASB) issued FAS 106 “Employers’ Accounting for Post-Retirement Benefits other than Pensions.” The effective date was for fiscal years beginning after December 15, 1992. This statement required Accrual Accounting for Post-Retirement Health Benefits just as prior statements required Accrual Accounting for Pensions. Because of this, Morrell would have to accrue a “$15 million dollar expense.” (Schmidt 2-19-95) Obviously, if that could be eliminated, it would be a “plus” as the parent attempted to sell its packing company. United Brands finally sold Morrell to Smithfield Products in 1995. Notice that the company’s law suit was filed within a year of the issue date of the FAS. Also notice, the company sold Morrell within months after the favorable ruling at the 8th Circuit. If one looks at Exhibit Two, one can see there may be a relationship between FAS 106 and the retirees’ healthcare benefits. John Morrell & Company was for sale. What better way to make the packing business more attractive than eliminating the $15 million expense?

EXHIBIT ONE RETIREMENT INFORMATION

I. Vacation Pay Any weeks of vacation that you have not used for the current year plus any

prorated vacation will be paid on the date of retirement. II. Retirement Checks You should receive your first retirement check in 8 to 12 weeks from the

date of retirement and retirement checks are generally paid between the first and the fifth of every month.

III. PCS Cards You should receive your retirement PCS care 8 to 12 weeks from the date of

retirement also. Claim forms are available until your new card arrives.

IV. Approximate Pension Figures $15.00 per Year of Service:

For Life - Employee

If Retiree Dies Spouse for Life

Credit Service to 1-1-84 35.1 1. Normal Position

540.00 None

Approx. Service for 1984 .9 2. 50% Option 498.00 249.00

TOTAL 36.0 3. 100% Option

444.80 444.80

V. Life Insurance

A. Employees who retire with 20 years or more of credited service will be provided with life insurance in the amount of $1,000 free.

B. You may convert the balance or any part thereof of your life insurance at the current age rate

premium by contacting the Hartford Life Insurance Company within 31 days from date of retirement.

VI. Medical Insurance

A. For each calendar year, the Health Plan will pay: -80% of the first $2,000 of covered expenses -90% of the next $3,000of covered expenses -100 % of the remaining covered expenses



A total combined deductible of $200/person each calendar year, maximum of pocket expense of $900 per family. Medicare deductible applies to Morrell deductible.

Outpatient Diagnostic Treatment - 90% of covered expenses (deductible does not apply; however the 10% unpaid amount does apply to the $200 deductible. This applies to Outpatient Surgery, Routine Diagnostic x-rays, and Laboratory work, Emergency Care and treatment of accident victims.

B. Vision Care Schedule per Active Plan. Eyewear can be purchased locally. C. PCS coverage continued - $2.00 deductible. HCS continued also. D. Reimburse retirees and spouse $8.70 each for their Plan B Medicare payments when

eligible for Medicare. The company will need a copy of the Medicare card. E. Discontinuation of Dental Care Plan

For continued healthcare benefits for an employee’s spouse and dependents beyond the life of the retiree,

employee must select a Joint & Survivor Form of Pension.

EXHIBIT ONE

EXPLANATION OF PENSION OPTIONS

1. Normal Form Pension 2. This form of payment provides a monthly pension to you for as long as you live. There

are no survivor’s benefits of any kind attached to this form of payment 3. 50% Joint & Survivor Pension

This form of payment provides a monthly pension to you for as long as you live. Upon your death, your surviving spouse will receive monthly payments equal to 50% of the amount of your monthly payments, and such payments will be made for the rest of his or her life.

4. 100% Joint and Survivor Pension This form of payment provides a monthly pension to you for as long as you live.

Upon your death, your surviving spouse will receive monthly payments in the same amount as you had received each month, and such payments will be made for the rest of his or her life.

EXHIBIT TWO KEY DATES

12/90 Issue FAS 106

12/17/91 Initial lawsuit to eliminate or change post-retirement benefits.

12/31/91 Restraining Order by Judge Richard Battey 12/15/92 Effective date of FAS 106



6/93 Judge Richard Battey rules Morrell can

reduce or eliminate post-retirement healthcare benefits.

10/12/94 US 8th Circuit Court of Appeals upholds

Judge Battey’s decision on 2 to 1 vote 1/31/95 John Morrell & Company cuts post-

retirement health care benefits for retirees younger than 65.

3/31/95 John Morrell & Company cuts post-

retirement healthcare benefits for retirees older than 65.

1995 John Morrell & Company is sold to

Smithfield Products



TEACHING NOTES

The case concerns a corporate management that decides to eliminate post-retirement healthcare benefits after more than forty years. The court approves the withdrawal of these benefits. As a side note, an accounting issue is brought up that may explain why the company may be taking this action. Another side note deals with labor contracts and ERISA.

The case could be used in accounting, business ethics, management, economics, labor management relations, business law, labor law and public relations.

TEACHING OBJECTIVES

The case could be taught as a straightforward ethics case – fairness to employees and contractual rights. From the accounting perspective it can be used to show unintended effects of changes in accounting requirements. The case can also be used to show how ethical issues and accounting issues can be interrelated. The case has extensive discussions of ERISA and labor contract issues.

DISCIPLINARY IMPACT

This is obviously a business ethics case, since it involves fairness to employees and contractual ethics. The students can see this case from a management perspective, Questions 2 and 3 are from an employee perspective. Finance classes could examine the impact of contractual changes on the financial attractiveness of a business for sale. Business law has an obvious interest in a case that has gone to the Circuit Court of Appeals on contractual matters. Business law also has an interest in the environment of business area.



REFERENCES

FAS 106 Employees’ Accounting for Post-Retirement Benefits Other Than Pensions Available: http://www.rutgers.edu/Accounting/raw/fasb/st/summary/stsum106.htm

John Morrell & Company v. United Food and Commercial Workers International Union, AFL-CIO.

United States Court of Appeals, Eighth Circuit, 37 Federal Reporter, 3d Series 1302 John Morrell & Company v. United Food and Commercial Workers International Union, AFL-CIO.

United States District Court, D. South Dakota, 825 Federal Supplement 1440. Schmidt, Brenda Wade “Possible Loss of Health Benefits Leaves Retirees Sick About Future.” Sioux Falls

Argus Leader, 12 July 1993, Sec. A, p.1. ---------- “Life After Morrell,” Sioux Falls Argus Leader, 11 Sept. 1994, Sec. A, p. 1. ---------- “Judges Let Morrell Cut Benefits,” Sioux Falls Argus Leader, 4 Nov. 1994, Sec. B, p.1. ---------- “Morrell Retirees Try to Keep Spirits Up After Sudden Loss of Health Insurance,” Sioux Falls

Argus Leader, 19 Feb. 1995, Sec. A, p.1. Trautmann, Mike “Morrell’s Lawsuit Criticized.” Sioux Falls Argus Leader. 22 December 1991 Sec. C, p.1. Zwak, Garrit. Personal Interview. 8 Nov. 1999.



THE IMPLICATIONS OF ACCOUNTANTS’ AWARENESS AND ATTITUDES TOWARDS INTERNATIONAL QUALITY STANDARDS

Cable Roberta J., Ph.D., CMA

Pace University [email protected]

Healy, Patricia, CPA, CMA

Pace University [email protected]

The ISO 9000 series of international standards certify a company’s quality systems. Their purpose

was to facilitate international trade by providing a level of assurance about the quality standards of any particular company. The need for this certification has been quickly recognized in companies that do business in the European Common Market but the drive for certification has been less accepted for US based companies. The importance of the export market though has provided an incentive for US companies to seek this certification. This research focuses on the implications for accountants, who play an important role in providing system information and measurement tools for quality systems in any company.

The research compared the attitudes and awareness of CPA’s with those of corporate controllers about the need for achieving ISO 9000 certification. There were very few statistically significant differences between CPA’s and corporate controllers in their awareness and attitudes. Both groups agreed that the benefits of achieving this certification exceeded the costs over the long run. Most saw the benefits to the company as a whole of increasing employee awareness of quality as one of the major benefits of the certification process. Both groups were also felt that it was important to include quality issues and ISO requirements as a part of accounting education in the US. The point where there were major differences for the two groups was in the impact of certification on sales. Corporate controllers were significantly more optimistic that certification would increase their market share. Controllers were also slightly more aware that the benefits of certification applied to large as well as small companies. Quality certification through the ISO standards continues to be a point of competitive advantage for companies. One of the most important results from our survey was that less than 40% of the respondents really had a familiarity with the ISO standards. As one of the key participants in companies information systems, accountants must become more involved in the issue of quality measurement and quality standards.



THE INFORMATIONAL CONTENT OF ACCOUNTING FOR DERIVATIVES AND

HEDGING ACTIVITIES

Seay, Sharon Mississippi College

[email protected]

Eduardo, Marcelo Mississippi College [email protected]

ABSTRACT

Financial statements are essential to the provision of quantitative information necessary to make economic decisions. FASB Statement No. 133 establishes accounting and reporting standards for derivative instruments and for hedging activities. By requiring firms to recognize all derivatives as either assets or liabilities in the statement of financial position and measure those financial instruments at fair market value, FASB 133 may improve financial disclosure and provide an enhanced picture of the firm. This paper tests whether this mandatory disclosure requirement possesses additional information and improves the quality of financial reporting. A market model is used to determine normal returns. These returns are then compared to actual returns during the event period to compute excess returns. These excess returns capture the effect of the derivative and hedging instruments disclosure requirement on equity prices. The results suggest that the additional disclosure required by FASB 133 would provide information of value to the financial markets as evidenced by the significant equity price reaction to the standard. These results are consistent with contracting and political cost hypotheses.

INTRODUCTION

Prior research confirms that derivative use is significant and not restricted by industry (Phillips, 1995). Firms of all sizes across a broad range of industries are using derivatives to manage financial risk exposure, obtain funding, or for investing. Previous studies indicate a distinct relationship between size and derivatives use (Phillips, 1995). This finding is consistent with the positive association between size and risk exposure.

In response to increasing risk exposure from rapidly changing global financial markets, companies have developed and used a variety of financial instruments to manage or hedge the increased financial risk. FASB has had difficulty keeping abreast of the myriad of financial instruments being developed. Previous pronouncements have provided rules on accounting for derivatives, but were somewhat piecemeal, inconsistent, and incomplete since only a few types of instruments were specified. Derivatives related losses and resultant lawsuits in recent years have given rise to demands for more stringent regulation and disclosure of derivative activity (Horowitz and Mackey, 1996; and Miller and Culp, 1996). Others have opposed such regulation.

On June 15, 1998, FASB, after years of deliberation and much public debate for more and less disclosure, issued SFAS 133, Accounting for Derivative Instruments and Hedging Activities. SFAS 133 provides the accounting and reporting requirements for derivative financial instruments and for derivative instruments used as hedges and represents a major change in hedge accounting. The standard applies to quarterly and annual financial statements. The current standard is an attempt by FASB to increase the visibility, comparability, and understandability of the risks of holding derivatives (Wilson, 1998). This is accomplished by requiring all entities in all industries to report derivative financial instruments at fair market value as assets or liabilities in the statement of financial position. If the derivative is not used as a



hedge, the change in fair value of the derivative for the accounting period is reported as a component of income from continuing operations. If the derivative is used as a hedge, accounting for the change in value of the derivative depends on the type of hedged activity and is reported in current earnings or comprehensive income as appropriate. In summary, Statement no. 133 requires companies to report in their earnings any changes in value of derivatives that don’t balance out a loss or gain on the instrument they are supposed to hedge.

SFAS 137 issued June 15, 1999 delayed effective implementation of SFAS 133 one year---fiscal years beginning after June 15, 2000. The Board cited concerns about companies’ needs to modify information systems and educate managers on how to implement the new standard. SFAS 133 provides companies with comprehensive rules for all hedging activities and derivatives, including financial instruments not yet developed, thereby reducing the incompleteness and lack of consistency of previous guidance and practice. SFAS 133 has implications for both users and preparers of financial statement information. By requiring that all derivatives be reported on the balance sheet at fair value, the standard ensures those assets and liabilities will be visible on the financial statements. In the past many of these derivative assets and liabilities would be “off balance sheet”, thereby concealing the risk exposure. This suggests that SFAS 133 should provide a more complete set of financial statements, thus producing a clearer picture of the entity. Prior research has studied the impact of incomplete information on capital markets and provided evidence that investor perceptions of being on the losing side in information asymmetry conditions has significant implications on required returns, cost of capital, and equity prices. Sunder (1973) showed that financial statements represent one of the critical channels through which investors receive information. FASB and the SEC regulate both the type and amount of information disclosed through the financial statements as well as the method of disclosure. In providing increased disclosure, SFAS 133 provides more complete information to economic agents. Raposa (1997) indicates that firms with higher disclosure levels are more highly valued.

The new approach to hedge accounting promulgated in SFAS 133 promotes greater understandability among users. Past guidance regarding the classification of deferred gains and losses from hedging activity was cloudy and measurement and reporting did not appear consistent with element definitions in the concept statements. SFAS 133 no longer reports deferred gains as liabilities and deferred losses as assets. Greater understandability among users suggests a clearer picture of the firm.

SFAS 133 reduces inconsistency in current practice by requiring that all derivative instruments, including those yet to be developed, are subject to the standard requirements. Past guidance applied only to specified instruments and provided conflicting treatments in some cases, leaving entities to create their own accounting practices. The result was a lack of comparability among entities. Treatment of a derivative now is based on why an entity holds it rather than on the type of instrument. SFAS 133 requires all reporting entities to account for similar derivative instruments in a consistent manner, thereby, providing a clearer picture of the entity’s financial position and performance and aiding decision making for financial statement users. The complexity of SFAS 133 may suggest costly implementation for some entities. Companies may be required to modify management information systems to comply with standard requirements.

While SFAS 133 provides more consistent and complete disclosure of derivative instruments and hedging activity, some have expressed concern that the new rules create earnings volatility. Other believe the new standards only unmask existing volatility which previously went unreported (Wilson, 1998). Changes in derivative fair value resulting from partial or imperfect hedges are reported in current earnings. Thus, earnings fluctuate with fluctuations in derivative fair value. Previously, holding gains and losses were deferred as liabilities and assets leaving earnings and equity unaffected. Now unrealized gains and losses from cash flow hedges are included in comprehensive income and, therefore, equity. Accumulated gains and losses are included in earnings in the same period as the earnings effect of the hedged item. Thus, under SFAS 133, the greater the derivative fair value fluctuations, the greater the volatility of earnings and equity.

PRIOR RESEARCH

Accounting and finance literature documents the relevance of accounting for derivatives (Benston, 1997;Hu, 1996;Venkatachalam, 1996). The literature also documents and confirms that accounting disclosures can have political as well as other costs (Watts and Zimmerman, 1985; Zwijewski and Hagerman, 1981). Botosan (1997) concludes that greater disclosure is associated with a lower cost of



capital. DeMarzo and Duffie (1995) show how financial hedging improves the informational content and quality of corporate earnings as a signal of management ability. Aggarwal and Simkins (1999) document that firms with higher disclosure levels enhance shareholder value. Schrand (1997) relates that derivative disclosure provides “value-relevant information.” Negative influences on derivative disclosure include information costs and externalities, agency costs, and political costs.

This study examines the equity price reaction to the increased mandatory disclosure for hedge accounting required under SFAS 133. By examining stock price behavior surrounding the promulgation of SFAS 133, we can make inferences regarding the information content of the new reporting requirements, the stock price impact, and the implications of mandatory disclosure.

Our study employs a multivariate regression model. Schipper and Thompson (1983) and Espahbodi, Espahbodi and Tehranian (1995) use such a model. These prior studies show that the model corrects for cross-sectional heteroscedasticity and the contemporaneous correlation of residuals often plaguing traditional event-study methodology brought about due to clustering of events.

HYPOTHESES

While the net equity price reaction to SFAS 133 can only be assessed empirically, SFAS 133 represents a major change in hedge accounting and allows us to examine the impact of increased mandatory derivative disclosures in providing a clearer and more enhanced picture of the entity. SFAS 133 strives to increase the comparability, visibility, and understanding of the risks associated with derivative usage by requiring entities to report all derivatives at fair market value as assets or liabilities on the statement of financial position. The standard reduces inconsistencies and incompleteness present in earlier standards as well as in practice. Changes in derivative fair value resulting from partial or imperfect hedges are reported in current earnings. Unrealized gains and losses are included in comprehensive income and equity. Thus, under SFAS 133, the greater the derivative fair value fluctuations, the greater the volatility of earnings and equity. Some critics of SFAS 133 are concerned that the new rules create earning volatility. Others believe the new accounting treatment merely unmasks existing volatility by reporting what previously went unreported. Much of the past derivative activity has been “off balance sheet.”

Improved disclosure levels tend to benefit investors by reducing uncertainty regarding true parameters implicit in their predictive return distributions. This study posits that the new mandatory reporting requirements under SFAS 133 improve the quality of financial disclosure, reducing uncertainty about stocks and affecting their prices. The greater comparability, completeness, and consistency in derivative reporting to be achieved under SFAS 133 suggests an enhanced picture of the firm and motivates the following null hypothesis:

H1: The changes in financial disclosure imposed by SFAS 133 have no impact on stock prices.

SAMPLE AND METHODOLOGY

Patell (1979) posits that from an investor’s perspective, information is any data whose disclosure will alter the probability distribution over future states of the utility derived from holding a portion of the firm’s debt or equity. To the extent that FASB 133 provides a more clear picture of the firm’s position with respect to its use of derivatives, such probability distribution will differ from a distribution that is free of FASB 133 information.

Given that the utility probability distribution of an investor is unobservable, it follows that we are left with an operational technique (events study methodology) in which we analyze stock returns and test for significant changes in them that can’t be explained by other events. This leads us to infer that the presence of abnormal returns during the event period is due to the FASB 133 pronouncement. Our sample consists of twenty U.S. firms randomly chosen from Fortune’s 1999 Global 200 list. Because of their size and market values, firms included in this list receive substantial scrutiny and are closely followed by a significant number of analysts. Moreover, to be eligible in our sample, the management discussion and analysis of each firm chosen must have stated that the firm makes use of derivatives in dealing with its foreign exchange, interest rate or commodity risk. This criterion insures the selection of firms that are most likely to be affected by FASB 133. Furthermore, eligibility was also limited to those companies which had not announced dividends in the 4-week period surrounding the announcement of FASB 133 as well as had not announced a stock split in the 8 week period surrounding this date.



The paper uses daily stock return data. The critical event period is the announcement of FASB 133. This took place on June 16, 1998 and since the event is defined in terms of the announcement of the new accounting rule, we consider a three-day event window, which includes 1day prior and 1 day after this date. The market model will be used to measure the expected (normal) returns of each security. Where Rit= the daily returns in period t on the stock of firm i. RMt= the daily return on the market period t, computed as the return on the S&P 500 Index Eit = random disturbance term

Bi = Risk coefficient of the ith firm The estimation of parameters for the market model is undertaken within a time frame that includes returns for 4 weeks before and 4 weeks after the event window. These parameters are used (see equation 2) to calculate normal, risk-adjusted returns -E(Rit)-which subsequently are compared to the actual returns Rjt in

order to compute the abnormal returns (eit) associated with the occurrence of the event:

RESULTS Table 1 presents the excess returns resulting from equation (2) for the period beginning one-day

prior and extending one day beyond the FASB 133 announcement. As is customary, the abnormal returns are averaged across firms for each of the event window days and then aggregated to provide the cumulative abnormal return (CAR) associated with the FASB 133 announcement.

TABLE 1 Average cross-sectional Abnormal Returns for the Sample during the Announcement Period

Period Average Abnormal Return t –1 -0.00027 t0 -0.00783 t+1 -0.00592 Cumulative (CAR) -0.01402

t-ratio-CAR -2.11171**

**95% confidence level As table 1 shows, the unstandardized excess returns suggest the presence of negative abnormal

returns accompanying the announcement of FASB 133. The average abnormal returns for each of the event days is negative and there is a 1.4% negative accumulative abnormal performance for the entire sample. The calculated t-ratio for the CAR is significant at the 95% level. While the results of Table 1 use unstandardized residuals, there is wide use in the event study literature of standardized aggregates, which are used to form test statistics. (Brown and Warner, 1985).

The test statistic for these standardized excess returns is essentially the same as the student t test on a regression coefficient. This provides us with the opportunity to add a dummy variable to the market model creating what has been labeled the event parameter model: Where: Rpt= = is the portfolio return in day t Alpha and beta = intercept of the portfolio and the risk coefficient respectively Dt = is a dummy variable that takes the value of one during the event period and zero otherwise Sigma = the impact on the portfolio’s return of the event

)()2( itjti RERe −=

itMtiiit RR εβα ++=)1(

pttpMtpppt DRR εδβα +++=)3(



In this model, the returns of our sample of firms are used to form an equally weighted portfolio. By characterizing the event window with a binary variable that takes the value of 1 during this period, we can identify a coefficient that measures the impact of the FASB 133 announcement on our sample. Furthermore, as Henderson (1989) has shown, the coefficient of this dummy variable is the same as the predicted error and its t or Z value from the regression is the same as the standardized predicted error.

Table 2 Regression Coefficients for the Event Parameter Model

Variable Coefficient T-statistic Intercept 0.00023 0.417202 Beta 1.038547 18.53224*** Sigma -0.00459 -2.49652** R2 = 0.91; n=34

***99% confidence level **95% confidence level

As the results in Table 2 suggest, the impact of the announcement of FASB 133 on the sample of

firms studied is negative and significant at the 95% confidence level. This results is consistent with the negative and significant aggregate abnormal returns (CAR) that were presented in Table 1 and further supports the hypothesis that the enactment of FASB 133 constituted a significant accounting change which provided information to investors. More specifically, the results suggest that FASB 133 places the use of derivatives in a more negative light and consequently has a negative impact in firm’s returns.

CONCLUSIONS The question of whether mandatory accounting policy changes do in fact entail improved

disclosure and greater information with which to make economic decisions is an important issue. The FASB 133 requirement that firms recognize all derivatives as either assets or liabilities and measure those instruments at fair value has been much debated and controversial enough to merit a postponement. As such, it provides us with a useful example to measure the impact of this accounting change on the financial markets.

Using a sample of twenty large U.S. firms that entered into derivative transactions, we tested the proposition that the announcement of FASB 133 would have a significant effect on their stock prices. The results suggest that the average abnormal return for this sample during the announcement period is negative and significant. Traditional event study methodology using a market model shows that the cumulative abnormal returns during a three day event window amounts to a 1.4% excess loss from that which would be predicted in the absence of the FASB 133 announcement. Furthermore, an additional test using the event parameter model provides results that are consistent with the results we obtained from the aggregate abnormal returns. In this context, the coefficient of the event parameter model is also negative and statistically significant suggesting that FASB 133 would provide a more clear and consistent picture of the firm, and in this case a more negative assessment of its value.



BIBLIOGRAPHY

Aggarwal, Raj and Betty J. Simkins, (1999). “Voluntary Disclosures of Derivatives Usage: Evidence and Determinants of US Companies”, Working Paper, John Carroll University and Oklahoma State University.

Botosan, Christine A., (1997). “Disclosure Level and the Cost of Equity Capital”, Accounting Review 72

(No. 3,July), 323-349. Brown, Stephen J. and Jerold B. Warner, (1985) “Using Daily Stock Returns: The Case of Event Studies.”

Journal of Finance (No. 8), 205-258 Coy, Peter, 1997, “Hey FASB, What’s the Rush?”, Business Week (September 29), p.54. DeMarzo, P. and D. Duffie, (1995). “Corporate Incentives for Hedging and Hedge Accounting”, Review of

Financial Studies 8 (No. 3), 743-772. Espahbodi, Hassan, Pouran Espahbodi, and Hassan Tehranian, (1995). “Equity Price Reaction to the

Pronouncements Related to Accounting for Income Taxes”, Accounting Review (October), 655-668.

Henderson, Glenn (1989). “Problems and Solutions in Conducting Event Studies.” Working Paper, 1-25. Horowitz, Donald and Robert Mackey, (1996). “SEC’s Proposed Rules on Derivatives Disclosures: The

Comment Letters”, Journal on the Law of Investment and Risk Management Products 16 (No. 5). Miller, Merton and Christopher Culp, 1996, “The SEC’s Costly Disclosure Rules”, Wall Street Journal

(June 25). Patell, James M., (1979) “The API and the Design of Experiments”, Journal of Accounting Research

(Autumn), 529-549. Phillips, Aaron L., (1995). “1995 Derivatives Practices and Instruments Survey”, Financial Management

24 (2), 115-125. Schrand, Catherine M., (1997). “The Association Between Stock Price Interest Rate Sensitivity and

Disclosure about Derivatives Instruments”, Accounting Review 72 (No. 1, January), 87-109. Schipper, Katherine and Rex Thompson, (1983). “The Impact of Merger-Related Regulations and the

Shareholders of Acquiring Firms”, Journal of Accounting Research (Spring), 184-211.



Sunder, Shyam, (1973). “The Relationship Between Accounting Changes and Stock Prices”, Journal of Accounting Research (Spring), 1-45.

Watts, Ross L. and Jerold L. Zimmerman, (1978) “Towards A Positive Theory of the Determination of

Accounting Standards”, Accounting Review (January), 112-134. Zwijewski, Mark E. and Robert L. Hagerman, (1981) “An Income Stategy Approach to the Positive Theory

of Accounting Standard Setting Choice”, Journal of Accounting and Economics 3, 129-149.



THE PRIMARY ATTRIBUTES OF ACCOUNTING GRADUATES: WHEN SHOULD THEY BE TAUGHT

IN THE CLASSROOM

Wilcox, William Bradley University

[email protected]

Carpenter, Jon University of South Dakota

[email protected]

Davies, Thomas University of South Dakota

[email protected]

Moen, David University of South Dakota

[email protected]

ABSTRACT

The education of accounting students has been an area of interest for both professional organizations, such as the American Institute of Certified Public Accountants (AICPA), and the academic profession. One of the resounding themes is that traditional education is too narrowly focused. In response, the AICPA identified a set of values and competencies necessary for future success in the accounting profession. This study surveys a set of educators and practitioners to evaluate when these requisite traits should be incorporated in the classroom. The findings suggest that practitioners and educators have similar views as to when the values should be covered in the classroom, but there is more disparity as to the competencies identified by the profession. These findings should provide information that is necessary for curriculum development to meet the objectives established by the accounting profession.

INTRODUCTION

In the past several years, institutions of higher education have devoted considerable time and energy to assessing student learning, often prompted by accreditation concerns. Educators must now formulate learning objectives for their courses and formally evaluate whether the expected outcomes are being attained. Furthermore, instructors are required to identify what are the primary and secondary objectives that are to be accomplished in a particular course. To this end, Imrie (1995) contends that, "in the pedagogical context, a study of issues of assessment should consider the appropriate use of taxonomies with reference to types and levels of learning."

There are several well-known taxonomies or models of learning, including the Myers-Briggs Typology and Perry's model of attitude toward learning. However, Benjamin Bloom developed in 1956 one of the best known and most widely used taxonomies. Bloom suggested that there are six levels of cognitive development: knowledge, comprehension, application, analysis, synthesis, and evaluation.



Horton (1987), citing Bentz (1975), offered an accounting curriculum model that utilized Bloom's taxonomy in establishing educational objectives in terms of expected student outcome behavior for each course. This archetype, adapted from Horton, is shown in Table 1.

Table 1 Levels of Objectives in Accounting Courses

Level Primary Objectives Secondary Objectives Tertiary Objectives Introductory Knowledge

Comprehension Application Analysis

Synthesis Evaluation

Intermediate Application Analysis

Comprehension Synthesis

Knowledge Evaluation

Advanced Evaluation Synthesis

Analysis Knowledge Comprehension Application

The education of accounting students has also been an issue raised by professional organizations, such as the American Accounting Association (AAA) and the American Institute of Certified Public Accountants (AICPA). The concerns raised by AAA and AICPA were due to their perception that accounting programs had not kept pace with the dynamic profession for which students were being educated. The Accounting Education Change Commission (AECC) was created in 1989 by the AAA to address concerns that entry level staff were not sufficiently trained to meet the evolving changes facing the profession. The AECC, in its first position statement, identified 39 specific traits that accountants need at the time of graduation.

The AICPA has also been actively involved in the shaping of accounting education, most recently through the CPA vision project (CPA Vision Project Report, 1998). By identifying both the challenges and opportunities for accountants in the future, the vision project identified five core values and five core competencies of the accounting profession. Therefore, it is important for accounting education to determine which of these competencies or values should be educational objectives in the classroom, and at what course-level should they be addressed.

The purpose of this study is to examine when certain traits or capabilities should be covered in the accounting curriculum. More specifically, one research question is whether the appropriate treatment should be (1) No Coverage – indicating that no concerted effort be applied to a particular topic; (2) Primary - indicating an introduction and explicit teaching of the topic; or (3) Secondary – indicating a reinforcement of the topic. The other important issue associated with accounting curriculum is the timing of the topical coverage. Therefore, it will also be interesting to examine whether coverage is more appropriate for (1) freshman/sophomore courses, (2) junior courses, or (3) senior/graduate courses. Survey responses from both practitioners and accounting educators will be used to analyze the research question.

LITERATURE REVIEW

Academic research has been interested in both the timing and the topics covered in the accounting

curriculum, from both a practical and theoretical perspective. Bhamornsiri and Guinn (1991) examined the skills needed by accountants as they progress within a firm or organization. Siegel and Sorensen (1994) focus on the different skill sets required by accountants based upon which segment of the profession employs them. The general tenor of these studies is that by determining what skills and/or attributes are necessary for professional success, accounting curricula can adjust to better prepare students for their respective careers.

The use of taxonomies and learning theory has also been utilized in a practical manner in accounting research. In redesigning the accounting curriculum, Ainsworth and Plumlee (1993) discuss the importance of course sequencing. In their framework of curriculum development, they considered the sophistication of content elements and the cognitive development of the learner as interdependent criteria in the process. The use of Bloom’s Taxonomy was the basis on which cognitive development of the learner was operationalized. While the use of learning theory has been shown to support a university’s approach to accounting

education, there are still some issues with the accounting profession that are contradictory to its use. For example,



Ainsworth and Plumlee (1993) discuss the importance of Knowledge and Comprehension in the accounting principles courses and tentatively conclude a lecture/problem-solving approach to teaching is often the primary method in meeting the educational objective. However, the AECC issued a second position statement that focused on the first accounting courses. Recognizing that not all students who take the introductory accounting courses will become Certified Public Accountants, the AECC provided further guidance as to the timing of the delivery of certain skills in the education process. While the statement indicates that the teaching methods should consist of cases, simulations, and group projects, such an approach may actually conflict with the learning objectives identified in Bloom’s taxonomy. This apparent difference in curriculum development between learning theory and the AECC's position statement indicates that this topic needs further exploration.


In 1997, a survey was mailed to a randomly selected sample of 1,000 accounting educators,

stratified by academic rank and primary accounting area taught (auditing, cost/managerial, financial, government/nonprofit, and tax). 127 educators responded to the survey instrument. A similar survey was sent to 1,000 practitioners identified from AICPA mailing lists. Practitioners were stratified into three separate groups: public accounting, private accounting, and government/not-for-profit accounting. 112 individuals responded. The surveys contained demographic questions, as well as questions explicitly related to the traits identified in AECC Position Statement No. One. More specifically, accounting educators were asked whether particular capabilities should receive No Coverage, Primary Coverage (introduce and teach), or Secondary Coverage (reinforce). In addition, they were asked to evaluate the appropriateness of that capability's coverage at the Introductory accounting level (freshman/sophomore), the Intermediate accounting level (junior), and the Advanced accounting level (senior/graduate). No Coverage was coded a value of "1," Primary Coverage was coded a value of "2," and Secondary Coverage was coded a value of "3."

In identifying the variables of interest, the AICPA’s recent Vision Project offers a new opportunity to study the requisite skills needed by accountants, and when they should be delivered in the classroom. The vision project identified the top five core values and core competencies of the accounting profession. These are identified and described in the 1998 CPA Vision Project Report. Core values, defined as “the essential and enduring beliefs” upheld over time, include the following: v Continuing Education and Life-Long Learning. CPAs highly value continuing education beyond

certification and believe it is important to continuously acquire new skills and knowledge. v Competence. CPAs are able to perform high quality work in a capable, efficient, and appropriate

manner. v Integrity. CPAs conduct themselves with honesty and professional ethics. v Attuned to Broad Business Issues. CPAs are in tune with the overall realities of the business

environment. v Objectivity. CPAs are able to deal with information free of distortions, personal bias, or conflicts of

interest. Core competencies of accountants, defined as “a unique combination of human skills, knowledge, and technology that provides value and results to the user,” were identified as:

v Communications and Leadership Skills. Able to give and exchange information within meaningful context and with appropriate delivery and interpersonal skills. Able to influence, inspire, and motivate others to achieve results.

v Strategic and Critical Thinking Skills. Able to link data, knowledge, and insight together to provide quality advice for strategic decision-making.

v Focus on the Customer, Client and Market. Able to anticipate and meet the changing needs of clients, employers, customers, and markets better than competitors.

v Interpretation of Converging Information. Able to interpret and provide a broader context using financial and non-financial information.

v Technologically Adept. Able to utilize and leverage technology in ways that add value to clients, customers, and employers (Thomas 1998).

The AECC traits included in the survey instrument were subsequently assigned to a corresponding AICPA category by each of the authors. After discussion, the authors came to a general agreement as to the final classifications. In total, 31 of the 39 AECC traits were ultimately determined to be comparable to, and thus a proxy for, a core value or competency as identified by the AICPA Vision Project. The specific



assignments are reported in Appendix I. A weighted average was calculated for each trait’s coverage recommendation at the Introductory, Intermediate, and Advanced levels. Pairwise t-tests were conducted to determine if statistical differences existed at the different levels of accounting where the trait should be taught, and if differences existed between practitioners and educators.

RESULTS AND SUMMARY

Table 2 reports the weighted average findings for each of the five core value recommendations for educators. In general, one can note a progression from lower values to higher values as a particular topic is covered in the introductory level through the intermediate level to the advanced level.

These results might at first suggest that the bulk of the core value instruction should occur at the junior level, with the advanced level serving more as a reinforcement opportunity. However, pairwise t-tests were performed comparing the intermediate to advanced levels and results indicated that there were no statistical differences for any of the core values at the .05 significance level. This implies then that primary and secondary coverage is an important element in both intermediate and advanced courses.

Table 2

Recommended Coverage of Core Values by Educators

Introductory Intermediate Advanced

Life-Long Learning 1.952 2.231 2.212

Competence 1.780 2.211 2.275

Integrity 2.005 2.200 2.239

Business Issues 1.872 2.202 2.266

Objectivity 2.073 2.345 2.414

Key:

Life-Long Learning = Continuing Education and Life-Long Learning. CPAs highly value continuing education beyond certification and believe it is important to continuously acquire new skills and knowledge. Competence = Competence. CPAs are able to perform high quality work in a capable, efficient, and appropriate manner. Integrity = Integrity. CPAs conduct themselves with honesty and professional ethics. Business Issues = Attuned to Broad Business Issues. CPAs are in tune with the overall realities of the business environment. Objectivity = Objectivity. CPAs are able to deal with information free of distortions, personal bias, or

conflicts of interest.

As Table 2 indicates, values for the introductory level are lower than those of either the intermediate or advanced levels in all cases. Performance of pairwise t-tests confirmed this and indicated statistical significance at the .05 level for each of the five core values. Three of the five core values result in averages less than 2.00, with the remaining two core values just slightly above 2.00. Analysis of individual responses indicated a relatively high number of 1’s being assigned by the educators. Apparently, many of these core values were deemed to be inappropriate material for significant coverage at the freshman/sophomore level.

Table 3 summarizes the weighted average findings for each of the five core competency recommendations by educators. As in the case of the core values by the educators, one can note a



progression from lower values to higher values as a particular competency is covered in the introductory level through the intermediate level to the advanced level.

When comparing results for intermediate vs. advanced coverage, pairwise t-tests did reveal statistical significance at the .05 level for the “technologically adept” competency. Relaxing the significance level slightly to .06, two more competencies become significantly different in the coverage recommendations at the intermediate vs. advanced levels: “leadership skills” and “interpretation of converging information.” Unlike core value coverage that seems to permeate both intermediate and advanced levels, there appears to be a general feeling among the educators that intermediate level courses serve to provide the primary competency instruction, with the advanced courses serving to reinforce or enhance those competencies.

As Table 3 indicates, values for the introductory level are lower than those of either the intermediate or advanced levels in all cases. Pairwise t-tests confirmed this and indicated statistical significance at the .05 level for each of the five competencies. All of the introductory level recommendations for core competencies demonstrated values very close to 2.0 for educators. With a range in values of 1.929 to 2.185 (compared to the core values which demonstrated a lower range of 1.780 to 2.073), there appears to be a slight shift in respondent recommendations to the lowest level of the curriculum spectrum for primary topic coverage. These results suggest that many competencies should in fact receive primary coverage at the introductory level, rather than waiting until the intermediate level.

Table 3

Recommended Coverage of Core Competencies by Educators


Leadership Skills 1.929 2.207 2.252

Critical Thinking 2.185 2.422 2.427

Focus on Customer 1.946 2.273 2.307

Converging

Information

2.162 2.329 2.380

Technologically

Adept

2.162 2.365 2.439

Key:

Leadership Skills = Leadership Skills. Able to give and exchange information within meaningful context and with appropriate delivery and interpersonal skills. Able to influence, inspire, and motivate others to achieve results. Critical Thinking = Strategic and Critical Thinking Skills. Able to link data, knowledge, and insight together to provide quality advice for strategic decision making. Focus on Customer = Focus on the Customer, Client, and Market. Able to anticipate and meet the changing needs of clients, employers, customers, and markets better than competitors. Converging Information = Interpretation of Converging Information. Able to interpret and provide a broader context using financial and non-financial information. Technologically Adept = Technologically Adept. Able to utilize and leverage technology in ways that

add value to clients, customers and employers.

Table 4 reports the weighted average findings for each of the five core value recommendations for practitioners. Similar to the educators, one can note a progression from lower values to higher values as a



particular topic is covered in the introductory level through the intermediate level to the advanced level. When performing pairwise t-tests on the intermediate to advanced levels, only objectivity showed a significant change. This would imply that practitioners also believe that primary and secondary coverage is an important element in both intermediate and advanced courses.

Table 4

Recommended Coverage of Core Values by Practitioners


Life-Long Learning 1.659 2.217 2.176

Competence 1.900 1.865 1.948

Integrity 1.802 2.115 2.171

Business Issues 1.888 2.147 2.122

Objectivity 1.677 1.911 2.177

Key:

Life-Long Learning = Continuing Education and Life-Long Learning. CPAs highly value continuing education beyond certification and believe it is important to continuously acquire new skills and knowledge. Competence = Competence. CPAs are able to perform high quality work in a capable, efficient, and appropriate manner. Integrity = Integrity. CPAs conduct themselves with honesty and professional ethics. Business Issues = Attuned to Broad Business Issues. CPAs are in tune with the overall realities of the business environment. Objectivity = Objectivity. CPAs are able to deal with information free of distortions, personal bias, or

conflicts of interest.

Similar to the educators ratings, practitioners assigned lower values for the introductory level relative to those of either the intermediate or advanced levels in all cases. Performance of pairwise t-tests confirmed this and indicated statistical significance at the .05 level for each of the core values, except the Competence value. All of the core values result in averages less than 2.000. There appears to be some agreement among the educators and practitioners that the introduction of these values at the freshman/sophomore level is not appropriate.

Table 5

Recommended Coverage of Core Competencies by Practitioners


Leadership Skills 1.759 2.021 2.089

Critical Thinking 1.755 1.990 2.158

Focus on Customer 1.803 1.920 2.155

Converging 1.633 1.883 2.112



Information

Technologically Adept 1.510 2.126 2.311

Key:

Leadership Skills = Leadership Skills. Able to give and exchange information within meaningful context and with appropriate delivery and interpersonal skills. Able to influence, inspire, and motivate others to achieve results. Critical Thinking = Strategic and Critical Thinking Skills. Able to link data, knowledge, and insight together to provide quality advice for strategic decision making. Focus on Customer = Focus on the Customer, Client, and Market. Able to anticipate and meet the changing needs of clients, employers, customers, and markets better than competitors. Converging Information = Interpretation of Converging Information. Able to interpret and provide a broader context using financial and non-financial information. Technologically Adept = Technologically Adept. Able to utilize and leverage technology in ways that

add value to clients, customers and employers.

Table 5 summarizes the weighted average findings for each of the five core competency recommendations by practitioners. As with all other categories, one can note a progression from lower values to higher values as a particular competency is covered in the introductory level through the intermediate level to the advanced level. Only the Focus on Customer is not significantly different from the Introductory category. An interesting observation is that practitioners indicated "No Coverage" for these competencies at the Introductory level at a much higher level than educators. This would provide further support to the profession's claim that Introductory courses should be more general in nature, rather than a preparatory course for accounting majors. When comparing results for intermediate vs. advanced coverage, pairwise t-tests did reveal statistical significance at the .05 level for all categories except the Leadership Skills competency. These results would suggest that practitioners view the roles of the Intermediate and Advanced courses similar for both values and competencies. One of the biggest changes in accounting education has been the focus on the first course in accounting, as per AECC Position Statement No. 2. The primary objective is for students to learn about accounting as an information development that supports economic decision-making. Therefore, the impetus is to move from a class that is introductory accounting to an introduction to accounting. However, with the ever-growing list of competencies necessary for success in an accounting career, it becomes an important question as to topical coverage. These results suggest that both practitioners and educators both agree that the core values should receive primary and secondary education objectives in Intermediate and Advanced courses. As to the competencies, practitioners also felt that the primary and secondary objectives should be met in the Intermediate and Advanced courses, while educators placed slightly more emphasis on the Introductory accounting course.



REFERENCES Accounting Education Change Commission (1990). Objectives of Education for Accountants, Position

Statement No. One, AECC. Accounting Education Change Commission (1992). Objectives of Education for Accountants, Position

Statement No. Two, AECC. American Institute of Certified Public Accountants (1998). CPA Vision Project: 2001 and Beyond,

Jeannie Patton, Project Director, New York: AICPA. Ainsworth, Penne L., and R. David Plumlee (1993). "Restructuring the Accounting Curriculum Content

Sequence: The KSU Experience," Issues in Accounting Education, Vol. 8, No. 1, Spring 1993, 112-127.

Bhamornsiri, Sak and Robert E. Guinn (1991). “The Road to Partnership in the ‘Big Six’ Firms:

Implications for Accounting Education,” Issues in Accounting Education, Vol. 6, No. 1, Spring 1991, 9-24.

Siegel, Gary and James E. Sorensen (1994). What Corporate America Wants in Entry-Level Accountants,

Montvale, N.J.: Institute of Management Accountants.

Appendix I

Classification of AECC Traits Into AICPA Categories

Core Values: The essential and enduring beliefs that we uphold over time. Core values enable us to retain our unique character and value as we embrace the changing dynamics of the global economy. Continuing Education and Life-Long Learning. CPAs highly value continuing education beyond certification and believe it is important to continuously acquire new skills and knowledge. PC9 A commitment to life-long learning Competence. CPAs are able to perform high quality work in a capable, efficient, and appropriate manner. ICS5 Ability to manage sources of stress by selecting and assigning priorities within restricted

resources and to organize work to meet tight deadlines AK9 In-depth knowledge in one or more specialized areas, such as financial accounting,

management accounting, taxation, information systems, auditing, nonprofit, government, and international accounting

Integrity. CPAs conduct themselves with honesty and professional ethics. GK4 An awareness of personal and social values and of the process of inquiry and judgment ICS3 Ability to identify ethical issues and apply a value-based reasoning system to ethical

questions PC2 Integrity PC8 Sensitivity to social responsibilities Attuned to Broad Business Issues. CPAs are in tune with the overall realities of the business environment.



GK3 A sense of the breadth of ideas, issues, and contrasting economic, political, and social forces in the world

OB1 A knowledge of the activities of business, government, and nonprofit organizations, and of the environments in which they operate, including the major economic, legal, political, social, and cultural forces and their influences

Objectivity. CPAs are able to deal with information free of distortions, personal bias, or conflicts of interest. AK3 Policy issues, environmental factors, and the regulation of accounting AK4 Ethical and professional responsibilities of an accountant Core Competencies: A unique combination of human skills, knowledge, and technology that provides value and results to the user. Enhancing our core competencies is key to sustaining a competitive and differential advantage in the marketplace. Leadership Skills. Able to give and exchange information within meaningful context and with appropriate delivery and interpersonal skills. Able to influence, inspire, and motivate others to achieve results. IPS1 Ability to work with others, particularly in groups, to influence them, to lead them, to

organize and delegate tasks, to motivate and develop people, and to withstand and resolve conflict

IPS2 Ability to interact with culturally and intellectually diverse people CS1 Ability to present, discuss, and defend views effectively through formal and informal,

written and spoken language CS2 Ability to listen effectively

OB3 An understanding of interpersonal and group dynamics in business PC7 Leadership Strategic and Critical Thinking Skills. Able to link data, knowledge, and insight together to provide quality advice for strategic decision making. ICS1 Capacities for inquiry, abstract logical thinking, inductive and deductive reasoning, and

critical analysis ICS2 Ability to identify and solve unstructured problems in unfamiliar settings and to apply

problem-solving skills in a consultative process Focus on the Customer, Client, and Market. Able to anticipate and meet the changing needs of clients, employers, customers, and markets better than competitors. ICS4 Ability to understand the determining forces in a given situation and to predict their

effects OB4 An understanding of the methods for creating and managing change in organizations OB5 An understanding of the basic internal workings of organizations and the application of

this knowledge to specific examples AK6 The concepts, methods, and processes of control that provide for the accuracy and

integrity of financial data and safeguarding of business assets AK7 The nature of attest services and the conceptual and procedural bases for performing

them AK8 Taxation and its impact on financial and managerial institutions PC1 Creative thinking Interpretation of Converging Information. Able to interpret and provide a broader context using financial and non-financial information. OB2 A basic knowledge of finance, including financial statement analysis, financial

instruments, and capital markets, both domestic and international AK2 Content, concepts, structure, and meaning of reporting for organizational operations, both

for internal and external use, including the information needs of financial decision



makers and the role of accounting information in satisfying those needs AS1 Ability to apply accounting knowledge to solve real-world problems

Technologically Adept. Able to utilize and leverage technology in ways that add value to clients, customers and employers. CS3 Ability to locate, obtain, organize, report, and use information from human, print, and

electronic sources AK5 The process of identifying, gathering, measuring, summarizing, and analyzing financial

data in business organizations, including: . The role of information systems . The concepts and principles of information system design and use . The methods and processes of information system design and use . The current and future roles of computer-based information technology



THE PUBLICATION PRODUCTIVITY OF ACCOUNTING FACULTY: FURTHER EVIDENCE

Carpenter, Brian W.

University of Scranton [email protected]

Mahoney, Daniel P.

University of Scranton [email protected]

ABSTRACT

Accounting faculty of colleges and universities nationwide, much like their non-accounting colleagues, recognize the importance of scholarship to tenure and promotion decisions. Differences in rate of faculty publication productivity and the identification of most common publication outlets have been the focal points of a number of prior studies involving accounting faculty. This study adds to the existing body of literature in this area by examining the issue of publication productivity among accounting faculty of different types of academic institution. It also identifies the most common publication outlets among accounting faculty of the various classes. The examinations undertaken in this study should serve to enlighten a profession that seems to hold preconceived notions regarding differences in rates of publication and appropriate publication outlets. The results, though somewhat mixed, were largely consistent with hypotheses.

INTRODUCTION The necessity of publication activity is recognized at virtually all institutions of higher education. Faculty who hope to obtain tenure and those who seek promotion to a higher academic rank are well aware of the necessity of scholarship. While specific scholarship requirements may vary by institution and nature of institution, publication activity remains a fact of life for all higher education faculty. In accounting, scholarship requirements are perhaps no less stringent than they are in other disciplines. Accounting academics, like their non-accounting colleagues, face the “publish or perish” ultimatum. Furthermore, expectations regarding frequency of publication and the journals deemed acceptable for publication vary by nature of institution. For example, accounting faculty from doctoral-granting, highly research-oriented institutions are known to face more stringent requirements than their colleagues from non-doctoral granting, teaching oriented institutions. Similarly, faculty from AACSB-accredited schools of business are typically confronted with higher scholarship expectations relative to their colleagues from non-accredited schools. These varied demands raise some interesting research questions. Across academic institutions of varying types, what exactly are the differences in rates of publication among accounting faculty? In which journals do accounting faculty of varying institutional types most frequently publish? How do the “most common journals” of one institutional category compare with those of other institutional categories? Are the relative differences in frequency of publication and rankings of publication outlets consistent with these commonly held beliefs? With respect to individual publication outlets, what is the average number of publications per faculty member from various categories of institution? This study examines these various research questions. Differences in rates of publication activity are examined across varying institutional characteristics, and the most common publication outlets are identified (and rank-ordered) for the various institutional categories. The results should be useful to accounting faculty who seek a better understanding of the exact degree of differences in rates of publication among various categorizations of accounting faculty. The identification of the most common publication outlets should likewise prove useful, since many faculty have preconceived notions regarding the perceived



quality of accounting journals and the “types” of accounting faculty who publish in these journals. Identification of the most common publication outlets should thus do much to either reaffirm these preconceptions or enlighten faculty regarding the actual facts.

CONTRIBUTION TO THE LITERATURE This study should serve as a useful addition to the “publication productivity” literature. Prior studies have examined the publication productivity of recently promoted accounting faculty (e.g., Englebrecht, Iyer & Patterson, 1994; Campbell and Morgan, 1987; Milne and Vent, 1987). Other studies have examined the perceived quality of accounting journals (e.g., Hull & Wright, 1990; Howard & Nikolai, 1983). This study examines the publication productivity of accounting faculty, exclusive of the timing of their most recent promotions. It further examines the “perceived quality” issue by identifying and rank ordering the journals in which accounting faculty of alternative institutional types most frequently publish. This latter examination is useful in determining whether perceptions of journal quality (as examined in previous studies) are consistent with the most common publication outlets.

METHODOLOGY This study utilizes Hasselback’s Accounting Faculty Directory in identifying the accounting faculty of colleges and universities throughout the United States. A sample of colleges and universities was randomly selected, and the respective accounting faculty were identified. The Hasselback directory was likewise used in identifying relevant institutional characteristics (i.e., whether the institution at which the faculty member is employed is AACSB accredited, and whether it is a doctoral granting institution). For purposes of identifying the number of publications of the selected faculty and their respective publication outlets, this study makes use of the Accounting Literature Index (ALI). ALI contains all necessary data with respect to the nature and number of accounting-related publications.

RELEVANCE OF THE STUDY Accounting faculty, like their colleagues in other disciplines, hold certain beliefs regarding required rates of publication activity and acceptability of alternative publication outlets. For example, faculty employed by AACSB accredited schools of business and faculty employed by doctoral granting, research oriented schools are generally expected to be more scholarly active than their colleagues from non-accredited, non-doctoral granting schools. This study provides evidence as to the exact magnitude of differences in publication activity, thus shedding light on the preconceived beliefs that are typically held by accounting faculty and their employing institutions. Accounting faculty and their employing institutions are thus provided with more than a cursory understanding of differences in publication activity. However, the study goes beyond the measurement of differences in levels of publication activity. It identifies the academic and practitioner journals in which faculty of various institutional characteristics most frequently publish. This latter identification serves to enlighten a profession, which is known to rate publication outlets based on perceived quality of the respective journals. Thus, this study should serve as a useful basis for further examination of productivity and quality issues concerning the scholarship of accounting faculty.

RESULTS The results of the various analyses in large part support the study’s hypotheses; however, some surprising results were likewise noted. With respect to differences in rates of publication among the various classes, the results indicated significant differences in publication productivity. With respect to differences in publication outlets among the various classes, the results were mixed. Faculty of different classes were found to publish at significantly different rates within the various journals. However, after controlling for these differences in rates of publication, the publication outlets were in many instances found to be similar.



REFERENCES Campbell & Morgan (1987). “Publication Activity of Promoted Accounting Faculty.” Issues in Accounting Education, Spring 1999, 28-43. Englebrecht, Iyer, & Patterson (1994). “An Empirical Investigation of the Publication Productivity of Promoted Accounting Faculty.” Accounting Horizons, March, 1994, 45-86. Howard & Nikolai (1983). “Attitude Measurement and Perceptions of Accounting Faculty Publication.” The Accounting Review , October 1983, 765-777. Hull, R.P., and G.B. Wright. (1990). “Faculty Perceptions of Journal Quality: An Update.” Accounting Horizons, March 1990, 77-98. Milne, R.A., and G.A. Vent (1987). “Publication Productivity: A Comparison of Accounting Faculty Members Promoted in 1981 and 1984.” Issues in Accounting Education, Spring 1987, 94-102.



THE QUALITIES OF A GOOD ACCOUNTING PROFESSOR: STUDENT PERCEPTIONS

Fay, Jack R., Ph.D.


Hardin, J. Russell, Ph.D. Pittsburg State University

[email protected]

ABSTRACT

Opinions vary as to what constitutes a good accounting professor. Even though professors are usually evaluated by students, faculty, and administrators, who could be better judges than students who sit in the classroom with a professor for approximately 45 hours per semester? The purpose of this study was to seek the opinions of students concerning the qualities or attributes of accounting professors they deemed important for effective educational processes to occur. The students were asked to list the attributes they considered most important and also to list the attributes they considered least important. Finally, the students were asked to write a brief narrative describing their concept of an excellent teacher. Knowledge of the subject being taught and the ability to teach were selected as the most important attributes while publications in professional journals and good appearance were chosen as the least important attributes.

INTRODUCTION

Accounting is an academic discipline that requires hard work and dedication from the professor

and the student. For example, high-level analyses must be conducted in many accounting courses requiring considerable time to complete and considerable skill in applying problem solving approaches. Also, since the theory and practice of accounting is evolving and becoming more complex as business organizations become larger and more complex, much outside work, including research papers and outside readings, is required in many upper division accounting courses. In addition, many college accounting professors have little or no training as a classroom teacher/manager. It is, therefore, not surprising that many students find accounting to be one of the most difficult subject areas in the college of business curriculum.

Teacher evaluation is both a difficult and delicate obligation which the administration of any institution of higher learning must confront. Performance evaluations provide useful data for improving the quality of instruction and are used to support decisions such as tenure, salary, and promotions. The performance evaluation system of a university deserves a careful examination to assess its fairness and validity. Qualified career professors who teach accounting are a scarce commodity since a qualified accountant can usually obtain better remuneration in the practice of accounting. The possibility exists that unfair evaluations may drive a competent professor away from teaching.

Institutions of higher learning use a variety of methods for faculty performance evaluation. Although there has been extensive research on the subject in recent years, institutional differences are found and different opinions exist in regard to the frequency of evaluation, the participation of students and peers, the benefits of standard institutional procedures and forms for all faculty members, and the relative weight attached to teaching competence, research, publication activity and other professional activities in the overall performance rating.



Kreuze and Newell (Kreuze and Newell, 1987) found significant aspects relevant to the evaluation of accounting instructors by students. Their preliminary reading of previous research findings disclosed two important general facts:

a. Teaching competence is generally judged in part by student evaluations. Students’ ratings are viewed as the only tangible source of teaching performance evaluation in the majority of colleges and universities, both in the United States and abroad. b. The characteristics of varying academic areas influence a student’s evaluation of instruction. The mean overall student ratings of instructors differ significantly among subject matter taught.

The fact that there were very few published studies dealing with student evaluation of accounting instruction induced Krueze and Newell (Krueze and Newell, 1987) to study 550 student questionnaires used in their school for instruction evaluation purposes. Each questionnaire contained an overall rating of the instructor plus fifteen questions which identified different aspects about the students, the course, and teacher behavior. Their main objective was to determine which attributes of teaching performance were considered important by students when determining the overall rating of an instructor. Factor analysis of the results indicated that teacher presentation and grading system had the highest impact on the students’ overall rating of the instructor. The Extended Degree Program at Central Michigan University recently printed a list of what a committee of professors and administrators at Miami-Dade Community College has proposed as a core of fundamental characteristics that define excellence for a faculty member. This list contains thirty items. The first ten items indicate that excellent professors: (1) are enthusiastic about their work; (2) set challenging performance goals for themselves; (3) set performance goals for their students; (4) are committed to education as a profession; (5) project a positive attitude; (6) display behavior consistent with professional standards; (7) see students as individuals operating in a broader perspective beyond the classroom; (8) treat students with respect; (9) are available to students; and (10) listen attentively to what students say.

In a recent study about 3,200 undergraduate and 300 graduate students in the College of Business of a regional state university with more than 17,000 students located in the southeastern part of the United States evaluated 126 business faculty. The results of the student evaluations indicate that the most important factors of teaching effectiveness are the following: instructor presents material clearly, instructor answers students' questions, instructor treats students in a courteous and/or professional manner, and instructor appears to be well prepared for each class (Tang, 1997).

SURVEY OF THE ATTRIBUTES OF A PROFESSOR

The questionnaire that Kreuze and Newell (Krueze and Newell, 1987) employed in their study

was apparently designed to evaluate all the faculty members of their school and, as such, inquired only about some general attributes of teaching performance. In an attempt to obtain further insight about the subject, the authors of this paper used a questionnaire containing eighteen items to find out which qualities or teacher attributes students consider most important for their education. Also these authors wanted to find out which attributes the students consider to be the least important. The list of items shown in Exhibit 1 is more detailed than the list made by Kreuze and Newell (Kreuze and Newell, 1987). Even though the list is rather comprehensive, the students were given an opportunity to express the most important characteristics in their own words in responding to the third question of the questionnaire.

The students were asked the following two questions: 1.Please rank what you consider to be the five most important attributes of a university professor as far as your education is concerned. Place a 1 by the attribute that you rank as the most important, a 2 by the next important, and 3, 4, and 5, in order of importance. 2. Please rank what you consider to be the three least important attributes of a university professor as far as your education is concerned. Place a 1 by the attribute that you rank as the least important, and 2 by the next least important, and a 3 by the third least important.

The questionnaires were given to 307 upper-class accounting students in three universities.


Proceedings of the American Society of Business and Behavioral Sciences, Volume 7,Number 1 Las Vegas, 2000

Summary of the results are shown in Exhibits 2,3,4 and 5. A few questionnaires were partially or fully disregarded when students did not follow the instructions properly. A third and final question on the questionnaire was: If you so desire, please give your opinions (in your own words) as to what primary characteristics or attributes does an excellent teacher have? Although not all students answered the question, many gave excellent and meaningful responses. A sample of such responses include:

(1) One who demonstrates a concern for the student - i.e., one who wants to know everyone's name, one who presents a clear, concise class and avoids irrelevant topics, and who knows the subject and obtains answers if he/she doesn't know particular answers.

(2) One who has a concern for students, which is reflected in his availability and ability to motivate students; one who has knowledge of the subject and willingness to do additional research to answer students' questions.

(3) An up-to-date knowledge of the subject; ability to quickly "see" the student's position and to answer quickly and accurately.

(4) Enthusiasm in presenting the subject in an interesting and motivating way; ability to admit that he/she doesn't know everything and can learn new things also.

(5) Knowledge and ability to explain with an interest in the students' progress; desire to encourage students not to give up.

(6) Well organized; clarity of presentation; interesting and enthusiastic orator; knowledgeable in field (no need to constantly look at notes or text).

(7) It is very important for a professor to have an in-depth knowledge of his/her field along with and ability to transmit this knowledge to others.

(8) An excellent teacher is one who cares about students and does not try to "weed" people out by giving unreasonable amounts of assignments or unreasonable tests.

(9) Ability to present material in a clear, straightforward manner without a lot of vagueness; ability and desire to prepare tests that reflect the material covered.

(10) Someone who enjoys his work (and subject) and enjoys teaching it to others. (11) An excellent teacher is one who possesses the ability to teach students in such a

way that the student wants to learn and does learn the basic concepts of the course based on the teacher's own knowledge and expertise in that field of study.

(12) Gets to know students on a personal basis (by name, etc.); explains subject matter until the majority understands it.

(13) Well prepared for class and fully utilizes available time; appropriately refers to the text for further clarification; realizes that the material covered should be relevant to education and life.

(14) He or she should be able to give to the students their money's worth. (15) A good teacher must have a good background in the subject and be able to

communicate with students in an effective way (examples, experiences, humor, etc.) (16) Patience in answering questions; outlined planned lecture in which he may

deviate. (17) Fairness in preparing and grading tests; makes sure he allocates time well in the

classroom covering the material; is available for students outside of the class period; presents material well; takes job seriously.

(18) Communicates well with the students; provides exams that are relevant to the important aspects of the course.

(19) Organized and clear presentations; visual aids (overhead projector, board work); enthusiasm for the subject area; relating the subject to "real world" applications, clear diction and volume.

(20) Tries to help you learn by: (1) being prepared for class (not reading from book), (2) making difficult things seem easier (not easy things hard), (3) testing on what is taught, not what he/she thinks you should know.

(21) The ability to clearly explain course material to students. Concern for students' learning of the material.

(22) A teacher's primary concern should be the student. Being in close contact with the students is very important. It is easier to listen and to understand a teacher who has knowledge and experience.



(23) Knows the material, is prepared, follows the syllabus, grades fairly, grades subjectively by giving partial credit for knowing processes and necessary steps, is optimistic and encouraging.

(24) A good teacher is one who is not lazy and one who makes up a new exam every semester to avoid cheating; giving a different exam each semester indicates the teacher's importance to the student's education.

(25) An excellent teacher has the ability to interest the students and keep them interested in the subject, and really good teachers I have had made me look forward to going to class - they also showed extensive knowledge of the subject and provide clear presentations of examples other than those in the textbook.

(26) An excellent teacher should have the desire to let students express their own thoughts.

(27) Competence and dedication. (28) Makes the subject interesting when it isn't. (29) 1. Great communication skills; 2. concern for ability and desire to motivate and

assist students; 3. teaching from a two-sided approach - students can get what they put in.

(30) The ability to participate in a two-way communication discussion and the ability to teach with an overall concern for students and a friendly attitude.

(31) Ability to teach is most important; the professor may be very knowledgeable in his or her field but without the ability to effectively communicate to the student, the knowledge is

useless. (32) A teacher should be able to teach students in a way that is enjoyable and makes

the student want to learn and to come to class. (33) Ability to teach and be flexible with each student; also the ability not to show a

dislike for a student. (34) Confidence in his/her ability to teach the subject matter. (35) An excellent teacher is one who answers students' questions and tries not to

avoid them.

CONCLUSION

Assuming that the 307 students surveyed in three universities are typical of how students throughout the country would respond to a similar survey, it becomes rather conclusive that university students believe that knowledge of the subject and the general ability to teach are the two most important attributes of a competent professor. The students also consider actual experience in the subject area, ability and desire to motivate students, and fairness in grading to be very important characteristics possessed by good professors. Even though sometimes it may be rather difficult for students to detect the correlation between a professor's publication and research work and his/her teaching of the subject matter, those attributes (publication and research work) appear to be insignificant to the students. The appearance of the professor also does not seem to hold any significance to most of the surveyed students. It may be questionable just what the "ability to teach" means, but the responses to the third question on the survey are indicative of how conscientious students (the major consumers of the university's teachings) would define the term. Most students have between 35-45 professors while attending four years of college and should have a competent idea of what the "ability to teach" really means. Rather than minimizing the importance of publications and research work, these authors suggest that this study provides some evidence that perhaps more universities need to have a policy (or strengthening of an existent policy) to have senior professors (assuming they are master teachers) guide new instructors during their first two or three years in the art of a teaching a particular subject, motivating students and dealing with classroom problems effectively. Also there is no doubt that doctorate programs should place more emphasis on the art of effective teaching in their curricula. As this study indicates, another quality favored by most students is a professor with actual experience in the subject area. This expertise needs to be fostered. Just as research work and publications



may enhance a professor's ability to teach the subject material, experience obtained through actual practice certainly can increase one's teaching skills. Unfortunately, we are in a current stage of seeing more and more younger professors entering the teaching profession with no actual experience in their fields, and actual experience seems to be often ignored by university administrations which attach exaggerated weight on research and publications in recruiting, tenure, and promotions.

REFERENCES



Arnett, Kirk and others, "Improving Business School Student Evaluation of Faculty Performance," Journal of Education for Business (March 1989), pp. 268-270. Avi-Itzhak, Tamar, "Teaching Effectiveness as Measured by Student Ratings and Instructor Self-Evaluation," Higher Education (Nov. 1982), pp. 629-634. Baldwin, Roger, "Faculty Validity: Extending the Concept Beyond the Research University, ASHE Annual Meeting Paper; paper presented at the Annual Meeting of the Association for the Study of Higher Education (Baltimore, MD Nov. 21-24, 1987). Basow, Susan and Nancy Silbert, "Student Evaluation of College Professors: Are Female and Male Professors Rated Differently?" Journal of Educational Psychology (Sept. 1987), pp. 308-314. _____ Central Michigan University, "What Characterizes an Excellent Professor? - Miami Dade Makes a List," (Feb. 1990). Cruse, Daniel, "Student Evaluations and the University Professor," Higher Education (1987), pp. 723-737. Cytron, Scott H., "Leading the class into the 21st century," Journal of Accountancy (June 1998), pp. 56-59. Eagle, Bruce and Ralph Catalanello, "Do Student Attributes Influence Perception on the Importance of Instructor Characteristics Associated with Learning?" Educational Research - Quarterly (1987), pp. 29-36. Fay, Jack R., William L. Ferrara, and Judson P. Stryker, "The quest for quality in business schools," Management Accounting (Dec. 1993), pp. 48-50. Ferguson, Donald and Gerald Thomas, "In Celebration of the Teacher," Action in Teacher Education (Spring 87), pp. 75-79. Freeman, Harvey, "Perceptions of Teacher Characteristics and Student Judgment of Teacher Effectiveness," Teaching of Psychology (Oct.88), pp. 158-160. Godwin, Larry, "Enliven your teaching," Management Accounting (Dec. 1991), pp. 54-55. Kierstead, Daniel and others, "Sex Role Stereotyping of College Professors: Bias in Students' Ratings of Instructors," Journal of Educational Psychology (Sept. 1988), pp. 342-344. Kreuze, Jerry G., and G.E. Newell, "Student Ratings of Accounting Instructors - A Search for Important Determinants," Journal of Accounting Education (Vol. 5, 1987), pp. 87-98. Marsh, Herbert, "Student Evaluations of University Teaching: Research Findings, Methodological Issues, and Directions for Future Research," International Journal of Educational Research (1987), pp. 253--288. Marsh, Herbert, "Utility of Student Ratings," International Journal of Educational Research (1987), pp. 337-350. Marsh, Herbert, "Validity," International Journal of Educational Research (1987), pp. 285-304. Miller, Allen, "Student Assessment of Teaching in Higher Education," Higher Education (1988), pp. 3-15. Minner, Sam, "The Influence of Instructor's Gender, Student's Gender, and Instructor's Experience on Student Evaluation," Teacher Education and Special Education (Fall 1988), pp. 180-183.



Miron, Mordechai, "Student's Evaluation and Instructors' Self-Evaluation of University Instruction," Higher Education (1988), pp. 175-181. Renner, Richard, "Professor X: How Experts Rated His Student Ratings," Assessment and Evaluation in Higher Education (Fall 1985), pp. 203-212. Saterlie, Mary Ellen, "Developing a Community Consensus for Teaching Values," Educational Leadership (May 1988), pp. 44-47. Seldin, Peter, "Evaluating Teaching Performance: Answers to Common Questions," AGB-Reports (Jan-Feb 1988), pp. 34-39. Seldin, Peter, "Using Student Feedback to Improve Teaching," New Directions for Teaching and Learning (Spring 1989), pp. 87-97. Tang, Thomas Li-Ping, "Teaching evaluation at a public institution of higher education: Factors related to the overall teaching effectiveness," Public Personnel Management (Fall 1997), pp. 379-389. Trahan, Collen and Bruce Swindle, "A Good Accounting Instructor: A Student Perspective," Journal of Education for Business (Feb. 1988), pp. 216-219. Waters, Marie and others, "High and Low Evaluations: Descriptions by Students," Teaching of Psychology (Dec. 1988), pp. 203-204. Weinstein, Art, "Become an excellent marketing educator," Marketing News (Aug. 12, 1996), p. 5.

EXHIBIT 1

List of Attributes of a Professor

_____ A. Knowledge of the subject being taught

_____ B. Actual experience in the subject area

_____ C. Ability to teach

_____ D. Good oral presentation

_____ E. Good appearance

_____ F . Concern for the students

_____ G. Ability to answer questions well

_____ H. Humor

_____ I. Ability and desire to motivate students

_____ J. Enthusiasm

_____ K. Publication in professional journals



_____ L. Research work in the subject being taught

_____ M. Fairness in grading

_____ N. Availability

_____ O. Flexibility

_____ P. Ability and desire to provide a comfortable classroom atmosphere

_____ Q. Professionalism

_____ R. Other (please state the attribute)

Exhibit 2

SUMMARY OF THE MOST IMPORTANT ATTRIBUTES

Attributes Rankings

1 2 3 4 5 Total Median Model

(Number of Choices) Choices Rank

Rank

A. Knowledge of the subject being taught 142 92 28 13 2 277 1 1

B. Actual experience in the subject area 6 39 41 30 30 146 3 3

C. Ability to teach 102 88 43 16 13 262 2

1

D. Good oral presentation 5 13 34 22 21 95 3 3

F. Concern for the students 7 10 24 38 34 113 4

4

G. Ability to answer questions 1 19 37 30 20 107 3 3

I. Ability and desire to motivate students 8 17 38 40 33 136 4 4

J. Enthusiasm 3 4 8 16 24 55 4 5



K. Fairness in grading 7 8 28 38 40 121 4 5

Other 3 4 13 53 74 147

Exhibit 3

SUMMARY OF THE LEAST IMPORTANT ATTRIBUTES

Rankings

Attributes 1 2 3

(Number of Total Median Model Choices Choices Rank Rank E. Good Appearance 106 43 49 198 1 1 H. Humor 24 19 36 79 2 3 K. Publications in professional journals 125 93 35 253 2 1 L. Research work in the subject

being taught 27 93 70 190 2 2

P. Ability and desire to provide a comfortable classroom atmosphere 7 18 30 55 3 3

Other 11 35 85 131



THE RELATIONSHIP BETWEEN RACE, SEX AND BUSINESS SIZE IN THE UTILIZATION OF

COMPUTER ACCOUNTING AND PRODUCTIVITY SOFTWARE BY SMALL BUSINESSES IN

SOUTHEASTERN VIRGINIA

Allan Unseth Norfolk State University, Norfolk

[email protected]

Jon Stuart, Norfolk State University, Norfolk

[email protected]

Raymond Laverdiere Norfolk State University

[email protected]

Michael Chester Norfolk State University

[email protected]

ABSTRACT

In reviewing the literature it appears much has been written about accounting and productivity software. However, none of the articles looked at the actual utilization of such software by small business. This research study attempts to fill this void. A questionnaire was mailed to one thousand and twenty-nine small businesses in Southeastern Virginia. The results indicated productivity software for word processing was the most common utilization of computer software with MS Word being the most popular word processing package. Accounting software was the second most utilized, with QuickBooks being the most popular accounting software. The third most popular were spreadsheet applications with Excel being the most popular software. Database software was rarely used. However, when it was used Acess was the most popular software package.

INTRODUCTION

Various studies have reviewed the features of computer accounting and productivity software. Some accounting publications have been publishing a regular column reviewing computer accounting software. The Journal of Accountancy has periodically surveyed certified public accountants (CPAs) on their use of such software. However, some of these surveys related the opinions of just one individual.

In a Journal of Accountancy survey (1996), CPA firms were asked about their particular needs and how much they should invest in the new computer technology. Khani and Zarowin [9] surveyed 256 small and large CPA firms as to what computer hardware and software they were utilizing. The differences between what the small and large CPA firms were using seemed to have been decreasing.

(Schulz, 1996) reviewed eight low cost computer software products. He related that the important



features to look for included reports and financial statements that can be modified along with multi-user options. (Luthy, 1994) recounted that there were a number of spreadsheet (productivity) computer programs to choose from. This article related that potential users of such programs wanted to determine if the particular features were suitable for their needs.

A number of articles were reviewed that dealt with computer accounting software used by small businesses. A number of DOS-based and Windows-based accounting software packages were evaluated by (Haas, 1994, 1995). These packages were reviewed with respect to their usefulness to small business users. The magazine entitled Inc.(1995) compiled computer magazine reviews of relatively inexpensive accounting packages. The good news was that the lower end of the market was growing steadily more competitive. The bad news was that it can be hard to get definitive information comparing the various packages, as reviewers often have very different opinions. (Collins, 1999) indicated that the job of assessing accounting software may be complex and the selections should not be based solely on someone’s recommendation.

(McCollum, 1997) and (Ashby, 1997) asserted that computer accounting software allowed small business owners to save money by doing their own accounting. (Heathfield, 1997) contended that small and medium-sized companies were calling for computer accounting software with strengthened financial reporting competencies. The article also stated that many small and medium-sized businesses were looking for new computer technologies which would adapt to their ever-changing needs.

The one exception to the above-mentioned studies, which related the opinions of an individual or certified public accountants, was one made by (Henry, 1997). The author surveyed one thousand businesses to determine the nature of their accounting computer systems and the related security techniques that were utilized. This study emphasized computer hardware and any security measures related to the computerized accounting system.

None of the studies to date have attempted to evaluate the actual utilization of accounting or productivity software packages in small businesses. This research project is designed to examine the current software packages that are being used by Southeastern Virginia entrepreneurs and small businesses to establish, maintain and provide the accounting records and information that is critical for making effective business decisions. By determining the accounting software that is actually being used by entrepreneurs and small businesses on a daily basis, accounting instructors may be better able to make decisions as to which computer software programs might be best used in accounting education.


A comprehensive questionnaire was developed and sent to one thousand and twenty-nine small businesses in Southeastern Virginia. The businesses surveyed represented a random sample taken from a Norfolk State University database of minority businesses in Southeastern Virginia and the Selectphone Pro data base. Three hundred and sixty questionnaires were returned as not deliverable, leaving an effective sample size of six hundred and sixty nine. Seventy-six usable questionnaires were returned resulting in an eleven percent response rate. The questionnaire was composed of questions concerning business demographics, the type of computer accounting software utilized and the type of computer productivity software used by the respondent.

RESULTS

Two-thirds of the respondents indicated they were male and fifty-one percent indicated they were a minority. Forty-two percent of the respondents were from the service industry and sixty-nine percent had twenty-five or less employees. Approximately three-fourths of the respondents had $2.5 million or less in annual sales.

As can be seen in Table 1, QuickBooks/Quicken Products were used by approximately thirty-four percent of the respondents. Peachtree ran a distant second with approximately fourteen percent and interestingly, in this age of computers, approximately twenty-eight percent did not use any computer accounting software.

Table 2 indicates that almost one-half of the respondents used Excel for a spreadsheet package, while approximately twenty percent used Lotus and forty percent reported that they did not use any spreadsheet software.



As suspected, a relatively large amount (approximately sixty-five percent) of the respondents used no database software. Table 3 does show that the most popular package was Access, used by about twenty percent of the respondents.

As can be seen in Table 4, word processing software was the most widely used productivity package. Fifty-three percent of the respondents used MS Word and forty percent used WordPerfect. Only about twenty-two percent reported not having used word processing software.

Looking at Table 5, respondents indicated the top five specific activities they use their computer for are: report writing preparation (seventy-nine percent), correspondence (seventy percent), payroll (sixty-one percent), E-mail (fifty-seven percent), and invoice preparation (fifty-two percent). As can be seen from these activities, the computer is primarily being used for business communication. This appears to be consistent with the results shown in Table 4.

CONCLUSION

The survey of the usage of computer software packages in Southeastern Virginia revealed some expected results and some findings that were surprising. As expected, the responding small businesses overwhelmingly employed Quick Books/Quicken Products as their computer accounting software. Also somewhat anticipated was the fact that Excel would be the most popular spreadsheet package and MS Word and WordPerfect as the most commonly used word processing packages. Not unexpectedly, the top five specific activities for which the computer was used were: Report Writing Preparation, Correspondence, Payroll, E-mail, and Invoice Preparation. An analysis of the data via sex, race and size of firm based upon sales revenue showed no significant difference in software packages utilized by the surveyed firms. See tables 1-4.

One surprising result of our survey was the fact that almost twenty-eight percent of the responding businesses did not make use of any computer accounting software. It was also not foreseen that approximately sixty-five percent of the respondents, who used a computer in their business, did not utilize database software. These research findings may be of interest to accounting professors as they make decisions as to what type of computer software to use in the education of future accountants.

Table 1 Percentage of Respondents Using Computer Accounting Software

Software Total * Less than $500,001 to $1,000,001 to More than

Package Percent Male Female White Minority $500,000 $1,000,000 $2,500,000 $2,500,000

AccountMate

1.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

DacEasy Accounting

3.9 1.5 9.5 0.0 5.8 4.8 0.0 6.7 0.0

M.Y.O.B. Accounting

0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

One-Write Plus

2.6 3.1 0.0 0.0 3.8 0.0 0.0 0.0 0.0

Open Systems

1.3 1.5 4.8 2.9 0.0 0.0 18.2 6.7 0.0

Peachtree

14.3 12.3 9.5 8.8 13.5 9.5 18.2 6.7 0.0

Profit from Champion

0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Proven Edge

0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

QuickBooks/Quic

33.8 24.7 28.6 35.3 25.0 23.8 36.4 33.3 33.3



oks/Quicken Prod RealWorld

1.3 1.5 0.0 2.9 0.0 0.0 0.0 0.0 8.3

SBT 1.3 1.5 0.0 0.0 1.9 2.4 0.0 0.0 0.0

Simply Acc'ting/ACCPAC

0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Softee 0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

State of The Art

0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Tax Cut 0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Turbo Tax

5.2 3.1 9.5 0.0 3.8 7.1 0.0 6.7 0.0

The Versatile Group

0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Other 27.7 21.5 19.0 26.5 23.1 14.3 18.2 33.3 41.7

Do Not Use

27.7 26.2 19.0 23.8 23.1 38.1 9.1 6.7 16.7

* Total adds up to more than 100% because some respondents used more than one software package.

Table 2

Percentage of Respondents Using Spreadsheet Software Software Total* Less than $500,001 to $1,000,001 to More than

Packages Percent Male1 Female1 White1 Minority1 $500,0001 $1,000,0001 $2,500,0001 $2,500,0001

Excel 46.8 57.8 69.2 62.9 54.5 60.0 50.0 66.7 64.3

Lotus 19.5 24.4 15.4 18.2 30.3 25.0 12.5 11.4 35.7

Quattro 6.5 11.1 7.7 14.8 6.0 10.0 25.0 0.0 0.0

Supercalc

0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Visicalc 0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Other 5.2 6.7 7.7 3.8 9.1 5.0 25.0 22.2 0.0

Do Not Use

40.0

* Total adds up to more than 100% because some respondents used more than one software package. 1 Percent includes the only the respondents who reported using spreadsheet software.

Table 3 Percentage of Respondents Using Database Software

Software Total* Less than $500,001 to $1,000,001 to More than

Percent Male1 Female1 White1 Minority1 $500,0001 $1,000,0001 $2,500,0001 $2,500,0001

Access 19.5 47.6 37.5 53.8 43.7 40.0 50.0 16.7 66.7

dBase 3.9 14.3 7.7 7.7 12.6 0.0 50.0 16.7 11.1

File maker

2.6 4.8 12.5 7.7 0.0 20.0 0.0 0.0 0.0

FoxPro 1.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Oracle 1.3 0.0 12.5 7.7 0.0 0.0 0.0 0.0 11.1

Other 13 33.3 37.5 23.1 43.7 40.0 0.0 66.6 11.1

Do Not Use

64.9

* Total adds up to more than 100% because some respondents used more than one software package.



1 Percent reported only those respondents who reported using database software.

Table 4 Percentage of Respondents Using Word Processing Software

Software Total* Less than $500,001 to $1,000,001 to More than

Package Percent Male1 Female1 White1 Minority1 $500,0001 $1,000,0001 $2,500,0001 $2,500,0001

MS Word 53.2 47.8 69.2 50.0 47.6 46.2 38.5 53.8 52.6

WordPerfect

40.3 40.0 26.9 36.1 42.9 42.3 46.2 30.8 42.7

Word Star 1.3 1.7 0.0 2.8 0.0 32.8 0.0 0.0 0.0

Other 10.4 13.5 3.9 11.1 9.5 7.7 15.4 15.4 5.3

Do Not Use 22.1

*Total adds up to more than 100% because some respondents used more than one software package. 1 Percent does not include non respondents

Table 5 Percentage of Total Respondents Using

Computer for Specific Activities Activity Computer Use (%)

Accounts Receivable 35.1

Accounts Payable 37.7

Correspondence 70.1

Data Base Management 37.7

Education (Training) 13

Fax 33.8

Forecasting 9.1

Games 22.1

Inventory Control 24.7

Invoice Preparation 51.9

Order Processing 26

Payroll 61

Production Activities 14.3

Report Preparation 79.2

Recording Sales 33.8

Scheduling of Work 26

Time Keeping 26

Internet: Web Site 35.1

Internet: Information 42.9

Internet: E-mail 57.1

Other Activities 5.2



REFERENCES

Ashby, Charles. (1997, February). “Small Businesses Save Money with New Accounting and Tax Software.” Knight-Ridder/Tribune Business News. p 218.

Collins, J. Carlton. (1999, September). “How to Select the Right Accounting Software.” Journal of

Accountancy. 188, 31-38. Haas, Amy D. (1994, November). “Windows-based Small Business Accounting Software.” The CPA Journal.

64, 22-27. Haas, Amy Diller. (1995, November). “DOS-based Accounting Software for Small Businesses.” The CPA

Journal. 65,30-36. Heathfield, Paul. (1997, May-June). “SME Business Leaders Need Powerful On-board Computers.”

Industrial Management & Data Systems. 97, 233-236. Henry, Laurie. (1997, December). “A Study of the Nature and Security of Accounting Information Systems:

the Case of Hampton Roads, Virginia.” Mid-Atlantic Journal of Business. 33, 171-190. Inc. (1995, August). “Budget Accounting Software.” 17, 108-109. Journal of Accountancy (1996, August). “Is Your Firm Making the Best Use of Technology?” 181, 49-58. Khani, Patricia E. and Stanley Zarowin. (1995, May). “Counting on Technology: Accountants Add More

Prowess to Their Computers and Access More Sophisticated Software.” Journal of Accountancy. 179, 59-68.

Luthy, David H. (1994, July). “Spreadsheets: Faster, Smarter.” Journal of Accountancy. 178, 67-76 McCollum, Tim. (1997, January). “Taking Account of Software.” Nations Business. 85, 41-44. Schulz, Wayne. (1996, May). “Buyer’s Guide to Low-end Accounting Software.” Journal of Accountancy.

182, 10-11.



THE RELOCATION DECISIONS OF ACCOUNTING FACULTY

Bitter, Michael E. Stetson University

EXECUTIVE SUMMARY

Several factors could potentially contribute to an accounting professor's decision to relocate--an imbalance in the supply of and demand for accounting academics (Schultz, 1989), salary compression (Jacobs & Herring, 1987; Schultz, 1989), the failure to receive tenure (Schultz, 1989; Schultz, et al., 1989), and nonwork (personal) issues (Holland & Arrington, 1987). Given conditions that encourage relocation and because faculty recruiting is an expensive and time-consuming endeavor, employer institutions should understand the factors that influence an accounting faculty's decision to relocate. This study explores the relocation decisions of experienced accounting faculty--the variables considered and characteristics of the current and previous positions. A two page survey was developed and sent to accounting professors who had relocated to a U.S. institution during 1996 or 1997. The survey contained three sections, the most important of which contained 54 variables, both institutional and personal, that may be important to the decision to change jobs. Respondents were asked to rate the relative importance of each variable using a five-point scale developed by Holland and Arrington (1987). The remaining sections of the survey requested information about a respondent's current and previous positions and demographic data.

CHARACTERISTICS OF RESPONDENTS The survey was mailed to 238 accounting professors. Ninety-eight usable responses were received, yielding a response rate of 41 percent. The majority of the respondents were white (90 percent) and married (77 percent); the average age of the respondents was 44. Most held an appointment at the assistant (47 percent) or associate (30 percent) professor rank at their current institution. The profile of the typical respondent's current employer was as follows: a public (65 percent), regionally-focused (67 percent), teaching-oriented (86 percent) institution located in the southeast (22 percent) or midwest (27 percent). Generally, there tended to be a migration away from research-oriented schools toward teaching-oriented schools. The majority of the respondents' institutions offered an accounting-related bachelor degree (93 percent), a MBA degree (86 percent), and an accounting master's degree (50 percent) and were AACSB accredited (58 percent). Twenty-seven percent offered an accounting-related doctoral degree. Respondents' current schools were less likely to offer an accounting-related doctoral degree or hold AACSB accreditation than their previous schools.

ANALYSIS AND RESULTS

A number of variables were of some importance to the relocation decision. Personal and faculty/administrative-related variables were most prominent among the 26 variables positively impacting the relocation decision. Surprisingly, all but one of the compensation variables were absent from this group. The ratings of faculty at doctoral-granting schools (DOC) for compensation, research resources, research support, and doctoral education variables were higher than those of faculty at schools not offering doctoral degrees (NONDOC). See Tables 1 and 2. Factor analysis indicated that faculty valued the reputation of the institution and the quality of their programs and faculty. In addition, faculty at DOC schools valued schools with faculty having compatible research interests. Faculty at NONDOC schools valued reputational variables and the ability to teach desired courses. The majority of respondents relocated to a NONDOC school. The typical respondent specialized in financial accounting and taught five classes per year with three preparations. Respondents at DOC schools



teach more at the upper division and graduate levels and less at the introductory level than those at NONDOC schools. The work load of respondents at DOC schools was weighted toward research, while the respondents at NONDOC schools spent the majority of their time on teaching activities. Regardless of affiliation, respondents reported that their research was aimed more toward academic journals than practitioner journals. Teaching effectiveness was perceived as most important to tenure and promotion decisions by the aggregate sample and by faculty at NONDOC schools. Not surprisingly, research effectiveness was perceived as most important by faculty at DOC schools. See Table 3.



TABLE 1 VARIABLES IMPORTANT TO THE RELOCATION DECISION MEAN RESPONSES AND RANKS Aggregate DOC NONDOC Variable Mean Rank Mean Rank Mean Rank Happiness of spouse/family 4.00 1 4.05 1 3.98 1 Collegiality of faculty 3.82 2 3.96 3 3.77 2 Compatibility with faculty 3.79 3 3.84 7 3.76 4 Geographic location of school 3.76 4 3.65 12 3.77 2 Opportunity to teach desired courses 3.69 5 3.56 16 3.71 6 Overall nonprofessional quality of life 3.67 6 3.88 4 3.59 7 Quality of faculty 3.62 7 3.88 4 3.53 8 Base salary 3.57 8 4.00 2 3.41 12 a Compatibility with dean 3.57 8 3.00 33 3.74 5 a University/school/ department mission 3.53 10 3.68 10 3.49 9 Quality of students 3.45 11 3.36 23 3.49 9 Quality of undergraduate program 3.43 12 3.40 18 3.43 11 Reputation of department 3.36 13 3.88 4 3.16 17 a Compatibility with department chair 3.36 13 3.60 14 3.24 16 Location: urban - suburban - rural 3.33 15 3.40 18 3.27 14 Teaching load 3.30 16 3.76 9 3.10 18 a Likelihood of obtaining tenure 3.27 17 3.24 26 3.27 14 Class size 3.23 18 2.92 39 3.31 13 Computing resources 3.21 19 3.60 14 3.06 21 Travel funds 3.19 20 3.40 18 3.10 18 Research interests of faculty 3.16 21 3.84 7 2.91 28 a Instructional resources 3.13 22 3.28 24 3.06 21 Cost of living 3.11 23 3.24 26 3.04 24 Promotion/tenure criteria 3.09 24 3.15 30 3.06 21 Research support 3.04 25 3.68 10 2.79 36 a Availability of recreation/culture 3.04 25 3.38 22 2.87 29 Classroom facilities 2.99 28 2.68 43 3.10 18 Ties to region 2.98 29 2.76 42 3.03 25 Library resources 2.88 33 3.40 18 2.67 42 a Summer school compensation 2.68 45 3.28 24 2.43 50 a Existence of doctoral program 1.71 53 3.52 17 .97 53 a Quality of doctoral programs 1.64 54 3.64 13 .84 54 a Note: Only variables ranked among the top 25 by at least one group are reported. a - significant difference between mean responses of respondents currently at DOC and NONDOC schools at the .05 level.



TABLE 2 VARIABLES MOST IMPORTANT TO DECISION ANALYSIS BY RANK SCORE Aggregate DOC NONDOC Variable Score Rank Score Rank Score Rank Happiness of spouse/family 131 1 26 3 104 1 Base salary 99 2 45 1 Likelihood of obtaining tenure 89 3 30 2 59 4 Geographic location of school 87 4 75 2 Compatibility with faculty 80 5 24 5 Ties to region 80 6 65 3 Collegiality of faculty 66 7 Promotion/tenure criteria 65 8 58 5 Employment opportunities for spouse 55 9 Compatibility with department chair 43 10 Research interests of the faculty 26 3 Reputation of department 24 5



TABLE 3 PROFILE OF WORK LOAD AND PROMOTION/TENURE CRITERIA PANEL A: WORK LOAD MIX Current School Previous School Aggregate DOC NONDOC Aggregate DOC NONDOC Teaching 50.9% 41.2% 54.6% 47.8% 41.0% 50.4% Research 34.6% 47.7% 29.6% 39.1% 48.4% 35.5% Service 14.5% 11.1% 15.8% 13.1% 10.6% 14.1% PANEL B: RESEARCH MIX Current School Previous School Aggregate DOC NONDOC Aggregate DOC NONDOC Academic Journals 57.7% 91.9% 46.1% 66.3% 95.4% 56.0% Practitioner Journals 31.7% 6.7% 40.2% 28.2% 2.3% 37.4% Other Research 10.6% 1.4% 13.7% 5.5% 2.3% 6.6% PANEL C: LEVEL OF TEACHING ASSIGNMENTS Current School Previous School Aggregate DOC NONDOC Aggregate DOC NONDOC Introductory level23.0% 17.1% 25.2% 22.8% 12.8% 26.6% Upper division level 47.6% 42.5% 49.5% 54.5% 49.9% 56.2% Graduate level 29.4% 40.4% 25.3% 22.7% 37.3% 17.2% PANEL D: PROMOTION/TENURE IMPORTANCE WEIGHTINGS Current School Previous School Aggregate DOC NONDOC Aggregate DOC NONDOC Teaching Effectiveness 47.4% 39.4% 50.4% 37.6% 29.2% 40.9% Research Effectiveness 41.6% 52.8% 37.3% 52.6% 62.4% 48.7% Service Effectiveness 11.0% 7.8% 12.3% 9.8% 8.4% 10.4%



REFERENCES Holland, R. G., & Arrington, C. E. (1987). Issues influencing the decision of accounting faculty to relocate.

Issues in Accounting Education, Spring, 57-71. Jacobs, F.A., & Herring III, H. C. (1987). Salary compression in the academic marketplace: Some empirical evidence. Issues in Accounting Education, Fall, 237-250. Schultz, J.J., Jr. (1989). Reorienting accounting education: Reports on the environment, professoriate, and curriculum of accounting (Accounting Education Series, volume 10). Sarasota, FL: American Accounting Association. Schultz, J. J., Meade, J. A., & Khurana, I. (1989). The changing roles of teaching, research, and service in the promotion and tenure decisions for accounting faculty. Issues in Accounting Education, Spring, 109-119.



USING ACL SOFTWARE IN THE AUDITING CLASSROOM: PREPARING STUDENTS FOR THE

NEW MILLENNIUM

Gelinas, Ulric Bentley College

[email protected]

Levy, Elliott Bentley College

[email protected]

Thibodeau, Jay Bentley College

[email protected]

ABSTRACT

Driven by economic pressures to perform internal and external audits efficiently and effectively, and by technological advances, the audit profession is becoming more dependent on audit software. ACL, the leading audit software package, has over 80,000 audit professionals in more than 100 countries as clients. ACL clients include 74 of the Fortune 100 companies, as well as governments and their agencies, and all of the Big Five international public accounting firms. Faculty at Bentley College, which is committed to substantive integration of technology into the curriculum, developed a three-part case that introduces students to ACL. The case first walks students through the basics of the software; then asks for a discussion of risks and related audit procedures that would, using the ACL software, address those risks; and finally requires the execution of audit procedures with ACL to analyze and test a database. The ACL case complements course discussion on risks, objectives, and procedures. In addition, students are exposed to the software package as an audit tool.

INTRODUCTION

The audit profession has been undergoing major changes in recent years. CPA firms are now

calling themselves professional services firms, women are entering the profession in large numbers, the education requirements for certification are increasing to 150-hours, customized work arrangements are gaining popularity, business process and knowledge management are becoming popular phrases (Bell et al., 1997; Flynn, et al., 1997). Computerization has been an agent of change driving and supporting these movements. Software supporting the audit process, in particular, is playing a major role. This paper discusses the use of the market’s leading audit software package in the auditing classroom.

ACL AND BENTLEY COLLEGE ACL Services Ltd. is based in Vancouver, Canada. Its software is the market leader in technology

tools for data inquiry, analysis, and reporting, and is used by over 80,000 audit professionals in more than



100 countries worldwide. ACL clients include 74 of the Fortune 100 companies, as well as governments and their agencies, and all of the Big Five firms. In a recent survey of auditors, ACL was recognized as the leading audit software in use today (www.acl.com).

Given this broad base of users, coupled with feedback from alumni and practitioners, auditing faculty at Bentley College decided to incorporate the ACL software in its undergraduate and graduate auditing course offerings. ACL Services Ltd. was very cooperative, granting a free site license to use the software on the college computing network and to give copies of the software to students for use on their own computers. The software is the actual package distributed commercially, restricted only in terms of the size of the data base (64K) that could be used with the software. The software, an electronic version of the Workbook Manual, and some data files were loaded on the Bentley network for student use. In addition, several hardcopies of the ACL Workbook Manual were purchased at retail prices for faculty and for use in Bentley’s Accounting Center for Electronic and Business Measurement (ACELAB). Bentley College was founded in 1917 as the Bentley School of Accounting and Finance. It is an independent, nonsectarian business school in Waltham, MA offering undergraduate and masters level degrees. Bentley is the largest institution of higher learning specializing in professional business education in New England. The College has approximately 3,500 undergraduate students and 1,500 graduate students. The College’s undergraduate Accountancy program was ranked among the top 20 in the country in the Public Accounting Report’s 1997 annual survey. Under the direction of its President, Joseph Morone, Bentley College has made a commitment to thoroughly integrate technology into the classroom (Crowley 1999; Hildebrand 1999; Whitford 1999). To that end, support has been provided to faculty to develop technology-related course materials. In addition, the college received funding from The Davis Educational Foundation to support faculty advocates to provide direct encouragement and guidance for faculty wanting to experiment with technology. The lead author of this paper is one of those advocates.

CAATS IN AUDITING COURSES Prior to the introduction of ACL across all the introductory auditing courses in the fall, 1999, computer-assisted audit techniques (CAATs) had been used to some degree. Preaudit, Fieldpak, and Auditpak, packages developed by the legacy firm Coopers & Lybrand, were the first packages used in the auditing and IT auditing courses. A case was developed that used the software to perform various analytical procedures. Searching online databases and Web sites has also been an integral part of the coursework. IDEA, a generalized commercial audit software package, was tried in 1998-1999, using a case provided by the software vendor. Also, ACL had previously been used in an elective IT auditing course. Several lessons were learned from the earlier experiences integrating CAATs into auditing courses. First, the application must not be an add-on, but rather must be seen as an integral part of the course. This avoids the possibility of students seeing the use of CAATs as simply another thing to do. Second, assignments must be a valuable experience and must be a significant portion of the course grade; otherwise students will not take the assignments seriously. Third, assignments must be challenging on both the content and technology dimensions. That is, the assignments cannot address simple aspects of the course content, and they cannot simply be keystroke data entry assignments. Other lessons learned included holding some office hours in the ACELAB, demonstrating the software in class, integrating instructions about the software into the assignments, and making the first assignment an exploration of the software.

PROCESS

The two faculty responsible for teaching the introductory auditing courses joined with the faculty advocate, who is a member of the accounting information systems and auditing faculty groups, on a regular basis during the summer, 1999. They researched the available software and decided on ACL, the market leader. They searched for existing cases, contacting list serves, academic and other colleagues. The decision was made to use an existing database that was created for assignments in other Bentley courses.



The database was updated and revised to reflect some of the issues to be covered in the new assignments. The assignments were prepared for use in the fall, 1999.

THE NORWOOD OFFICE SUPPLIES CASE STUDY

The case assignment (available from the authors upon request) goes through several stages. First, students are assigned text readings on CAATs. This is followed by class discussion that connects CAATs to course learning objectives related to assertions, objectives, evidence, tests and procedures. Also, a class demonstration briefly showing how to access and use the software and data is presented. The students are given access to the Norwood database that has customer, accounts receivable, sales order, and inventory files for this fictitious office supply company. Students are also given access to the ACL software, Workbook Manual, and workbook data files. They can download these files for use on their own computers or they can use college computing facilities (e.g., ACELAB). The case has three assignments. The objective of the first assignment is for students to be able to get access to and perform some simple functions using the ACL software. A handout gives the students an overview of the assignment, explains how to get access to the files and manuals, and explains some terms and functions. The students then must perform some of the functions. They have to open an existing document, open and close a file, add comments to the command log, analyze data within a file, total a field, count the number of items in a file, and create a new file. The students are given specific directions on how to perform those functions, using the data provided by ACL. After this introduction, the students then have to analyze the Norwood inventory and accounts receivable data files. The questions that they have to answer and the procedures that they have to perform grow out of the earlier part of the assignment, but require analytical and critical thinking skills. Students must submit printouts of the command log and files showing that they understood how to use the software and had themselves completed the assignment. The second assignment does not involve the use of ACL software. Rather, the objective is to be able to assess audit and business risks and to prepare an audit plan that describes audit objectives and audit procedures. This assignment focuses on course learning objectives regarding the recognition of risks and the design of audit procedures to address those risks. Students are asked to read some background information on Norwood Office Supplies, including financial statements and systems flowcharts. Based on this background and their understanding of auditing, students are required to discuss operational and financial statement risks that exist and audit procedures that can be used to test for the existence and extent of those risks. The students must include audit procedures that can be performed using the ACL software. For example, there is a risk that Norwood is selling items below cost. ACL can test this by comparing the cost and sales price fields in the inventory file and printing a list of items that are being sold below cost. This inventory example has operational and financial statement implications. The last assignment takes the students back to the ACL software. The objective of this assignment is to use the ACL software to conduct audit procedures. They must now perform some of the tests that were recommended in the second assignment. They are asked to describe the audit tests, why they chose that test, and conclusions about the results of the test. Printouts and the command log have to be submitted with the analysis. Each assignment is debriefed in class and connected to class discussions of audit topics. Because the case was assigned early in the semester, there was ample opportunity to refer back to ACL, Norwood Office Supplies, and each of the lessons learned.

STUDENT AND FACULTY FEEDBACK

The case assignment was a very positive experience for faculty and students. The learning curve was steep but the payoff was high. Students were exposed to a popular audit software package. They may use this specific package, or the skills they developed responding to the new package. Faculty developed the skills necessary to direct student effort and address student concerns regarding the commercial ACL software. This helps keep full-time faculty in touch with the world of practice. The connection of course learning objectives and technology as a tool was explicitly made.



Data are currently being compiled from a student questionnaire. The results will be presented at the American Society of Business and Behavioral Sciences meeting in February, 2000. Copies of the questionnaire are available from the authors upon request.



BIBLIOGRAPHY

Bell T. B., Marrs, F. O., Solomon I., & Thomas, H. (1997). Auditing Organizations Through a Strategic-Systems Lens: The KPMG Business Measurement Process. KPMG Peat Marwick. Crowley, A. (1999). Building IT into an MBA. PC Week, January 18, 1999. Flynn, P. M., Leeth, J. D., & Levy, E. S. (1997). The Accounting Profession in Transition. The CPA

Journal (May), 42-45,56. Hildebrand, C. (1999). A Little School Turns the Traditional MBA Program on its Head. CIO Magazine,

March 15, 1999. http://www.acl.com Whitford, D. (1999). A New MBA for the E-Corp.: Half-Geek, Half-Manager. Fortune Magazine, Vol.

139, No. 5, March 15, 1999.



USING VIRTUAL TOURS TO IMPROVE STUDENTS' CRITICAL THINKING SKILLS

Bachman, Virginia

Arkansas Tech University [email protected]

Johnson, Hans

Arkansas Tech University [email protected]

ABSTRACT

In years past, organizing a field trip to a manufacturing plant was a real hassle, especially for college students located in rural areas. Students studying cost and managerial accounting who have never toured a manufacturing plant often found it difficult to relate to the product cost concepts presented in their textbook. Today, thanks to the Internet, students can take a virtual tour of a wide variety of manufacturing plants. The sound, smell, and live activity is missing, but the logistical time and cost is eliminated. We believe teaching and learning has become more effective and enjoyable thanks to the new technology. This year we have asked students to reflect on what they have learned and apply this knowledge to businesses in the New Economy; that is, information technology businesses associated with the Internet. This paper summarizes our classroom experiences to date. At the meeting we will discuss in detail the current case materials used in class. The new AICPA Competency Framework for Entry into the Accounting Profession, in explaining the importance of critical thinking, states that “being in tune with ‘big picture’ perspective is a necessary component for success.” Part of the ‘big picture’ is that in the next century the Old Economy, based on manufacturing, is forecasted to be replaced in overall importance by a New Economy based on information technology. A century ago the struggle for supremacy was between the agricultural sector and the newly emerging manufacturing sector. Then, the power and lighting from electricity was having a profound impact on the economy. A multitude of new technological inventions followed, the telephone and “horse-less carriage” included, that dramatically changed the business landscape, and thus our culture; i.e., “What was good for General Motors was good for our country!” In the new millennium, the business landscape is going to be far different from that to which we are accustomed. Established manufacturing operations have long been the primary textbook model for cost and managerial accounting courses, and rightly so. A brief discussion of the conceptual implications of costing for business in the service sector is also included in most textbooks. The Internet, however, is a new phenomenon in the last five years. The business models adopted by the new Internet companies are bound to be markedly different. Included in the Cisco Systems, Inc. 1998 Annual Report are the following comments:

Digital assets are taking the place of physical assets, causing Internet companies to grow both in presence and in revenue. Because operating costs are minimal , products and services can be substantially less expensive….The companies …that are successful in the Internet Economy are those that can create a network with ease and respond instantly to changing market conditions and customer demands. Customers, suppliers, employers, and business partners can all collaborate in ways that allow them to be more productive, rapidly adapt to change, and make effective decisions. The network is the essential engine of this new, Internet-enabled world.

In discussing the change made by Merrill Lynch & Co. to online trading, a June 14, 1999 editorial in Business Week stated the “switch to an Internet strategy means a wrenching change in its business model…..the disintermediating effects of the Net , making entire distribution channels redundant by



connecting sellers directly with consumers—or producers directly with each other—are being felt in one market after another….and dozens of …industries are in various stages of remaking themselves to take advantage of the Net. Indeed there is no more important business challenge today.” What we are attempting to do is to get our students to start thinking about the ‘big new business picture’ as it is unfolding in the year 2000. What are the critical factors for success in these new businesses? What costs are relevant for analysis, and for what purposes? And, will the traditional quantifiable performance measures as contained in and determined from financial statements continue to be relevant? For this new business picture new thinking is required, and no virtual tours exist.

Our students have used the Internet, but only a few have actually purchased an item directly on the Internet. Initially, we present a brief review of the history of the Intranet, its structure [backbone, hardware, software, access services, content providers, and portals], and then focus on e-commerce; the concept of e-business is also briefly discussed. As an aside, the website www.isworld.org/isworld/ecourse/index.html has over 400 links to topics on e-commerce and e-business. Next we identify some major companies that currently are deeply entrenched in this New Economy. This past year we identified and studied, among others, (1) Cisco Systems, Inc., the major manufacturer of routers and switches, (2) America Online, an ISP, a content provider, and an owner of Netscape’s browser, and (3) Amazon.com, a leading e-commerce business.

Cisco Systems Inc. is a good case study to initially bridge the gap between the Old and New Economies. Established only 15 years ago, it manufactures and sells over 80 percent of the world’s Internet routers and switches, which are used to direct the flow of the information. The company’s stock recently reached a total market value capitalization of over $300 billion. Only Microsoft and General Electric, which has existed for over 100 years, have achieved this feat. We ask students to (1) read an article about Cisco in the September 13, 1999 [page 129] issue of Business Week, (2) research the company’s website, www.cisco.com, including the financial statements, and (3) gather further insight by consulting www.hoovers.com [ex. a PE ratio of 155]. Cisco’s statement of operations reveals a gross margin rate in the mid-60 percent range, and spending on research and development of about 16 percent of net sales. We ask the students what kind of revenue and cost structure might cause such a high gross margin rate. How does gross margin relate, if at all, to contribution margin, and why isn’t the contribution margin disclosed in the income statement? The Business Week article states [page 140] that Cisco gets about 80 percent of its orders over the Internet, about $30 million per day, $1.5 billion in costs have been cut in the last three years, and revenues per employee average $650,000, which is far better than its few competitors. The balance sheet reveals abundant cash, investments, and receivables, but little inventory; inventory is about 5 percent of total assets. Net cash provided from operations for the year ended July 31, 1999 was $4.4 billion, more than double the net income of $2.1 billion. The cash inflow has been used to purchase investments. We ask the students to think about Cisco’s apparent business model, and their impression of what all this information says about the quality of Cisco’s management.

America Online, Inc. [AOL] also is 15 years old, but does not manufacture any products. According to its website www.corp.aol.com AOL is “the world’s leader in interactive services [19 million members], Web brands, Internet technologies, and e-commerce services.” Students are asked to consult AOL’s website including the financial statements, and look for additional information at www.hoovers.com [ex. a PE ratio of 245]. AOL’s quarterly consolidated summary of results at September 30,1999 is simple and straightforward. The September 30 balance sheet assets are about 80 percent cash, investments, and receivables. Stockholders’ equity includes a $424 million unrealized gain on available-for-sale securities; retained earnings is only $335 million. Net cash provided from operations is double quarterly net income. Key measurement statistics cited in management’s fourth quarter press release include (1) subscription revenues, (2) AOL member daily average usage, (3) advertising and commerce revenues, (4) advertising and commerce backlog, (5) sales and marketing expenses, (6) operating margins, (7) earnings before income taxes, and (8) cash flow from operations. We ask students to compare and contrast AOL’s apparent business model to that of Cisco’s. How does the revenue and cost structure differ between the two companies? Which company would you rather invest your money in?

Amazon.com is only five years old and started by selling books on the Internet. It now sells CD’s, videos, toys, electronics, gifts, and in November 1999 announced that it will also sell software, video games, and home-improvement supplies. Amazon provides online services such as a comparison-shopping tool and conducts auctions for numerous items. Students are asked to learn about Amazon at their website www.amazon.com, read the financial statements [linked to EDGAR], and consult www.hoovers.com again [ex. PE ratio is not applicable for Amazon]. The 1998 consolidated statements of operations show a gross



profit [margin] rate of 22 percent, marketing and sales expenses of $133 million, and merger and acquisition expenses including amortization of goodwill of $50 million. Revenues increased from $148 million in 1997 to $610 million in 1998. Amazon had a net loss of $6 million in 1996, $31 million in 1997, and $124 million in 1998. However, during 1998 its common stock sold in the range of $30 to $110 per share. The 1998 consolidated balance sheet lists assets that total $648 million. Included are inventory $29 million, fixed assets $29 million, cash and marketable securities $372 million, and good will $186 million. Long-term debt of $272 million was added in 1998. An accumulated deficit [no retained earnings] is $162 million. Net cash provided by operating activities in 1998 was $31 million, net cash used in investing activities [purchase of marketable securities] was $261 million, and net cash provided by financing activities [proceeds from long-term debt] was $254 million. A non-cash common stock issuance of $217 million was made to acquire other businesses including three international Internet companies. Footnotes to the financial statements state that goodwill is being amortized over a period of only two or three years. A competitor, Barnes & Noble has purchased Amazon’s largest supplier of books. The fixed assets consist of computers and equipment, purchased software, and leasehold improvements; Amazon leases its offices and distribution facilities. Students are now asked to compare and contrast Amazon’s apparent business model to that of Cisco and AOL. The differences become rather dramatic. Students are asked to reflect on the risks and opportunities faced by new Internet companies such as Amazon. Historical based financial statements are not accurate indicators of Amazon’s potential, at least not in the eyes of investors. Qualitative measures such as the quality of management, strength of the company’s business model, and the potential size of its markets are much more important.

We have used both individual and learning team assignments for students to study Cisco, AOL, and Amazon. Since there are no textbook answers, we tend to withhold judgement as students present their answers to our questions. We often survey the class by a show of hands as to their agreement or disagreement as to what has been presented. Sometimes we play the role of the devil’s advocate to stimulate class discussion. We encourage the students to develop their own list of questions to be answered. Our overall assessment of effort to improve our students’ critical thinking skills has been frustrating. Many students would like for us to “just stick with the subject matter in the textbook.” Nevertheless, we believe that the new experience has been very interesting and worthwhile for the both the students and us.



“WILL SHIFTING CPA FUNCTIONS AFFECT THE ACCOUNTING CURRICULUM?”

Stuart Shough

University of South Carolina Spartanburg [email protected]

Donald Yates

University of South Carolina Spartanburg [email protected]

We are reviewing the curriculum currently offered to the students at the University of South Carolina Spartanburg School of Business and Economics. As instructors, we feel it is our responsibility to keep abreast of “What is happening in the real world” with the objective to develop subjects which simulate the “real world” as much as possible. This is necessary in order to do a better job of enabling our students to meet these challenges upon graduation. This is particularly true in the area of accounting where it appears that a shift in the emphasis of certain basic accounting functions may be occurring. Our first phase in this process was to establish a base line upon which we could build historical data over a period of time to determine if a trend was occurring in CPA firms to shift the emphasis between the different functions being performed by those firms. Our first step was to establish a baseline of what is happening right now and then build upon this data over the next few years. In this way, we hope to continually be able to stay current with our textbooks, accounting software, and our teaching methods. In the spring of 1999, we sent out the following survey, via e-mail, to approximately 1500 CPA firms in the continental United States: Dear Accounting Professional: We are trying to determine which area we should emphasize in the accounting and management curriculum at the University of South Carolina Spartanburg. We ask that you assist by taking a couple of minutes to complete the following survey. Please use rough estimates and do not spend a lot of time trying to be exact.

HOW MANY PERSONS PARTICIPATE IN THE FOLLOWING ACTIVITIES: (PLEASE USE TENTHS IF THEY SPLIT THEIR TIME BETWEEN AREAS.) A. AUDITING _____ B. TAX _____ C. WRITE-UPS _____ D. CONSULTING _____

E. OTHER _____ Thank you for your time and your help. Stuart Shough/Don Yates We received approximately 150 replies, of which 101 could be included in this analysis. We received replies from 30 different states and the number of professional employees in each of these firms ranged from a low of one (1) employee to a high of 170 employees. The total number of professional employees as reported was 1,745.6 which included part-time professional help. The average number of employees per responding firm was 17.3. A breakdown of the responses with a grouping of firms by size, the total employees, and the average number of employees per firm within each grouping are included in a table on the following page.



SYNOPSIS OF RESPONDENTS % OF % OF NO. OF TOTAL TOTAL TOTAL EMPLOYEES FIRM SIZE FIRMS FIRMS EMPLOYEES EMPL. PER FIRM < 05 29 28.7 83.8 04.8 02.9 5 < 10 23 22.7 167.5 09.6 07.3 10 < 15 22 21.8 250.7 14.4 11.4 15 < 20 05 05.0 97. 1 05.6 19.4 20 - 50 17 16.8 554.0 31.7 32.6 > 50 05 05.0 592.6 33.9 118.5 TOTAL 101 100.0 1,745.6 100.0 17.3 This spectrum of responses indicates that they were a relatively accurate representation of the population. Out of the101 responses, 51% of the companies had less than 10 employees each, with a total of 251 employees which was 14% of the total employees; 74 companies (73%) had less than 15 employees with a total of 502 or 29% of the total; 79 companies (78%) had less than 20 employees and a total of 585 employees or 33.5% of the total. Only 22% of the firms had 20 or more employees, with a total of 1,147 employees or 65.7% of the total. When we looked at the make-up of the responding firms, we found the following:

AUDITING TAX WRITE-UPS CONSULT OTHER NO. OF FIRMS WITH: 53 98 87 97 57 % OF TOTAL 53% 98% 87% 97% 57% NO. OF EMPLOYEES 428 582 284 271 180 % OF TOTAL 24.5% 33.4% 16.3% 15.5% 10.3% This was an interesting make-up because 98% of the firms were involved in tax and 97% did consulting. While only 53% of the firms did any auditing, their employees comprised 24.5% of the total which was second only to tax. When we examined the 53 firms with auditing functions, we found: ANALYSIS OF FIRMS WITH AUDITING EMPLOYEES IN FIRM 0<5 5<10 10<15 15<20 20-50 >50 TOTALS FIRMS W/AUDITING 7 9 12 5 15 5 53 % OF FIRMS W/AUD. 13 17 23 9 28 9 100% % OF LIKE SIZE FIRMS 24 39 54 100 88 100 53% NO. OF EMPLOYEES 5 13 33 19 123 235 428 % OF AUDITING EMPL. 1 3 8 4 29 55 100% (NO. LIKE SIZE FIRMS) 29 23 22 5 17 5 101 Of the approximately 27% of the reporting firms with 15 or more employees, nearly 92% had auditors whereas less than 38% of the firms with less than 15 employees did any work in auditing. Because of this, even though we will continue to stress auditing for those students who wish to join a public accounting firm, we will inform them that those graduates who wish to pursue a career in auditing should concentrate their search primarily on the larger firms. While we did not examine the motive for any shift which may be occurring, we were told that many small firms have quit auditing due to the risks involved, the potential for lawsuits and the cost of malpractice insurance. This should not deter any student from wanting to enter the functional area of auditing; however, they should be made aware of the situation.



A breakdown of the firms with tax functions is as follows: ANALYSIS OF FIRMS WITH TAX EMPLOYEES EMPLOYEES IN FIRM 0<5 5<10 10<15 15<20 20-50 >50 TOTALS FIRMS W/TAX 26 23 22 5 17 5 98 % OF FIRMS W/TAX. 27 24 22 5 17 5 100% % OF LIKE SIZE FIRMS 90 100 100 100 100 100 99% NO. OF EMPLOYEES 33 65 111 26 178 169 582 % OF TAX EMPLOYEES 6 11 19 4 31 29 100% Since some 98% of the responding firms reported activity in the tax area with over 33% of the total employees involved in taxes, we confirmed our belief that any graduate going into public accounting should have a firm foundation in taxation. Based on this, we will continue to offer strong, up-to-date courses in taxation using the most current literature and textbooks. There were 97 responding firms which indicated that they were involved in consulting. This indicates that the graduating accountant must be well rounded in all of the core business courses. We will continue examining this area as it is felt that this may be one of the areas that are growing within the field. ANALYSIS OF FIRMS WITH CONSULTANTS EMPLOYEES IN FIRM 0<5 5<10 10<15 15<20 20-50 >50 TOTALS FIRMS W/CONSULTING 27 22 21 5 17 5 97 % OF FIRMS W/CONSUL. 28 23 22 5 17 5 100% % OF LIKE SIZE FIRMS 93 96 95 100 100 100 96% NO. OF EMPLOYEES 20 31 37 18 85 81 271 % OF CONSULT EMPL. 7 11 14 7 31 30 100% Some 86% of the responding firms had employees involved doing write-ups. This is one area we need to examine to determine if our graduates have received sufficient training in this area. This will definitely be a topic for discussion on our next curriculum review. ANALYSIS OF FIRMS WITH EMPLOYEES DOING WRITE-UPS EMPLOYEES IN FIRM 0<5 5<10 10<15 15<20 20-50 >50 TOTALS FIRMS W/WRITE-UP EM. 21 22 18 5 16 5 87 % OF FIRMS W/WR-UPS 24 25 21 6 18 6 100% % OF LIKE SIZE FIRMS 72 96 82 100 94 100 86% NO. OF EMPLOYEES 17 35 41 26 116 49 284 % OF WRITE-UPS EMPL. 6 12 15 9 41 17 100% While 57 of the responding firms indicated they had a total of 271 professional employees involved in other activities, we were not able to determine exactly what they were doing as our survey did not request a breakdown of that specific information. ANALYSIS OF FIRMS WITH “OTHER” EMPLOYEES EMPLOYEES IN FIRM 0<5 5<10 10<15 15<20 20-50 >50 TOTALS FIRMS W/OTHER EMPL. 12 14 15 3 10 3 57 % OF FIRMS W/OTHER 21 25 26 5 18 5 100% % OF LIKE SIZE FIRMS 41 61 68 60 59 60 56% NO. OF EMPLOYEES 9 23 29 7 53 59 180 % OF “OTHER” EMPL. 5 13 16 4 29 33 100% In conclusion, this only establishes a base upon which we can build over the next three (3) to five (5) years. The real value of this project, to identify any shift in the emphasis in the accounting functions, will not be fully realized for several years. However, the results of our current findings will assist in providing current programs and courses with contemporary data.



WORK/LIFE BALANCE AND CAREER PROGRESSION IN PUBLIC ACCOUNTING FIRMS

Doucet, Mary S., Contact Author

California State University – Bakersfield [email protected]

Doucet, Thomas A.

California State University – Bakersfield [email protected]

Hooks, Karen L.

Florida Atlantic University [email protected]

ABSTRACT

This study reports results of the American Institute of Certified Public Accountants Women and

Family Issues Executive Committee 1997 survey of professionals and survey of firms. The two primary questions asked in the survey of professionals were: (1) Are you concerned about upward mobility? and (2) Are you concerned about work/life balance issues? Almost twice as many professionals responded they were concerned about work/life balance issues as responded they were concerned about upward mobility. An analysis of the open-ended responses reveals that the demands of a client service industry and changing societal values are the most prevalent reasons for a lack of work/life balance. While firms are increasingly offering flexible work options and family-friendly policies to alleviate some of the pressures, it is apparent from the open-ended responses that the rhetoric does not always match the reality. The open-ended responses were also analyzed to determine what factors affect career progression. The analysis suggests that the decrease demand for audit services, an oversupply of partners, and gender bias have slowed career progression and made the possibility of achieving partner more remote.

INTRODUCTION

The changing role of women in business and society is more evolutionary than revolutionary. Driven by the global economy and ‘New World Order’ the demand for highly skilled and talented individuals has increased from the boardroom to the battlefield. This has resulted in increased opportunities for women in what were once male dominated sectors of our economy such as the public accounting profession. The goal of equality of opportunity in the public accounting profession regardless of gender appears realistic. However, equality of opportunity does not always lead to equality of outcome, nor should it. Outcome should by no means be guaranteed; however, equal opportunity to enter the front door accomplishes little if the stairway door to the upper floors is locked. So as women become increasingly integral to the success of public accounting firms several questions must be asked. Have the glass ceilings for partnership finally been shattered for women? Does equal opportunity exist beyond the entrance level or has career progression simply been restructured to give the illusion that equal opportunity exists beyond the entrance level? Have men and women changed their own professional and personal expectations and, if so, what is the impact on career progression and work/life balance choices?

In an effort to address these questions as well as to track the upward mobility of women and the presence, use, and operating effectiveness of work/life balance policies in the public accounting profession, the Women and Family Issues Executive Committee (WFIEC) of the American Institute of Certified Public Accountants (AICPA) conducted a survey of firms and a survey of professionals in 1997 to follow-up the



Committee’s 1993 survey of firms. The surveys gathered information on a number of issues including career progression, turnover, and work/life balance programs and policies. The information from the surveys provides insight into the current role of women in public accounting and how that role is evolving. The surveys also provide information that will help guide the profession as it seeks to recruit and retain the talented and skilled individuals who are needed to lead the profession into the next century.

BACKGROUND

Two major studies in the 1990s (Catalyst 1998; Families and Work Institute 1995) address the issue of the changing role of women in the workplace and document the use of flexible work arrangements (particularly part-time arrangements) to manage work/life balance issues. Two important themes which emerge from the Families and Work Institute study are that women fully accept their roles as both economic and nurture providers, and that while women bring to the workplace what it needs, they are not getting what they need in return. In particular, women who take advantage of part-time arrangements, to better provide nurturing to their families, often are not provided with benefits commensurate with the work they do. Benefits are essential to these women because they often are also the economic providers for their families.

The Catalyst report found that part-time arrangements are often viewed as accommodations for women with children and are not viewed as being acceptable for men (p. 25). The inconsistent management of part-time arrangements challenges the effective use of these arrangements (p. 33). Finally, those using part-time arrangements are not seen as being as committed as their full-time counterparts (p. 52).

Other than the brief report by Catalyst in 1994 on achieving work/life balance in the accounting profession, limited research has been conducted specifically addressing this issue in the accounting profession. Hooks (1998) may be the first study which specifically addresses changing work patterns in a large professional services firm, although the primary focus was not the changing role of women or work/life balance per se. The study provides information regarding the changing work environment, the impact of work on personal time, and the use of technology to facilitate flexibility.

SURVEY

The second nationwide survey of CPA firms was mailed to a random sample of 5,383 managing

partners of non-sole practitioner firms during January 1997. The survey instrument is identical to the one mailed to 5,300 managing partners of non-sole practitioner firms during December 1993. The purpose of the 1993 survey was to provide a benchmark from which to measure career progression, changes in work/life balance programs and policies, and changes in turnover. The purpose of the 1997 survey of firms was to measure changes relative to these benchmarks since the 1993 survey. An analysis of these changes is reported in Doucet & Hooks (forthcoming 1999).

In 1997 a companion survey of CPA firm professionals was also conducted. The purpose of this survey was to elicit the opinions of professionals regarding career progression and work/life balance issues. The professional surveys were mailed to a random sample of managing partners of 249 firms (chosen from the 5,383 firms randomly selected to participate in the 1997 survey of firms) who were asked to distribute the survey questionnaires to professionals in their firms. Firms and professionals were assured that neither individual professional responses nor their respective firms would be identified in the analysis of their responses.

The survey of professionals was designed to elicit responses regarding: their concerns about upward mobility, their concerns about work/life balance, their understanding of the flexible work options and family-friendly policies offered by their firms, how effectively the policies are operating, and whether they thought they would be penalized if they took advantage of the flexible work options or family friendly policies offered by their firms. In addition to responding to structured questions regarding these issues, professionals were also given several opportunities to provide open-ended responses; over 200 pages of



open-ended responses were received. A total of 1,103 professionals from 74 firms responded to the survey. Our analysis of professional responses is presented in three broad size categories (small, medium, and large) based on the number of AICPA members: Under 21, 21-200 and Over 200.

In order to gauge how well firm policies are communicated, the study was designed and conducted to allow some matched pairs analyses of firm and professional responses to questions about firm policies and procedures. Of the 74 firms represented by the respondents to the survey of professionals matching responses were available for 42 firms.

Demographic information regarding the professional respondents is provided in Table 1. Fifty-six percent of the respondents are female. The majority (75% of females and 70% of males) of the respondents are married. Fifty-five percent of the females and 42% of the males have no dependent children. Of those reporting dependent children, the majority (75% of females and 80% of males) has children under six years of age. The percentage of respondents who have young (between 6 and 12 years) school-age dependent children is 35% for females and 37% for males. There are even fewer respondents with older (between 13 and 19 years of age) school-age children.

Table 1

Demographic Information on Professional Respondents

Female Male Gender of Respondents 56% 44%

Percent of Respondents who:

are Under 35 68% 60%

are Married 70% 75%

have no dependent children 55% 42%

Of those who have dependent children, percent who have children:

Under 6 years 75% 80%

Between 6 and 12 years 35% 37%

Between 13 and 19 years 20% 19%

Years of experience in public accounting:

Fewer than 6 years 47% 40%

Between 6 and 14.9 years 41% 39%

Fifteen years or longer 12% 21%

Area of experience:

Audit 55% 58%

Consulting 16% 24%

Tax 48% 38%

Position in Firm:

Staff 25% 14%

Senior 21% 19%

Supervisor 10% 6%

Manager 25% 24%

Senior Manager 10% 13%

Partner/Shareholder 6% 20%

Certification and Organizational Memberships:

CPAs 67% 74%



AICPA members 48% 61%

State Society members 61% 69%

Region in which Respondents’ office is located:

Northeast 24% 23%

Midwest 40% 41%

South 23% 20%

West 13% 16%

Future plans:

Plan to stay in public accounting 59% 64%

Plan to stay with current firm 69% 70%

When asked their area of experience, 55% of females and 58% of males responded audit, 16% of

females and 24% of males responded consulting, and 48% of females and 38% of males responded tax. It is interesting to note that far fewer women indicated consulting as their area of experience, while a greater percentage of women indicated tax as their area of experience.

The positions that respondents held in their firm shows large differences based on gender. A greater percentage of the women are at the staff and senior levels than are men (46% of females versus 33% of males). Far fewer women occupy the top two positions (Partner and Senior Manager) than do the men (16% of females versus 33% of males). Females also seem to lag behind their male counterparts in terms of certification and organizational memberships.

It is interesting to note the responses to the two questions about the respondents’ future plans. When asked whether they planned to stay with their current firm 69% of females and 70% of males responded yes. However, when asked whether they planned to stay in public accounting, only 59% of the females and 64% of the males responded yes.

DISCUSSION & ANALYSIS

The results of the survey of professionals can best be understood by examining the responses to two questions concerning career progression and work/life balance: 1) Are you concerned about upward mobility in your firm? and, 2) Are you concerned about work/life balance issues? The responses to these two questions are presented in Table 2. The table presents the percentage responding yes to these two questions. The responses have been categorized by size of firm and by gender. When the responses to these two questions are presented together it is clear that concern about work/life balance far outweighs concern about upward mobility.

Table 2

Concern About Upward Mobility and Concern About Work/Personal Life Balance

Number of AICPA members / Size of firm Under 21 Small

21-200 Medium

Over 200 Large

Female Male Female Male Female Male Concerned About Upward Mobility 33 42 43 35 37 36

Concerned About Work/Personal Life Balance

66 75 76 68 81 70

significant at p<.01




Though not as great as the concern for work/life balance, at least one third of all respondents in all size categories are concerned about upward mobility. While there are differences in the percentage of females and males responding yes to this question in all size categories, none of the differences are statistically significant. Female professionals in small firms appear to be less concerned about upward mobility than their male counterparts. The reverse is true in medium size firms where the percentage of male professionals responding yes is less than the percentage of female professionals responding yes. In large firms the percentage responding yes is about the same for both female and male professionals.

Work/Life Balance. There is a substantial concern about work/life balance among both the female and male professionals. Again, there were no statistically significant differences between female and male responses within size categories to this question. Female professionals from large firms responded yes (81%) to this question most frequently, while female professionals from small firms responded yes (66%) least frequently. When asked to comment on their concerns about work/life balance, professionals responded in force. There were more open-ended responses in total number to this question and the responses appear to be more detailed.

The open-ended responses indicate that for some balance does not appear to be an issue (1[F] indicates a female respondent and [M] indicates a male respondent.). Two responses indicative of this view are, “I believe and have found it to be true that it is one’s choice to ensure that the work and personal life are balanced. If one’s personal life is important enough to them, their life will inevitably be balanced. [M]” and “I make sure that I keep a balanced lifestyle. I think that if you make it a priority, it will happen. [F]” However, for many respondents, to suggest that work/life balance is just a matter of choice is an oversimplification. Indeed for many it is a constant struggle. The demands of a client service industry and changing societal values appear to be the most frequently cited reasons for a lack of work/life balance. While many firms have responded by offering flexible work options and family-friendly policies, the rhetoric often does not match the reality, which oftentimes leads to disillusionment and a hard look at life choices.

Demands of Client Service. Many responses indicated that a major factor in not being able to achieve balance in one’s life is the client service market. The practice of public accounting is now, more than ever, driven by client demands that are often beyond the control of the firms and their professionals. As one respondent indicated, “In a service industry such as public accounting, control over one’s work/personal time oftentimes is dictated by our clients, which frequently is removed from our control. [M]” Another respondent laments the pressures of client expectations, “Difficult to plan your life when clients have major emergencies. When client service is the name of the game, there is significant pressure to work ‘round the clock’ to impress the client. Time spent is not always value-added. [M]”

Technology and other changes in the profession have contributed to the ability to serve clients anytime, anywhere, possibly without regard to its impact on employees. In her study of the changing workplace environment in one large professional services firm, Hooks poses the question as to whether technology has enabled professionals to have a better balance or whether technology has intruded into professionals’ personal lives (Hooks, 1998). The open-ended responses to this survey tend to favor the latter explanation that technology has made work/life balance more difficult to achieve. As one respondent put it, “Work, particularly with hoteling and laptops, never has an end point. One is nearly always working. [F]” As another respondent indicates, leaving the office doesn’t stop the work, “The environment changes constantly and the expectations of the firm and clients continue to increase at an alarming rate. The advancement of technology (car and portable phones, pagers, voice mail, e-mail, etc.) has almost made it a 24-hour job. The demands and pressures of the business put a great deal of strain on the personal life. [M]”

The public accounting profession is highly competitive, and that, coupled with client expectations, often demands significant overtime and travel during ‘busy season’ which for some firms covers more than half the year. Overtime and travel make it difficult, if not impossible, to balance work and personal life. As one respondent stated, “Public accounting requires significant overtime at certain points during the year. It is at these points where the three hour commute, 10-12 hour days, six days a week plus raising a family and managing a household can make one wonder why I am doing this. [F]” Another respondent expressed similar concerns, “Increasing needs to travel further make it necessary to increase the number of hours



worked in order to maintain a high level of client service hours. I am arriving home most nights between 7 and 8 PM. [F]” The increasingly competitive environment has also expanded the geographic boundaries of client service necessitating more travel. One respondent explains how this can make work/life balance very difficult, “In trying to obtain client work, the geographic boundaries are expanding from our office. Although overnight travel is not common, 1-2 hour drive times (one way) with the requirement to be on-site are becoming more common. This requires 12-hour days for 8 productive hours and cuts into family time severely. [F]”

The competitive nature of the public accounting profession also cuts into firm margins and often leads to fewer professionals to handle the increased workload during busy season. Typical of the responses about tight margins one response is, “Client service environments are inherently driven by time pressures and cost reduction factors. We continually serve our clients in a reactionary mode, thus creating more stress and time at work. Secondly, and just as important, we manage our business at a very tight personnel level in order to maximize margins. This results in more time and effort from employees at work and less at home. [F]” Another response typical of those with concerns about staffing levels indicated, “As with most firms, ours expects a high degree of commitment and is often unwilling to ‘carry’ people through the slow months so we’ll be adequately staffed during the January-April time frame. And while our administrative department realizes that the demographics of the work force have changed and that we need to rethink our recruiting and hiring practices, these changes are slow to occur at the local office level. [F]”

Other factors which makes it difficult to achieve work/life balance are the expectations, real or perceived, of what is necessary to achieve career progression. Many professionals believe that in order for their careers to progress, the expectation is to put one’s personal life on hold. As one respondent put it, “The only way to stay competitive within the firm is to meet client service needs, sell more work, recruit staff, market self within and outside of the firm; all of which take a great deal of time (60-70 hours per week). [M]” Other professionals indicate their desire for career progression causes them to put in excess hours and for the work side of the equation to outweigh the personal life side, “At this time in my career, I am expected to work long hours. I believe that if I did not put forth this effort, my chances of realizing my goal would be impossible. I enjoy my work, however, the work load is not fair to my family. I do not believe any other executive position would require this effort. [M]” “I think that in order to achieve advancement I will have to spend more time focusing on work and less on home/family matters. [F]” “The job demands to reach director level will conflict with my personal goals of marriage and children. [F]” “Substantial pressure is placed upon managers to work overtime and remain highly chargeable. It becomes more and more difficult to maintain a good balance without sacrificing a long-term career. [F]” “Public accounting is very hour intensive - cannot commit to community activities, i.e. coaching, boy scouts, etc., without sacrificing success at the office. [M]” “Associated with the increased earnings pressures are high demands on work performance and effort. [M]”

A Change in Societal Values. The structure of families is evolving from what was once considered the traditional family (stay-at-home mother, working father; 16.7%, 1996) to more dual-career families (42.7%, 1996), single parent families (16%, 1996) and other nontraditional families (24.6%, 1996) (Catalyst, 1998, p. 19). While these shifts have occurred over time, their impact can be felt in the public accounting profession which still has professionals at the upper levels of CPA firms who are from the traditional family generation. Several comments indicative of this generational issue which still haunts the public accounting profession are, “My generation accepted imbalance. [M],” “Most partners here are males with wives who do not work. Thus, they do not care if I need to get home, have childcare issues, etc. There is a total lack of understanding. [F],” “I tend to believe you work to live, not the other way around. I don’t feel that the partners in my firm feel that way, work is their life. [F],” and “I feel that public accounting is changing and the demands for family are getting tougher to balance. For instance, most of the partners in our firm have spouses who do not work, whereas it’s difficult today for a manager level staff to support a family on one salary. [M]”

The responses above indicate that as family structure has evolved, so has the interest in having both work time and personal time. In fact, in a recent study by the Families and Work Institute, approximately one third of women and men indicated that they would work part time if they could afford it (May 1995, p. 12). So as traditional gender roles have become increasingly blurred, both in the work place and at home,



the profession is perfectly positioned to take the lead in changing the workplace expectations both for women and men. Yet, in this profession that seems to lead the way in facing the challenges of a changing world in so many other ways, we still are made aware that change can come ever so slowly. As one respondent put it, “As a male, I am not allowed to have the same work/family balance issues. [M]”

Those who have reached management levels in CPA firms are well aware of the changing values of the new work force. In CPA Personnel Report’s annual survey of accounting professors more than one fourth of the professors (26%) indicated that their students were concerned about employee-friendly work environments (CPR, August 1998, 4). While there is an awareness of the increasing importance of work/life balance many in management are at a loss as to how to help new recruits succeed both professionally and at work/life balance. One respondent expressed the following concerns, “It seems young professionals must work more hours to keep pace, and that reduces time available to their families, which is unacceptable. However, trying to work less jeopardizes their jobs. [M]” This, coupled with the changing structure of families and the blurring of gender roles can lead to much conflict in balancing work and personal life.

Some of the responses indicate that it may be very difficult for women to have families and a career in public accounting, “I don’t see any women in my area that have a family. My concerns are for the future when I decide to have children. [F]” “Two small children (two and five and a half) and a full-time job commitment makes balancing a challenge. [F]” “The demands of being a partner have increased substantially over the past five years. A typical work week is 60-70 hours or more. That makes it very difficult to spend time with my family. [F]” “As a mother of two small children, spending quality time at home has become a very important factor in my life. However, working in the public accounting field, I frequently run into situations when I need to give up part of one in order to achieve the other. [F]”

While women made a majority of the responses that mentioned family, men also find it hard to have a family and a career; “My wife and I just had our first child. Finding a balance is very difficult as I take my responsibilities as a father very seriously. [M]” “I’m tired of working 50 to 80 hours week in and week out. It seems that the firms keep milking their employees in order to grow partner growth. My views are that the family is more important than work. [M]” Some of the men were quite succinct about it, “I work way too much. Not enough time with family. [M]” “Not enough attention given to personal/family needs. [M]”

Rhetoric vs. Reality. With a growing concern for work/life balance among all of their professional staff, CPA firms are increasingly offering flexible work options and other family-friendly policies. Table 3 shows the percentage of firms that currently offer certain flexible work options and family-friendly policies as indicated in the 1997 survey of firms compared with the percentage of firms that offered these policies during the time period covered by the 1993 survey. It appears that the variety and prevalence of flexible work options are increasing more rapidly than other family-friendly policies. The number of firms offering flex-time (p<.01), part-time (p<.05), job sharing (p<.05), and work-at-home options (p<.01) have all increased significantly between the two study periods. As far as other family-friendly policies, the number of firms offering paternity leave (p<.05), sick/emergency child care (p<.01), and elder care policies (p<.01) have all increased significantly. While these are positive signs, many firms still do not offer these options. Additionally, it is hard to determine what firms are offering beyond the federally mandated family leave policies.

Table 3

Percentage of Firms Offering Flexible Work Options and Family-friendly Policies

1994-1996 1991-1993

Flex-time 69% 57%

Part-time 69% 65%

Job Sharing 10% 7%

Work-at-home 32% 24%

Special summer or holiday hours 50% 44%



Maternity Leave 64% 60%

Paternity Leave 25% 19%

Child care resource and referral program 6% 4%

Sick/emergency child care 37% 32%

Elder care 15% 10%

Adoption assistance 0% 1%

Dependent care/flexible spending account 17% 20%



However, simply offering flexible work options and family-friendly policies is not enough. Firms

must communicate their existence to employees and an environment must be created such that employees who take advantage of these options will not be made to feel uncomfortable or be penalized for doing so. While many firms indicate that they offer these options, and firms often profess their support for their use, the survey responses suggest that the rhetoric does not always match the reality.

In order to assess whether firms are communicating the existence of these options to their professionals, we matched professional and firm responses regarding the prevalence of key flexible work options, family-friendly policies, and other firm policies and programs. Tables 4 through 7 show the results of this analysis. Table 4 presents the results of the matched pairs analysis for flexible work options. Overall, it does not appear that the firms do a good of communicating their flexible work options to their professionals. However, large firms in this sample appear to have effectively communicated their policies regarding flex-time hours and part-time hours. Small firms have effectively communicated their part-time hours policies.

Table 4

Professional vs Firm Responses Regarding Flexible Work Options

Firm Policy Under 21 Small

21-200 Medium

Over 200 Large

Flex-time hours p<.01 p<.01 NS

Part-time hours NS p<.01 NS

Job Sharing p<.01 p<.01 p<.01

Work-at-home options p<.01 p<.01 p<.01

Special summer or holiday hours p<.01 p<.01 p<.01

The matched pairs analysis for family-friendly policies is presented in Table 5. Small and

medium size firms appear to do a better job communicating their family-friendly policies than do large firms. There were statistically significant differences between professional and firm responses for large firms regarding all the family-friendly policies (p<.01). Some might argue that large firms have a considerably larger professional staff to inform or that often professional staff might not be aware of these policies because they haven’t needed to use them. For medium size firms the only policy for which the firms did not effectively communicate their policy was paternity leave (p<.01). For small firms there was a statistically significant difference between professional and firm responses for child care resource and referral programs (p<.05), for sick/emergency child care (p<.01), and for elder-care leave (p<.01).

Table 5

Professional vs. Firm Responses Regarding Family-friendly Policies



Firm Policy Under 21 Small

21 - 200 Medium

Over 200 Large

Maternity Leave NS NS p<.01

Paternity Leave NS p<.01 p<.01

Child care resource and referral program p<.05 NS p<.01

On-site firm-sponsored child care facility NS NS p<.01

Off-site firm-sponsored child care facility NS NS p<.01

Sick/emergency child care p<.01 NS p<.01

Elder-care leave p<.01 NS p<.01

Adoption assistance NS NS p<.01

Dependent care NS NS p<.01

Table 6 indicates that medium size and large firms have not effectively communicated their

policies on sexual harassment, client assignments, and criteria for selecting managers and partners. Small firms have not effectively communicated their policies on client assignments and criteria in selecting managers and partners. Table 7 indicates that professional staff in medium size and large firms are not aware that their firms have persons/committees designated to address gender/workforce diversity issues and work/family issues. The results of these matched pairs tests indicate that CPA firms could do a better job communicating all of their policies to their professional staff.

Table 6

Professional vs. Firm Responses Regarding Firm Policies

Does your firm have a policy in each of the following areas?

Under 21 Small

21 - 200 Medium

Over 200 Large

Sexual harassment NS p<.01 p<.01

Client assignments p<.01 p<.01 p<.01

Criteria in selecting Managers and Partners p<.01 p<.01 p<.01

Table 7

Professional vs. Firm Responses Regarding Designated Persons

Firm Question: Is there a person at your firm who is designated to address? Professional Question: Does your firm have a person/committee designated to address?

Under 21 Small

21 - 200 Medium

Over 200 Large

Gender/workforce diversity issues NS p<.01 p<.01

Work/family issues NS p<.01 p<.01

In addition to awareness, there needs to be an environment conducive to employees taking

advantage of these options. The majority of the open-ended responses suggest that such an environment does not always exist in medium and large firms. As one respondent stated, “Despite much positive rhetoric, balance is not a well accepted practice. I believe this is due in large part to our focus on input (chargeable hours for example) rather than on output (productivity, quality etc.) and the pressure to conform in order to progress. [F]” Several other responses indicate frustration with all the talk in their firms about work life balance: “This firm tends to talk out of both sides of its mouth on this issue. In reality work/life is not a priority of the firm as seen by managers and staff. [M]” “Sometimes I can’t stand the stress and uncertainty. Everyone talks work/life balance, but no one in the partner level really lives it. [F]” “Very much so. At this point the firms are still more talk than action regarding balance and work-life



issues. They say they care, then demand that we commit 110% of our job at all times of the year, however many hours a week that takes. [F]” “I feel that to an extent, I have sacrificed some of my personal life for my career. While the industry has progressed in this area, the motto is still, ‘work comes first.’ [F]” “There is a very strong emphasis on work first and family second. This is not necessarily a written policy, but it is communicated at various times. [M]” “There appears to be more lip service paid to life balance. Working six days a week for four months a year to leverage staff is not life balance! [M]” “At times work is so busy that I regret having chosen this profession. Even though human resources has said over and over that it is important to balance, when busy season hits (mostly 8-9 month of the year) it is forgotten. [F]”

In one instance, flexibility was offered, but then withdrawn later. “When accepting the position, it was agreed that I could go home during tax season around 5-6 PM since I am a single parent and have two children at home. Dinner, homework, after school activities were taken care of during the early evening hours and I would return to work around 8-9 PM. This year I am no longer allowed to work late nights. I end up staying until 8 PM, therefore, children’s meals, homework, etc., have been suffering immensely. [F]”

Upward Mobility. In addition to the reasons discussed above, the overriding concern for work/life balance may also be related to upward mobility or rather the lack of upward mobility. As professionals see their career progression slowed and the possibility of achieving partner becoming increasingly remote, they become discouraged and disillusioned. This is apparent from the open-ended responses. When asked if they were concerned about upward mobility professionals’ responses suggest an undercurrent of discouragement and disillusionment. In responding to her concern about upward mobility one respondent stated, “Not anymore. I’ve lowered my expectations of what I can achieve here. Over the years my confidence has been chipped away. I feel like I’m still contributing so I am staying put until I develop a plan. [F]” Other respondents expressed similar feelings, “With the partner track at public accounting firms becoming longer and longer, it is difficult to remain motivated and driven when one is unsure of the rewards (if they exist at all). [F]” “The firm recently made its first partner in six years. There seems to be a reluctance to reward those who have given their careers to the firm. [M]” “The time to partner grows longer each year. After ten years with the firm, I still don’t know what the likelihood of promotion is. [F]” “The current trend is not to promote qualified individuals to equity partner. [M]” “Not to Sr. Manager. Making it to partner is a different issue. The path is almost non-existent. [F]” “It appears that criteria for admission to partnership is becoming more stringent and less opportunities exist at this level. Time to partner continues to lengthen. [M]” “We currently have six partners, three of which are less than 40 years old. We have four managers who also plan to make partner. If they make partner and the three older partners retire, then will the firm grow enough to support me as a partner? [M]” “Senior partners are nowhere near retirement age and enjoy keeping profits for themselves too much to share. [M]”

Because they are discouraged and disillusioned professionals may be reassessing their personal and professional priorities with an increasing emphasis on personal over professional priorities. This reassessment can be viewed as a pragmatic response to the current career realities in public accounting, i.e., slowed career progression and the increasingly remote possibility of achieving partnership. An analysis of the open-ended responses suggests some possible reasons for these career realities. Based on this analysis the two reasons that appear to be most influential are Market Forces and Gender Bias. As the effect of Market Forces and Gender Bias are discussed it is important to note that slowed career progression and the increasingly remote possibility of achieving partner are not mutually exclusive. In fact slowed career progression and the remoteness of achieving partnership can be seen as occurring in tandem with a shared causality.

Market Forces. The impact of market forces on the public accounting profession has probably had the most dramatic effect on career progression. Consolidation within the profession as well as by clients has shifted the supply and demand for audit services in the favor of clients, which has resulted in a more competitive environment. This, in turn, has created greater pressure to control costs, has increased workloads, and has resulted in fewer opportunities both in public accounting and in industry which is also facing pressures to reduce costs and increase workloads.

Demand for Audit Services. While some may argue the cause for the reduced demand for audit services, the effect has been a longer career progression with fewer opportunities for those who aspire to



partnership. As one respondent stated, “Partnerships in the audit practice are becoming increasingly difficult, largely in part due to suppressed margins, shrinking client bases and cost reductions (internal and external pressures). Too many audit partners, not enough work. [F]” The following are representative of similar concerns expressed by a number of other respondents: “Professional staff seems to be growing older without significant growth in firm business. Therefore, there will be more people competing for a stable number of higher level positions. [M]” “Lack of growth limits upward mobility. [M]” “It appears that people reach senior level and rise no further. Personal growth stops because the firm is not growing. [F]” “Partners are young and not close to retirement. Firm must grow for there to be more partners and that’s no easy task. [F]” “Not enough growth or turnover to make room for mobility at all levels. [F]”

No Room at the Top. The slowing of career progression by market forces may be partially responsible for one of the more most frequent themes in the open-ended responses -- that firms are “top heavy” at the partner level. Many see this as resulting in elongated career progression and fewer opportunities for advancement to partner. This view appears to be shared by respondents from all firm size categories. Some typical comments include: “At this point our firm is somewhat top heavy and it seems unwilling to accept new partners as shareholders. [F]” “The firm is top heavy and there may be no place for advancement. [M]” “Many young partners. No room to advance to that level. [M]” “Fewer and fewer partners are being admitted each year. Due to the economy more professionals are staying longer at the Big 6. [M]” “Top heavy in our office, not all current managers can or will make partner. [F]” “Although the skills may be achieved to move upward, especially to the partner level, actually proceeding to the next level is based on capacity. Also with high turnover of staff and seniors, I feel that progression to partner is stifled at the manager level. [M]” “The majority of our partners are between 35 and 45! This means that they all have 20 to 30 years of work left. We already have an overload of partners and it doesn’t appear space will open up for a long time. [F]” “The firm exhibits a reverse triangle. [M]” Finally, one respondent sums up the situation as follows, “Seems to be plenty of room at the top, just no place to sit down. [M]”

Alternative Career Tracks. The concerns about upward mobility expressed by professionals in their open-ended responses are supported by a significant drop in the percentage of new partners created during the most recent study period. Of the total number of partners from firms responding to the 1997 firm survey only 3.6% were new partners compared to 14.9% for the 1993 firm survey. Additionally, the percentage of the new partners who are female was 19% for the 1997 firm survey compared to 26% for the 1993 firm survey.

Some firms have responded to the concerns of their professionals by restructuring career progression. This has been done by offering non-traditional partnership/shareholder tracks (e.g., part-time, salary only, graduated benefits) and non-partnership/non-shareholder career tracks. In fact, as shown in Table 8, the percentage of firms offering non-traditional partnership arrangements has increased significantly since the 1993 benchmark survey, as has the percentage of firms offering non-partnership or non-shareholder career tracks. One can see from Table 8 that non-partnership career tracks are much more prevalent than non-traditional partnership arrangements.

Table 8

Percentage of firms offering non-traditional partnership arrangements and non-partnership career tracks

Study Period Non-traditional Partnership Arrangements

Non-Partnership Career Tracks

1994-1996 6% 20%

1991-1993 3% 13%

When professionals were asked to describe the non-traditional partnership arrangements in their

firms many indicated that there were a few part-time partners, but overwhelmingly the descriptions were of limited equity and salary only options, with many describing these positions as having no voting rights. The following is a typical responses that describe non-traditional partnership arrangements: “Firm offers



national partnership, which is basically a higher salaried position but has no voting rights and does not share in the profits. [M]”

While these new career track options may help to improve morale there is still concern about the difficulty of achieving partnership. Several responses expressing this concern follow: “The years of service required to attain the level of fully participating partner continues to increase and intermediate positions that are essentially the same as senior manager, or somewhere less than partner, continue to increase. It’s easier to be a principal than it used to be, but harder to be a partner. [M]” “I am not a full equity partner. Concern is related to the ability to be admitted as a full equity partner. [M]” “Shareholding partners are becoming less and less frequent (i.e. admission). Clearly shareholding partner is the goal and with the goal becoming harder to achieve, upward mobility is definitely a concern. [M]” “Where directorship is relatively new, it is something more than a senior manager but not a partner; often in practice it becomes an ‘enhanced’ senior manager. [M]”

Some respondents see the alternative career tracks as more work and responsibility for less pay. As one respondent stated, “My satisfaction with these arrangements is not very high as responsibilities are not different from an equity partner and compensation is substantially less. [M]”

Perhaps most important is that some respondents expressed a concern with the stigma that might be attached to alternative career track. Some typical responses expressing this concern include, “If offered I would accept a Director position, however, I am concerned about the client and in-house staff perceptions of what the title implies (i.e. couldn’t make partner, ‘second best’). [F] “ “Current firm structure is evolving to (hopefully) offer more options for alternative careers and address/minimize stigma issues. [F]” “If there were no stigma attached to being a director I would take the opportunity. [F]”

Gender Bias. As mentioned previously, the percentage of new female partners has dropped significantly during the most recent study period. In fact the gender of women promoted at all senior management levels dropped as shown in Table 9. Some of the decrease in new female partners as well as the results in Table 9 can be explained by some of the previous discussion; however, a number of female respondents believe that gender bias has also had an impact on upward mobility. Female respondents expressed concerns that gender bias affects promotion, pay, assignments, and family decisions. The following comments are representative of many others: “The fact that I am a women and very few of us are made partners. [F]” “It seems were moving very slowly in promoting women to partner position or helping them achieve it. [F]” “Not many female partners. Low pain threshold for male partners for life balance issues. [F]” “There are no female partners in this office. The female managers do not run big jobs, but are supervised by another manager who is male. [F]” “I feel that it is more difficult (i.e. takes longer) to become a partner for a female than a male employee. [F]” “There is still a boys club mentality which pervades the upper management levels. [F]” “Not until you’ve reached the partner level. Once there, it’s still the good old boys club. [F]” “Public accounting is a very political arena based on likes and dislikes, not necessarily technical or professional skills outweighing those options. Also, it is evident in my firm that males are the obvious choice for partners than females. [F]” “From what I have witnessed, once a woman chooses to start her family, commitment to the firm, for whatever reason, is perceived to be less than it was before. [F]” “Gender biases, having children may stunt the growth of my career. [F]” “Women are not paid as much as men, are not promoted as quickly and are not given the same opportunities to improve themselves as men. [F]” “Females do have to work harder than males to receive promotions. [F]”

Table 9

Gender of Persons Promoted in the Last Three Years

Gender Study Period New Partners Principals Directors Senior Managers

1994-1996 19% 20% 24% 30% Female

1991-1993 26% 38% 27% 33%

1994-1996 81% 80% 76% 70% Male

1991-1993 74% 62% 73% 67%



SUMMARY

At the beginning of the paper three questions were posed. As is quite often the case the answers to

these questions are more complicated then they seem on the surface and are beyond the scope of any single study. That said this paper does begin to provide some answers to these questions.

Have the glass ceilings for partnership finally been shattered for women? Yes and no. The responses from professionals suggest that there has been some progress in eliminating career barriers for women; however, the responses from professionals also suggest that gender bias continues to be a serious problem. While some may argue that the problem is more perceived than real it does not matter. The public accounting profession must continue its efforts towards gender neutral promotion, compensation, and assignments, in perception as well as in reality.

Sometimes what may be the result of market forces or other factors is perceived as gender bias. One way to address the perception problem is for firms to apply the same approach used to assess the internal control environment of clients. A similar approach should be used when assessing whether a firm’s work environment is gender neutral and determining how that environment can be improved.

Does equal opportunity exist beyond the entrance level or has career progression simply been restructured to give the illusion that equal opportunity exists beyond the entrance level? Yes. But how far beyond the entrance level is probably the more appropriate question. Equal opportunity for advancement through the staff levels to the senior level does not appear to be an issue. What does appear to be an issue is the opportunity to advance through the various upper management levels to partner, and whether the opportunity for advancement at these levels is equal. The opportunities to advance through the various upper management levels have dwindled largely as a result of the market forces in the public accounting profession. The dwindling opportunities for advancement have slowed career progression for both men and women. However, the few advancement opportunities that do exist seem to be more opportune for men than for women. As noted previously it is apparent that gender bias is still a problem. Some may argue the ‘pipeline theory’; however, with each passing day that argument becomes more difficult to support if indeed it is at all supportable.

Determining the illusory part of equal opportunity is more difficult. Career progression is being restructured with the introduction of non-traditional partnership arrangements and more non-partnership tracks. Some respondents suggest that the newer non-traditional career tracks have a disproportionate number of women. Whether this is due to personal choice, the current career realities in the public accounting profession, or gender bias is not entirely clear. As these non-traditional career tracks become more prevalent further investigation will be needed to more fully understand their impact on the career progression of both women and men. Have men and women changed their own professional and personal expectations and if so what is the impact on career progression and work/life balance choices? The responses by professionals suggest that professional and personal expectations are changing. A more interesting question is why are they changing? Are professional and personal expectations changing because; Professionals are discouraged and disillusioned?, Career realities in the public accounting profession have changed?, or There has been a more general change in societal values? The answer in each case is yes. Evidence of discouragement and disillusionment on the part of many professionals can be found in their open-ended responses. The study also provides evidence of the impact of market forces on career progression and the increasingly remote possibility of partnership. The open-ended responses also suggest that the values of public accounting professionals are changing as they are throughout society, in response to changing family structures and a redefining of gender roles.

The result is an increased awareness of work/life balance on the part of some professionals as well as some firms. The results of the 1997 survey, when compared to the 1993 survey, show that firm awareness continues to increase. More firms are instituting family-friendly policies. However, as noted previously, the rhetoric regarding family-friendly policies does not always translate into reality. Perhaps the reality would be more consistent with the rhetoric if these policies were referred to as ‘firm-friendly’ policies



instead of family-friendly. The extent to which these policies serve to attract and retain a quality workforce does indeed make them ‘firm-friendly.’

If the public accounting profession is to successfully assume a leadership role into the next century it must continue to invest in its most valuable asset: a highly trained, highly skilled, and motivated workforce. This investment must be more than training and salary or other forms of compensation. The profession must make the necessary investment to insure an environment where all professionals can reach their potential. Firms look to the individual to add value to the firm and rightfully so. But firms must also look to add value to the individual. The profession must not be complacent. The cost of complacency is too high.



REFERENCES Catalyst. 1994. Achieving a Balance in the Accounting Workplace. New York. Catalyst. 1998. A New Approach to Flexibility: Managing the Work/Time Equation. New York. CPA Personnel Report. August 1998. “AA Remains Teachers’ Pet: Professors’ Survey 1998,” CPA

Personnel Report. Doucet, M. S. and Hooks, K. L. 1999. “Women CPAs: What’s Changed, What Hasn’t,” Journal of

Accountancy, forthcoming. Hooks, K. L. 1998. “Work Patterns in a Big 6 Professional Services Firm: A Survey-Based Case Study,”

working paper presented at the 1998 ABO Conference.