the war of the sidewardly mobile corporate financial report 2006 critical perspectives on accounting

8/9/2019 The War of the Sidewardly Mobile Corporate Financial Report 2006 Critical Perspectives on Accounting

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Critical Perspectives on Accounting 17 (2006) 419455

The war of the sidewardly mobile corporatefinancial report

T.A. Lee

University of Newcastle Upon Tyne, Accounting and Finance Division, Business School,

Newcastle Upon Tyne NE1 7RU, UK

Received 15 November 2003; received in revised form 22 April 2004; accepted 30 September 2004

Abstract

A war exists in corporate financial reporting and the purpose of this paper is to identify and anal-

yse why it persists despite continuous efforts to provide a resolution. The study uses the organic

intellectual approach to criticism recommended by Tinker [Beyond the Brilovian critique: tradi-

tional vs. organic intellectuals in critical accounting research. Acc Public Interest 2002;2:6887]

and focuses on the related commodity forms of public accountancy professionals and historical

cost accounting as key features of the war. The methodology of the study is broadly historical

and the analysis reveals battlegrounds of reporting deception, audit criticism, governmental andprofessional responses and academic challenge. The paper argues that the war has caused report-

ing quality to remain poor throughout its historyi.e. to be sidewardly rather than upwardly mo-

bile in terms of quality aspirations and achievement. It recommends fundamental debates on two

commodity forms in corporate financial reporting. The first debate concerns the type of public ac-

countancy professional wanted and needed by society in relation to corporate financial reporting.

The second debate relates to the problem of social reality construction and its representation by

accounting numbers. The responsibility of academic accountants in these debates is particularly

emphasised.

2004 Elsevier Ltd. All rights reserved.

Keywords: Academics; Corporate financial reporting; Fraud; Historical cost accounting; Professionalism; Public

interest; Social reality construction

E-mail address:[email protected].

1045-2354/$ see front matter 2004 Elsevier Ltd. All rights reserved.

doi:10.1016/j.cpa.2004.09.001


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420 T.A. Lee / Critical Perspectives on Accounting 17 (2006) 419455

1. Preface and caveat

This paper presents observations and opinions on the state of corporate financial report-ing from more than three decades of involvement by the writer in its practice, teaching and

research. It incorporates the work of many researchers and provides a commentary to en-

courage further thought and debate. The paper describes historical events and periods but is

not a history of these events and periods and does not offer new historical evidence. Instead,

the papers historical descriptions suggest that corporate financial reporting is in a state of

crisis and has been for many decades. Using a social analogy of mobility related to aspira-

tions and achievement of improvement, the paper particularly argues that, far from being

upwardly mobile, corporate financial reporting has been, at best, sidewardly mobilei.e.

lacking substantial improvement in relevance and reliability.

The paper offers two recommendations as a first step to remedy the situation. These

are debates on the type of professional needed in corporate financial reporting, and the

problems associated with social reality construction and its accounting representation. The

recommendations are not whatTinker (2002, p. 77)describes as sentimental and traditional

intellectual yearnings to return to a golden age of the past. The point about this study is that

there never was such an agewhich is arguably the most damning criticism to make about

the current state of corporate financial reporting.

2. Introduction

This study rests on a primary assumption that there is a private war over a public good in

corporate activity. On one side of the divide are protectorsindividuals and organisations

who implicitly and explicitly covenant to protect the public interest in capital markets.1 Onthe other side are deceiverscorporate managers who attempt to deceive actors in these

markets. The public good is the corporate financial report by managers to shareholders

that forms an important information source for normal market activity. The main content

of the report is a related set of accounting numbers derived from a rule-based system of

calculation, disclosed according to legislative or regulatory mandate, and verified by expert

public accountants. The war usually takes place far from the public eye in corporate and

professional offices but becomes visible when protectors catch deceivers in the act of major

reporting deception.

There are various protectors in capital markets including auditors, legislators, govern-

ment regulators and academics. Each group has a significant role to play in protecting the

public from any harm caused by accounting deceit in corporate financial reports. However,when fulfilling their public interest mission, protectors also necessarily pay attention to

their economic self-interests and this can result in compromising behaviour. This duality of

focus does not affect deceivers. They are corporate executives and directors who, with few

exceptions, manage by economic self-interest in a capitalist society. It is easy to exaggerate

1 Protection in the accounting literature typically appears in association with the needs of investors and lenders

operating within capital markets. However, for purposes of this paper, protection includes the needs of corporate

stakeholders and includes customers, employees, government agencies, and suppliers.


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What problems endemic to corporate financial reporting permeate its questionable con-

dition internationally?

Recent events in the US are the initial focus of the broad historical analysis in the

paper as they include the most serious financial reporting deceptions of modern times.

The commentary, however, also contains cases of UK deception and readers may wish to

consider comparable events in other countries and at other times. The study is therefore not

a detailed history of corporate financial reporting. Instead, its modest objective is to use

historical facts to inform arguments and recommendations, and encourage debate about a

serious problem. The analysis identifies problematic responses by various protector groups

to reporting deceit and castes serious doubts about the use of the conventions of historical

cost accounting to faithfully represent relevant corporate economic activity.

The study proposes that there is a debate on the type of public accountancy professional

required in corporate financial reporting (Macintosh and Shearer, 2000; see also Macintosh,2004). It also recommends that the socialreality subject matter of accounting requires debate

to consider its construction and accounting (Macintosh et al., 2000; Mattessich, 2003).As

such, the study is consistent with recent professional critics such as Zeff (2003)andWyatt

(2003),and historical cost accounting critics such asWest (2003).However, as previously

stated, it is not a traditional intellectual call to return to a golden age of public accountancy

professionalism or accounting theorising (Tinker, 2002;see alsoMacintosh and Shearer,

2000).Instead, it is a response toTinker (2002, p. 80) appeal to examine the commodity

forms associated with financial reporting in a capitalist systemi.e. commodities that act

as bearers of the alienated social relations of capitalism. It also relates to Williams (2004)

charge that academic accountants develop and change accounting separate from the influ-

ence of the public accountancy profession. If the recommended debates are to take place,the contributions of academics are essential.

3. Initial thoughts on war

There was no formal declaration of war between protectors and deceivers in corporate

financial reporting, nor is it usual to characterise their activities as warfare. However, a

continuous and long-lived history of specific conflicts over reporting quality suggests a

war does exist. An obvious starting point in this historical analysis is the principalagent

relationship in corporate activity.

Companies publish financial reports because shareholders frequently delegate their man-agement to agents who account periodically for their performance. These agents have incen-

tives to produce deceitfulperformance reports, particularly if accountingnumbersdetermine

their compensation. Shareholders, however, have auditors in place to attest report quality.

More specifically, shareholders seek comfort from auditors that reported accounting num-

bers and related disclosures given to them are not deceitful and are therefore safe to use in

decisions. Crises in shareholders confidence arise if auditors fail to detect reporting deceit.

The public nature of corporate financial reports also means that reporting deceit affects all

stakeholders and the efficient operation of capital markets.


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T.A. Lee / Critical Perspectives on Accounting 17 (2006) 419455 423

Reporting deceit takes many forms and covers all accounting and disclosure practices

designed to mislead report users. It therefore includes practices designed to cover up theft

of corporate assets and ineffective management, as well as numerous earnings manage-ment strategies (Nelson et al., 2003). This study assumes that reporting deceit refers to

any accounting or disclosure practice that deliberately misrepresents economic activity

by enlarging or diminishing corporate assets, liabilities, equity, profits and cash flows re-

ported in financial statements.4 Motivations for reporting deceit vary but, in the case of

earnings management, the need to meet capital market expectations of earnings appears to

be a typical trigger for manipulation of accounting numbers. According to Nelson et al.

(2003),expenses and losses are the most manipulated aspects of financial reports in this

respect, followed by accounting data connected to revenues and gains. Whatever the rea-

son or method of deception, however, the result is a corporate financial report with ac-

counting numbers and disclosures that do not faithfully represent underlying economic

activity.

Reasonable assumptions that this study make are that the protectors of corporate financial

reporting are rational, regard reporting deceit as undesirable, and act to detect, prevent, or

minimise it. In addition, although some commentators describe deceptive reporting as a

form of game in which, particularly, managed earnings are hocus-pocus (e.g.Levitt,

1998),this analysis assumes the approach ofDechow et al. (1996)that deliberate deception

in financial reporting is a form of fraud. In other words, the distortion of accounting numbers

is a cynical exercise by corporate management to mislead shareholders, other stakeholders

and protectors. Capital markets depend on credible information sources and expect corporate

financial reports to faithfully represent economic activity even though there are accounting

researchers who believe that misleading information is useful because it permits report users

to identify ineffective management within the information content of manipulated accruals

(Arya et al., 2003).It is also clear that reporting quality issues create internal divisions between protectors

because of an uneasy relationship between the public accountancy profession and gov-

ernment. In recent times in the US, for example, McNamee et al. (2000) report conflict

between the Securities & Exchange Commission (SEC) and the largest public accountancy

firms with audit clients caught reporting deceitful accounting numbers. The SEC accused

these auditors of accommodating reporting deceit in order to secure non-audit services. Irre-

spective of the truth of the matter, this episode reveals the war against reporting deceit is not

just about conflict between protectors and deceivers. Instead, it also involves paradoxical

battles between different groups of protector.

4 The term economic activity is used at this point in the paper to simplify the discussion, although more spe-

cific terms such as economic substance appear later at appropriate points in the narrative. Economic substance

frequently appears in conceptual explanations of accounting practices and is typically undefined and unexplained.

Its conventional appearance is in recommendations by accounting standard-setters to account for the economic

substance of transactions rather than their legal form (e.g.FASB, 1980; IASB, 1989).Its generic form is encapsu-

lated by the term economic reality. Adapting the arguments of the American philosopher John R.Searle (1995),

economic reality is a form of social reality collectively constructed by humans with agreed rules and functions. In

other words, economic reality is a mental construct that may not be easily associated with empirical referents that

provide it with so-called economic substance and meaning (seeMacintosh et al., 2000andMattessich, 2003).


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3.1. Recent events

The 1990s witnessed considerable reporting deceit by major American companies andthe 1998 disclosure of accounting fraud by the Cendant Corporation illustrates this point

(Barrett, 1998). Cendant restated previously reported earningsby approximately300 million

dollars because of revenue and other accounting misstatements, and dismissed its auditor,

Ernst & Young. It paid its shareholders nearly three billion dollars in damages settled out

of court in 2002 and Ernst & Young settled with it for more than 300 million dollars.

Also in 1998, Sunbeam Corporation secretly transferred more than 20 million dollars of

reserves to reported income in order to appear profitable (Byrne, 1999). Sunbeams auditors,

Arthur Andersen, paid an out-of-court settlement to its shareholders of one hundred and 10

million dollars. Unsurprisingly, major reporting incidents such as these provoked the SEC

to action. However, before it could put effective counter measures into place, a much larger

reporting scandal emerged. The Enron Corporation disclosed its reporting fraud in 2001

and sought Chapter 11 bankruptcy with accounting manipulations of more than one billion

dollars despite audits by Arthur Andersen (Sridharan et al., 2002).Senior executives of the

company created false profits and hid massive amounts of debt in more than three thousand

off-balance sheet partnerships. The scandal traumatised the stock market and worsened

when Arthur Andersen admitted shredding Enron audit papers shortly after disclosure of

the fraud. With the rapid loss of other clients, Arthur Andersen dissolved in 2002.

Cendant, Sunbeam and Enron are not isolated incidents and regulatory responses are

unsurprising.Accounting Today, for example, reported four hundred and sixty-four earn-

ings restatements by major American corporations in 1999, 2000 and 2001 (Carlino, 2002).

The SEC issued restrictive rules of independence for auditors in 2000 and 2003, and the

SarbanesOxley Act entered the statute book in 2002 (AICPA, 2002). The Act created

the Public Company Accounting Oversight Board (PCAOB) of the SEC. The PCAOBis intended to be independent of the public accountancy profession, registers public ac-

countancy firms, has overall responsibility for audit-related standards, and inspects and

disciplines public accountancy firms for audit transgressions. The Act effectively identifies

the state in the US as the overall manager of the profession and inevitably this diminishes

the professional status of American public accountants. However, it came too late to prevent

a further shockwave in 2002 when one of the worlds largest corporations, WorldCom, an-

nounced the discovery of accounting fraud in excess of nine billion dollars. The accounting

manipulation was a simple one in which the costs of telecommunication lines appeared as

capital rather than revenue expenditure. Stock market prices fell worldwide, senior World-

Com executives faced criminal charges, investors sought compensation for damages, and

the company remains in Chapter 11 bankruptcy. The deeply disturbing circumstances ofcompanies such as Cendant, Enron, and WorldCom suggest a broader context is necessary

to understand the current state of corporate financial reporting.

3.2. Broader context

The scandals of the late 1990s were recent events in a long-running war and there were

many other incidents without the intense international public exposure given to Cendant,

Enron and WorldCom. Equity Funding Corporation, for example, was a 1970s fraud in-


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volving false life assurance contracts and poor auditing (AICPA, 1975).It was the basis for

a television movie and a professional inquiry by the American Institute of Certified Public

Accountants (AICPA), but had little long-term impact on public accountancy or corporate fi-nancial reporting. It preceded a wider crisis in American banking in the late 1970s and 1980s

in which savings and loan banks and the largest public accountancy firms were involved

(Merino and Kenny, 1994). The accounting practices of these banks failed to represent

the economic substance of banking transactions, their auditors focused on rule compliance

rather than economic substance, and bank regulations sanctioned these practices.5 When the

American economy declined, numerous banks declared bankruptcy and public accountancy

firms paid in excess of one billion dollars in fines and out-of-court settlements. At the same

time, there were numerous examples reported inThe Wall Street Journaland elsewhere of

US companies reporting dubious or fraudulent accounting numbers (e.g. MiniScribe, W

R Grace, Bausch & Lomb, Waste Management and Crazy Eddie) (see e.g. Byrne, 1999).

Although their existence was well known in the US, their international exposure was limited.

In the UK, accounting and auditing scandals were also prevalent and some impacted

internationally. For example, the Bank of Credit & Commerce International (BCCI) col-

lapsed in 1991 with assets overstated by thirteen billion dollars to conceal poor lending

within an organisational structure in 73 countries. The fraud involved numerous crim-

inal devices including money laundering, resulted in a US senate investigation, audi-

tors Price Waterhouse under investigation for negligent auditing, and the Bank of Eng-

land defending a substantial civil law suit for failure to intervene. The Barings bank-

ing group, on the other hand, collapsed in early 1995 following 850 million pounds of

losses due to fraudulent currency trading by an individual employee (Rawnsley, 1995).

Following a Bank of England investigation, UK public accountancy regulators in 2000

(confirmed in 2002) fined Baring auditors, PricewaterhouseCoopers (formerly Coopers

& Lybrand) for a negligent audit relating to the assessment of market risk. In 2003, theHigh Court in England found fellow auditors, Deloitte & Touche, guilty of negligent

auditing.

Each of these reporting deceits can be characterised as a single battle in the war of corpo-

rate financial reporting. It typically involves fraudulent reports by senior management, and

auditors whofail to report the fraud, andtherefore, fail to protect the public interest (Cullinan

and Sutton, 2002).Auditors in these situations appear intent on ensuring representational

faithfulness through compliance with specified accounting rules, and are seemingly willing

to accept managerial explanations without much questioning or challenge. Regulators get

involved and investigate typically after exposure of reporting deceit. In an increasingly liti-

gious environment, legal actions by shareholders and liquidators frequently arise but rarely

get to court because of out-of-courtsettlements. Accounting fraud details are therefore rarelyexposed. Deceivers can then retreat before re-emerging to practice further deceit when the

regulatory spotlight disappears from them. Proposed and actual counter measures appear

and the cycle of warfare continues. Unsurprisingly, problems of a century ago re-appear as

issues of today (Chandler and Edwards, 1996).

5 There appears to be a more widespread condition in contemporary accounting, particularly in the US, in which

compliance with legal form rather than economic substance is associated with compliance with generally accepted

accounting principles (GAAP). SeeAlexander and Archer (2003)for an analysis of this issue.


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To emphasise the persistence of reporting deceit, it is salutary to examine briefly a

nineteenth century case that mirrors those of the twenty-first century. Indeed, the reporting

by directors of the City of Glasgow Bank (CGB) in 1879 is relatively unsurprising in thecontext of 2003. CGB pursued aggressive expansion in the 1860s and 1870s based on

dubious lending to a small number of individuals and speculative overseas investments.

Assets were deliberately overstated and the fraud amounted to an asset deficiency of more

than 6 million pounds by 1878.6 The following statement describes the public reaction to

the trial of the directors (Anonymous, 1879,p.i.):

The Trial which has now terminated, and of which, in the following pages, we present

a full and authentic report, will in all probability rank as the most important which

has ever taken place in Scotland. Whether regard be had to the magnitude of the

distress occasioned by the collapse of the City of Glasgow Bank, the social position

of the directors who managed, or rather so grossly mismanaged the concern, the

disclosures that followed the preliminary investigation of its affairs, or the startlingcharacter of the evidence disclosed by the witnesses for the Crown, no other great

trial at all approaches it in permanent interest. The facts presented in these pages

will long be regarded as a standing memorial of unparalleled commercial disaster

disaster brought about not by innocent misfortune, but by the culpable recklessness of

gentlemen moving in the highest social and commercial, not to say religious circles,

in whose honour and integrity many thousands of their countrymen had for years

placed the most unbounded confidence.

The quotation illustrates the shock felt in Scotland in 1879 because prominent citizens

mismanaged a major bank and covered up with false accounting numbers. The UK govern-

ment in 1879 passed national legislation requiring all banks to publish an annual balance

sheet. BCCI is a recent UK banking example of similar dysfunctional behaviour and only

its twenty-first century size distinguishes it from CGB in nineteenth century Scotland. Both

cases illustrate consistent problems with managerial agencyin particular, that without

credible accounting numbers and auditing procedures, there is inadequate accountability

of managerial agents to their shareholder principals. In addition, both cases reveal how

managers used financial reports to create false messages about economic performance and

position, caused corporate failure, and damaged all stakeholders. Protectors reacted in both

cases to counter the scandals. However, an examination of a longer history of reporting

failure suggests these individual measures were unsuccessful.

3.3. Longer history

A more detailed historical review of corporate financial reporting in the UK and US

reveals the endemic nature of deception and the difficulties associated with countering it.

In 1720, for example, the South Sea Company imploded due to speculation that pushed its

stock price many times beyond its underlying economic value (Watzlaff, 1971). This was not

a case of reporting deceit because the company did not publish financial information and had

6 This represents an approximate equivalent of more than 700 million pounds in 2003.


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no auditor. However, it marked the first corporate financial scandal to trigger governmental

intervention to protect investors. The Bubble Act 1720 attempted to control the formation

of companies such as the South Sea Company, as well as the activities of stockjobberswho fed speculative comment to investors. Nevertheless, it failed to consider the option to

require companies to publish and audit financial information at a time when participants

in capital markets lacked such protection. Regulating these matters only returned to the

governments agenda in the early 1800s and, although audited balance sheets appeared

voluntarily in certain companies prior to its introduction, the Companies Act 1844 was

the first legislation that required audits for all companies (Hein, 1978).7 However, it did

not specify auditor qualifications and, in any case, the Companies Act 1856 removed the

general audit requirement as capital markets reverted to a more liberal and less protected

regime. Individual industries with specific problems, however, adopted reporting practices.

For example, railway scandals led to the Railway Companies Act 1867, as previously

mentioned the City of Glasgow Bank case resulted in the Companies Act 1879, and these

specific measures widened to all UK companies in the Companies Act 1900. The Companies

Act 1948 was the next significant change and required all companies to disclose audited

statements of profitability and financial position, with auditors being qualified accountants

in the case of public companies. Each of these enactments resulted from a prior review of

corporate governance concerns by a parliamentary select committee.

Government was therefore the first major protector against reporting deceit in the UK

and governmental measures resulted in ever-increasing disclosure and prescription, forcing

deceivers to look for ways around regulations. UK courts also offered protection to share-

holders against reportingdeceit, butparticularly in the nineteenthcentury, gave littlecomfort

because judges did not regard auditors as guarantors of the accuracy of accounting numbers

(Wardhaugh, 1984). Protection for deceived third-party users of reports remains unclear

to the present day (Pacini et al., 2002).Prior to the 1880s, British public accountants andtheir institutions were pre-occupied with establishing their professionalism and monopoly

in the area of court-related services rather than expanding into new areas such as corporate

financial reporting (Moore and Cooper, 1994; Walker, 1991; Walker and Shackleton, 1995).

However, during the 1880s and 1890s, accountants began to make a public case that they

had bodies of knowledge to cope with emerging services such as auditing (Chandler and

Edwards, 1994).This was the beginning of a period lasting to the present day in which the

public accountancy profession used image management techniques to engage the trust of

report users, particularly those ill informed about its bodies of knowledge (Neu, 1991).

The case of the Royal Mail Steam Packet Company in 1932 stimulated the British

public accountancy profession to specific protectionist action (Ashton, 1986). The case

centred on the then accepted practice of secret reserve accounting and led inevitably tothe explicit involvement of professional bodies in the war against reporting deceit and a

stream of measures to protect report users over several decades. The Institute of Chartered

Accountants in England and Wales (ICAEW) started its Recommendations on Accounting

Principles in the late 1940s and subsequent Statements on Auditing in the early 1960s.

These were the forerunners of todays standards in the UK and prior reporting problems

7 Nobes and Parker (1979)provide a full chronology of UK corporate financial reporting developments from

1844 to 1977.


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and criticisms initiated each step in their evolution. In particular, reporting problems over

major acquisitions and mergers in the late 1960s led to a series of mandatory accounting

standards in 1970 from the ICAEWs Accounting Standards Steering Committee (ASSC).The ASSC evolved into the multi-body Accounting Standards Committee and, in 1990, the

independent Accounting Standards Board (ASB). In 1992, the ASB became the standards

arm of the financial communitys Financial Reporting Council. In contrast, the auditing

recommendations of the ICAEW became mandatory in 1976 when its Auditing Practices

Committee (APC) joined the Consultative Committee of Accountancy Bodies because of

fraudulent reporting by the secondary bank London & County Securities. This case also

led to the formation of the Joint Disciplinary Scheme of the main UK public accountancy

bodies in 1979. The APC evolved into the Auditing Practices Board (APB) in 1991 and the

APB joined the independent Accountancy Foundation in 2002. In most recent times, these

self-regulatory changes took place in a wider context of continuous governmental inquiry

into the state of corporate governance in the UK (e.g. Dearing in 1988, Cadbury in 1992,

and both Higgs and Smith in 2003).

The UK reporting protection process therefore changed over a relatively few decades

from voluntary procedures to mandatory standards and from committees of public accoun-

tancy bodies to apparently independent regulatory authorities representing a wider financial

community. It also resulted in a proliferation of accounting rules for the conventional system

of historical cost accounting that, according to its critics has no basis in an authoritative

theory or body of knowledge (e.g.Sterling, 1979;see alsoWest, 2003).In the US, a similar

history is evident (Previts and Merino, 1998; Zeff, 2003).8 The preference of protectors

prior to the Securities Acts 1933 and 1934 was for supervision rather than regulation of

companies in industries with financial reporting problems. Public accountants were slow

to develop a political relationship with the state.9 Despite pressures, the American Institute

of Accountants (AIA) and its predecessor body had no desire to provide accounting andauditing standards, preferring to control and police these areas on behalf of the SEC (Sriram

and Vollmers, 1997).

The quest of US public accountants in the early part of the twentieth century was for

standardised accounting practice and the AIA published its Uniform Accounting in 1917.

This was disastrous for the AIAs professionalism project as it implied rulemaking and lack

of professional judgment in financial reporting. Consequently, several later generations of

American public accountants advocated accounting flexibility in reporting practice. This

precipitated a debate on the issue by leaders of the profession that, inter alia, ignored

the fundamental point of whether historical cost accounting was credible in its role of

representing the financial results of corporate economic activity (e.g. seeZeff, 1982a;see

alsoStorey, 1964).There was also a governmental aversion at the time to interference incorporate affairs and it was not until 1926 that protection against reporting deceit became a

serious issue. The credibility of accounting numbers was the major problem and the inability

of public accountants to enforce acceptable accounting practices on corporate clients the

main concern. Secrecy by companies was not only the norm but also acceptable to many

8 Zeff (1979)provides a US chronology of corporate financial reporting events from 1926 to 1978.9 Macdonald (1995)explains the importance of this relationship to professions generally and Cooper et al.

(1994)discuss its importance to the public accountancy profession.


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in the financial community (e.g. bankers). Nevertheless, the New York Stock Exchange in

1926 recognised the need to monitor corporate financial reporting and started discussions

with the AIA to lobby for mandatory audits. The crisis of the stock market crash in 1929coincided with this concern, and the Securities Acts 1933 and 1934 introduced the SEC and

mandatory accounting and auditing provisions for public companies. The AIA, however,

realised the danger of losing its control of reporting standards and, following several years of

discussion, persuaded the SEC to delegate responsibility for these matters to it in 1938. The

AIAsAccounting TerminologyandExamination of Financial Statementsin 1931 predated

Accounting Research Bulletins that started in 1939. The latter evolved into Accounting

Principles BoardOpinions in 1962 while the SEC prosecuted the reporting fraud case of

McKesson-Robbins in 1939 that led to a significant reform of audit practices in the 1940s

and 1950s (Baxter, 1999). Thus, by 1940, public accountants in the US appear to have

developed into an authoritative profession, with an influential leadership and control over

its accounting and auditing standards (Zeff, 2003).

A mixed system of voluntary and mandatory provisions to protect against reporting

deceit in the US, however, did not reduce criticism of report quality. Indeed, follow-

ing the Second World War, and building on prior ad hoc studies, there emerged a sig-

nificant and growing literature by academic accountants concerned with the frailties of

historical cost accounting and the lack of a theory to justify it ( Gaffikin and Aitken,

1982).10 In addition, the public accountancy profession was inundated with criticisms

and lawsuits. Leading practitioners began to initiate responsive action and eventually set

up the Wheat and Trueblood Committees and the Cohen Commission of the AICPA in

the 1970s. Wheat and Trueblood resulted in the independent Financial Accounting Stan-

dards Board (FASB) in 1973. Zeff (2003) argues that this was the point at which the

profession lost its control over accounting standards, the largest firms began to disen-

gage from the standard-setting process, and a more difficult relationship with the stateemerged.

The Cohen Commission criticised the standard-setting processes of public accountants

and questioned the education and training of auditors. More generally, these reports pre-

cipitated continuous governmental monitoring of the public accountancy profession to the

present day. For example, the Treadway Congressional Commission in the mid 1980s in-

vestigated ways of improving financial management and reducing fraud. It emphasised the

need for ethical management by corporate executives and influenced several audit standards

dealing with expectations gap problems (Guy and Sullivan, 1988). The Dingall Congres-

sional Committee held a number of enquiries into public accountancy in the early 1980s.

The financial reporting abuses of the 1990s then led to, first, the Private Securities Re-

form Act 1995 to reduce apparently discriminatory litigation against public accountants byrecognising proportional liability, and second, the SarbanesOxley Act 2002 that signalled

the direct involvement of national government in public accountancy. Also in 2002, the

Financial Accounting Standards Advisory Council that regulates the FASB added a User

Advisory Council to its structure in order to provide report users with a formal part to play

in the accounting standard-setting process.

10 Nelson (1973)describes this period as the golden age of a priori accounting research, andGaffikin and Aitken

(1982)provide a selection of research by the most influential accounting writers of the time.


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Parallel with these institutional changes in recent decades, the US government pressured

public accountants to remove restrictions of trade and this led to changes in the focus and

structureoftheprofession(Zeff, 2003). More specifically, thelarger firms decided as a matterof growth policy to enlarge their non-audit services. Management consultancy became the

lead activity and audit effectively was the loss leader. A consequence of these changes was

the removal of senior partners in the leading US firms from the standard-setting process

generally and the leadership of the AICPA particularly. A similar, although less pronounced

trend was noticeable in the UK.

3.4. Current state

The above broad analyses reveal parallel histories in the UK and US. The British ex-

perience is much longer, however, with government and legislative prescriptions from an

early stage. These initially related to specific industries with known corporate governance

problems (e.g. in banking), but extended in the twentieth century to all companies and pre-

dominantly provided report protection by increased financial disclosure. However, by the

1940s, the main public accountancy bodies were publicly involved in prescribing account-

ing and auditing practicesfirst as voluntary pronouncements, then as mandated standards.

The US evolution, on the other hand, has depended on an unspecified partnership between

the AICPA and the SEC. Nevertheless, it followed the same sequence from voluntary pro-

nouncement to formal prescription as noted in the UK. In both countries, therefore, there

was a progression in standard-setting from committees of accountancy bodies to separate

and apparently independent bodies. However, most recently in the US, as a result of promi-

nent scandals, there has been direct intervention by government in the form of legislation

to control the public accountancy profession.

Despite this history of measures to resolve the waron corporate financial reporting deceit,there is no evidence that the latter has disappeared or reduced. Indeed, the most recent public

scandals in the UK and the US suggest the contrary. Increased prescription of accounting

and auditing standards parallels deceptions of increasing amounts such as in Cendant, Enron

and WorldCom in the US and BCCI and Maxwell Communications Corporation in the UK.

This conclusion should be of concern to all involved with protection in corporate financial

reporting. A war that persists for more than fifteen decades with no sign of a conclusion is

a war of failure. In addition, it is reasonable to argue based on the historical evidence that

deceivers appear to believe that the economic benefits of reporting deceit exceed any costs

of punishment due to discovery. In other words, they seem unwilling to forgo the economic

rewards of deceit and embrace proper disclosure in the public interest.

Equally obvious is protectors failure to introduce accounting and auditing changes ofsufficient power to discourage deceitful managers. The most recent initiative in the US

is that of the FASB to introduce principles-based accounting standards because of the

SarbanesOxley Act 2002 (FASB, 2002a).These standards are to be based on qualitative

reporting characteristics such as relevance and reliability as defined in the FASBs concep-

tual frameworks (FASB, 1980). The initiative will also affect many other countries due to the

recent pact between the FASB and the IASB to produce compatible and consistent standards

globally (FASB, 2002b).Thus, once implemented, principles-based accounting standards

will presumably have to produce accounting numbers that faithfully represent relevant eco-


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nomic reality or substancei.e. if they are to adhere to the relevance and reliability qualities

defined by the FASB and the IASB. Yet nowhere in the conceptual pronouncements of the

FASB and the IASB is there evidence that standard-setters appreciate the problems of usingaccounting numbers to represent social reality constructed by humans. 11 In these circum-

stances, it is reasonable to predict that the SarbanesOxley Act 2002 and related responses

will not prevent major reporting deceits in the future. Indeed, the existence of false report-

ing throughout so many decades suggests inherent problems beyond the intention of any

such legislation or response. SarbanesOxley implies deceitful financial reports result from

pressures placed by corporate mangers on auditors to agree to dubious accounting practices

or else lose non-audit services. However, this appears to be a symptom of the disease rather

than the disease itself. There appear to be more substantive factors at work and these need

to be identified. This study suggests there are two primary candidates within the system

of protection. The first is public accountancy professionals, many of whom appear to have

forgotten or ignored their public interest mission in favour of economic self-interests. The

second is an enduring system of historic cost accounting calculation that produces arbitrary

numbers used to compensate corporate managers, hold them accountable, and inform cap-

ital markets. Before these matters are considered, however, the existing protection system

requires evaluation to determine these underlying problems.

4. Responses of protectors

As previously stated, corporate financial reportingis a system thatinvolvesseveralgroups

of protector. Each has featured in the foregoing analyses and it is reasonable to argue that

the system works when there is inherent stability, with each protector group managing its

self-interest without compromising its public interest mission.Nelson (2003)describes thisstability as a situation in which accounting and auditing standards are precise enough to

determine reporting issues, dissuade reporting deceit, and remove incentives to avoid stan-

dards; yet imprecise enough to prevent auditors seeking safe harbours and allow regulators

to regulate. In other words, standards need to be strong enough to permit the public interest

to over-ride self-interests. Instability, on the other hand, arises when self-interests domi-

nate the public interest. If this state persists, as it appears to have done for many decades,

then trust for protectors evaporates and it is unsurprising to find respected contemporary

commentators such as Wyatt (2003) andZeff (2003) describe the demise of the public

accountancy profession and its professional values.

The argument of this paper is that there has been instability in corporate financial re-

porting throughout its history as particular protectors respond to specific crises. No majorprotector group appears to have been able to place its public interest mission clearly be-

yond an intuitive need to address its self-interest. This is a conclusion that reflects the

survival instincts of human beings and is therefore more than a point of criticism. It de-

scribes a condition endemic to corporate financial reporting and is a substantial explanation

of the longevity of the war. The remainder of this section examines these points in more

detail.

11 See footnote 3.


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4.1. Public accountancy responses

Professions are socially closed communities permitted first, to control markets for theirservices based on expert bodies of knowledge and second, to self-regulate (Larson, 1977).

Within this framework, membership entry hurdles are the primary method of providing

social closure for professions. Public accountants belong to a profession with these char-

acteristics and specifically covenanted to protect the public interest when forming their

organisational institutions (e.g. Brown, 1905). Lee (1995) presents their history in the

Anglo-American world. He observes it as a continuous balancing of public interest mission

with economic self-interests.12 In addition, his analysis reveals matters pertaining to the

war of corporate financial reporting and the following commentary uses this as a basis to

demonstrate the public accountancy professions responses to reporting problems.

The formation and early maturation of public accountancy in the UK and US took

place in a period that started with general corporate legislation in the UK in the 1840s

and 1850s and ended with corresponding federal legislation in the US in the early 1930s.

Throughout this period, it is clear that matters affecting their economic self-interests tended

to distract public accountants and their institutions in both countries.13 They attempted to

legitimise their professional claim by demonstrating explicit entry hurdles, self-regulatory

systems, control over standards, and an expert body of knowledge. They also defended

their professional territory from rivals and critics and expanded their firms nationally and

internationally with a growing menu of financial and other services. At this critical time,

the institutions of public accountancy were relatively small, managed by practitioners on

a part-time basis, and only slowly recognised the importance of their political role with

the state. It is therefore unsurprising to find that, beyond offering audit services as part of

their economic expansion, public accountants were relatively late into the area of corporate

financial report protection.Because British and American public accountants focused for so many decades on their

self-interests rather than the public interest, it is probable that their earlier behaviour con-

ditioned the responses to reporting problems of more recent generations. In short, public

accountants attempted to protect the public interest in a self-interested way. However, with

government already in the driving seat, public accountants inevitably had to assume a role of

catch up. Their eventual realisation of the need to control their standards and body of knowl-

edge led to an uneasy relationship with the state that persists to the present day. Particularly

in the period after the Second World War, they also observed a gradual public exposure of

their body of knowledge. Criticism of accounting and auditing practices created pressures

to respond and these responses led to prescribed standards and practice implementation

details and exceptions. The more the body of knowledge was exposed, the more deceiverswere able to determine ways of either adapting or circumventing standards, and the more

subjective the body of knowledge appeared to be. West (2003)provides a detailed review

of this history and concludes that accounting is rule-based and does not have the cognitive

authority required of expert knowledge. He further argues that practitioner judgements are

12 Mitchell and Sikka (1993), for example, provide a recent commentary on the politics of this situation.13 The early problems of institutionalised public accountancy in the UK are reported in studies such as Walker

(1991)andShackleton (1995).Miranti (1990)provides comparable evidence about the US.


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consequently restricted to rule compliance rather than intellectual interpretation. In other

words, financial reporting qualities such as relevance and reliability have come to be inter-

preted by public accountants in terms of rule compliance instead of faithful representationof a relevant social reality of economic activity (Alexander and Archer, 2003; Clarke et

al., 2003).Responding to the public interest in circumstances of criticism and response

is therefore a two-edged sword for public accountants. Response to criticism is what they

need to do to fulfil their public interest mission. However, it also has the potential to dimin-

ish their claim to professionalism by revealing their body of knowledge as rules and rules

compliance.

In this uneasy and unstable world of self-interest and public interest, it is unsurprising

that the public accountancy profession has been observed as adopting an implicit strategy

to address the problem of making visible its body of knowledge. The strategy described

byFogarty et al. (1991) suggests that public accountants and their institutions do noth-

ing in relation to pressures on their professional claim. More specifically, they de-couple

their explicit pronouncements of ideal states of accounting and auditing practice from any

corrective actions they put in place because of reporting crises. Thus, when a reporting

problem arises, public accountants typically respond with a search for a solution that claims

to have the potential to remove concerns and criticisms. The solution, however, is rarely

implemented. Responses typically take the form of institutional inquiries, commissioned

research projects, and tentative recommendations for discussion. In these circumstances, the

primary objective is to address the reporting issue with the intention of providing comfort to

report users that it is being attended to rather than that substantive changes to practice take

place. The strategy therefore maintains the status quo so long as this remains an economi-

cally viable option for public accountants. Examples observed by Fogarty and hiscolleagues

include fraud detection by auditors, competition for audit services, improvements to audit

practices, non-audit services, liability reform, and disciplining of auditors. The tactic inthese matters is to appear to respond when, in reality, there has been no response, and the

outcome is to control the debate over the body of knowledge of accounting and auditing.

Paradoxically, however, exposing the body of knowledge in this way makes it available to

others not within the control of accountants (e.g. corporate managers who wish to deceive).

Other researchers report evidence of the effect. For example, Humphrey et al. (1992)

andHumphrey et al. (1993),respectively, examine means by which UK public accountants

control debates on the issues of the expectations gap and fraud detection in auditing in order

to maintain the status quo.Cullinan and Sutton (2002)reveal improvements by American

auditors in their audit of corporate information system controls when the critical issue is not

this matter but the ability of senior managers to perpetrate reporting deceit by over-riding

system controls.Citron (2003)demonstrates the UK professions recent attempt to controlthe area of practitioner independence by switching to a principles rather than rules-based

standard covering audit and non-audit services.

As if the doing nothing strategy was not sufficiently problematic, Byington and

Sutton (2001)reveal problems associated with the public accountancy professions po-

litical monopoly tendencies. They argue that public accountants respond to reporting issues

only when there is sufficient pressure placed on them. Their evidential support for this

condition is the correlation of reporting issues and subsequent responses, with the latter

appearing typically after prolonged criticism. Byington and Sutton also highlight the prob-


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lem of judging the effectiveness of responses to crises when practitioners who are sued

continually settle out of court. There is also the issue of auditors seeking a safe harbour

of following the rules of GAAP instead of the more risky audit strategy of examiningthe underlying economic substance of transactions (Martens and McEnroe, 1992;see also

Alexander and Archer, 2003).

The search for a conceptual framework to support the financial accounting used in cor-

porate reports is a further area that, until recently, illustrates the strategy of doing nothing.

Hines (1989, 1991),for example, argues that public accountants have no body of knowl-

edge of their own and, instead, rely on ideas imported from other disciplines. Yet it is

politically important for public accountants to demonstrate the existence of an expert body

of knowledge that supports their professional claim. For this reason, according to Hines,

the purpose of conceptual framework studies by public accountants has more to do with

emphasising professionalism than with changing practice. Hines further argues that these

studies have not changed financial accounting. Instead, they appear to make its standards

theoretically based and therefore authoritative and legitimate. They provide perceptions of

an objective world to represent in accounting terms. Dean and Clarke (2003) come to a simi-

lar conclusion when suggesting conceptual frameworks are more concerned with providing

a rationale and explanation for current practices than searching for the economic, legal,

and social concepts underpinning accounting. In addition, there are frequent discrepancies

between concept statements and standards of practice (Loftus, 2003;see alsoBooth, 2003).

In support of these conclusions on the role of conceptual frameworks, there are specific

instances of professionally-commissioned conceptual studies being rejected or ignored by

practitioners as too radical when they advocate practices different from the conventional

system of calculation. These include the US projects ofMoonitz (1961)andSprouse and

Moonitz (1962)on the postulates and principles of financial accounting14 and the two UK

studies of the corporate financial report (ASSC, 1975; McMonnies, 1988).The US studies,in particular, were rejected despite publication because they were perceived by the AICPA

as too radically different from GAAP to be implemented. Other commissioned studies have

resulted in short-term experiments in practice that quickly end due to claims of lack of use,

relevance, or popularity. A relatively recent example is current cost accounting in the UK

and US that existed in practice for a few years in the early 1980s (Tweedie and Whittington,

1984).Mumford (1979)relates this specific cycle of interest to disinterest in accounting re-

form to prevailing rates of inflation andtheireffect on theeconomy. In light of this history and

as previously mentioned, it is of relevance to note the previously mentioned announcement

by the FASB (2002a) in the US that it proposes to introduce principles-based accounting

standards in response to recent crises such as Enron and WorldCom. These standards will

effectively be global because of FASBs (2002b) pact with the IASB to produce compatiblestandards. Of relevance to this paper is the question of whether the FASB and the IASB will

be able to produce standards that are capable of faithfully representing a social reality of

economic activity relevant to a wide range of capital market decisions. Leading academics

such as Shipper (2003) appear to believe it is not only possible but is already happening

with existing standards, and that the problem is that stated exceptions and guidance notes

give standards the appearance of rules. An American Accounting Association committee

14 These studies, and the ensuing debate about their publication and approval, are contained in Zeff (1982b).


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(AAA, 2003),however, is more cautious and warns of difficulties when determining the

economic substance of transactions and attempting to represent them faithfully in the form

of accounting numbers.In summary, the existence of numerous conceptual accounting studies in recent decades

suggests that public accountants know their professional claim is flimsy unless they demon-

strate a credible body of knowledge. A fruitful wayof making this demonstration convincing

is to imply in conceptual frameworks that practice has a basis in theory. In other words,

that it is predictable and justifiable rather than random and arbitrary, and has whatWest

(2003)describes as cognitive authority. However, accountants also know from experience

that conceptual studies produce recommendations for accounting change that challenge an

economically-rewarding conventional practice based on historical cost accounting, and this

runs contrary to the strategy of maintaining the status quo. Thus, from time to time, and

at least until the 2002 initiative of the FASB, conceptual studies of accounting have ap-

peared to support the professional claim without any explicit or prior commitment to follow

through and change practice. This has left public accountants with apparent authority over

corporate financial reporting but with no responsibility to revert to an alternative form of

accounting.15 Thus, professional institutions have concentrated on rule-based standards of

historical cost accounting as their preferred way of complying with their public interest

mission. However, a practitioner focus on rule compliance tends to diminish professional

judgement and intellectual reasoning, and erodes the professionalism claim. For this reason,

history suggests that the FASB (2002) initiative has potential to be yet another example of

the strategy of doing nothing.

4.2. Governmental responses

The responses of government to corporate financial reporting issues in the UK andUS appear to reflect favourably on legislators and regulators, at least in the sense of a

historical sequence of provisions that offers protection to report users. Due to the late

arrival of public accountants to the task, government was the main protector for many

decades. This was particularly the case in the UK during the period from approximately

1850 to 1950. Governmental legislation and regulations in this time focused predominantly

on audit and disclosure provisions. They did not address accounting and auditing standards

and therefore government protection was limited because it avoided the area in which

corporate management could best practice reporting deceit by means of manipulation of

accounting numbers.

In more recent times, however, reporting protection evolved in the UK and the US as an

unwritten partnership between the state and the public accountancy profession. Until veryrecently, the former provided an overall framework of corporate governance and the latter

was left to police and control accounting and auditing standards within it. However, in the

US, the SEC recently assumed control of auditing standards via the PCAOB. The history of

the state-profession partnership reveals a difficult situation in which neither partner wishes

to divest control of its particular domain and where there is constant danger that reporting

15 Thisis not to denythat somechangeshave taken place within the principalstructure of historical costaccounting

(e.g. market valuations for financial securities, and cash flow statements using the indirect method of calculation).


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issues fall between the cracks as each group waits for the other to respond. The enormity

of this problem is clear in the historical evidence ofMerino and Mayper (2001). Both

protector groups have been content to maintain the status quo in corporate reporting asneither has any incentive to constrain or challenge the capital market system. Regulation

thereforeappears to exist to provide comfort to investors that protection is there symbolically

rather than to provide effective protection. It also provides monopolistic opportunities for

public accountants to account and audit, and offer non-attest services as substantial by-

products. It is also the case that government agents are professionals and, like any other

professional community, need to demonstrate their professional claim to be acting in the

public interest. All parties in the partnership therefore have strong social and economic

reasons to maintain the systems complexities and ambiguities. It is effectively their reason

for being. Thus, corporate financial reporting issues such as earnings management are not

just matters affecting the public interest. They also have the potential to serve the self-

interests of protectors. The more complex and ambiguous accounting is, the greater the

need for professionals to audit and regulate it.

Evidence of a status quo similar to that of public accountants is not difficult to find as

far as the state is concerned. In the US, for example,Briloff (1993)examined corporate

financial reporting since the early 1970s and found little change over twenty years other than

larger monetary amounts in reporting deceit.Garner (1979)came to a similar conclusion

when reviewing financial reports from the 1920s to the 1970s. There is also evidence that

the SEC targets small rather than large companies and audit firms when prosecuting deviant

behaviour (Bremser et al., 1991). More recently, Briloff (2001) identified this bias in cases of

corporate fraud in which the SEC had acted, and particularly revealed numerous high profile

cases not investigated by the SEC. In the UK too there is evidence that national government

regards issues of corporate financial reporting as largely matters affecting shareholders and

the public accountancy profession (Cousins and Sikka, 1993).It seems curiously reluctantto interfere in capital market affairs that clearly affect many other stakeholders in society.16

Thus, the state in the UK and the US does not seem to appreciate fully the complexity and

longevity of the war of corporate financial reporting.

4.3. Academic responses

Academic accountants are the intellectual conscience of the public accountancy profes-

sion and, as such, implicitly covenant to protect the public interest by observing, criticising,

and recommending on practice issues (Sikka et al., 1995).As accounting and auditing ex-

perts, academic accountants are in a position to challenge other protectors to achieve higher

levels of protection in corporate financial reporting, and to expose reporting deceit. Theyalso have a responsibility to protect the bodies of knowledge of accounting and auditing,

particularly when an ill-defined partnership between the state and the public accountancy

profession controls it ineffectively.

16 At the time of writing, for example, the Secretary of State for Trade and Industry in the UK seems reluctant

to introduce proportional liability for auditors, apparently preferring to retain the current situation of unlimited

liability (Warner, 2004).


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Writers such as Briloff (1993) and Sikka et al. (1995) argue that in recent times academic

accountants have poorly protected the public interest in this area. They particularly con-

demn the silence of academic accountants and the lack of critical comment on issues in theirwriting and teaching. Wilmott et al. (1993), however, are mindful that there are problems for

todays academics when responding to issues such as corporate financial reporting. They

argue that responses by academics are political in nature, reflect personal values, and may

lack coherence due to compromise.West (2003),on the other hand, argues that public ac-

countants preoccupation with accounting rules and rule compliance diminishes intellectual

activity within the profession. He believes rules have silenced scholarly discourse and left

academics to justify and excuse conventional practice through their research. In addition,

West criticises the teaching of students within the framework of conventional accounting

and auditing where practice is separate from theory in the curriculum. Williams (2004),on

the other hand, believes that public accountants commitment to serving the public interest

and not their self-interests is so shallow that it is necessary for academic accountants to

develop accounting and auditing separately from the profession. Tinker (2002)goes fur-

ther and condemns academics recently critical of the public accountancy profession (see

also Tinker and Carter, 2002). He describes them as traditional intellectuals who focus

narrowly on the activities of the largest public accountancy firms in the area of corporate

auditing, and who seek a return to a golden age of professionalismi.e. of guild control

and monopoly. He further argues for organic intellectuals embedded in accounting and au-

diting who observe and challenge the commodity forms of these practices. Macintosh and

Shearer (2000)also condemn academic researchers for their pursuit of a chimerathe sa-

cred covenant of the public interest. Through historical analysis of a genealogical form,

they conclude that recommendations for a return to the covenant are outmoded and a

waste of time as the covenant no longer exists due to specific client relationships held by

accountants.What these comments suggest is that the academic community in public accountancy has

changed over several decades. Accounting researchers of the past were often practitioners

(or had prior practice experience) and their research reflected a practical focus (Fleming et

al., 1990, 1991).In addition, their work had potential to influence practice directly through

responses to corporate financial reporting issues. In the period from the early 1900s to the

late 1960s, leading accounting academics were at the forefront of criticism of reporting

practice and many individuals developed careers and reputations as leading critics. Indeed,

criticism, deductive reasoning, and normative prescriptions dominated accounting research

at that time and continue to influence the research of standard-setters to the present day.

However, since the early 1970s, and with few exceptions, academics withdrew from this

area of intellectual activity and concentrated instead on two connected matters ( Fleming etal., 2000).

The first matter concerns what is claimed to be scientific research aimed at observing

accounting and auditing practice objectively without offering solutions (e.g. Watts and

Zimmerman, 1986). Its intellectual basis is a branch of political economy that favours

laissez faire and deregulation (Mouck, 1992), but there is no evidence that it influences

the body of knowledge that informs economic thinking and practice (Bricker et al., 2003).

Instead, to its critics, it seems to be a form of anthropology in which the subject matter is the

behaviour of accountants rather than accounting (or auditing) processes (Sterling, 1993).


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As such, its critics argue that it has no prospect of and nor does it intend to influence change

in corporate financial reporting practice.17

The second related matter is that, for many researchers, contemporary accounting re-search appears to be an activity designed to impress fellow academics rather than influence

practitioners and other corporate financial report protectors. Indeed, the stated audience of

the leading journal in the US, The Accounting Review, is academics, graduate students,

and others interested in research. Originally launched in 1927 to meet the needs of both

academics and practitioners, it is reasonable to suggest that todays research in the Review

is unlikely to impact practice. The objective of the research appears to be one of con-

forming rigidly to apparently scientific standards of design, methodology, and presentation

rather than satisfying the criterion of practical usefulness. Research in journals of great-

est prestige typically describes projects that are mundane and commonsense (e.g. capital

markets react to new information, practitioner judgments depend on expertise and experi-

ence, and managerial agents deceive investor principals if they have incentives to do so).

In addition, when leading researchers get involved in practice issues, they merely offer

advice supporting the status quo of the conventional system of accounting calculation.

Schipper (2003), for example, argues for historical cost accounting standards explicitly

based on principles rather than rules in the form of exceptions guidance and implementa-

tion detail. Her argument is intended to support public accountancys professional claim,

but it does not and was not intended to challenge the fundamental structure of conventional

accounting.

The result of this inward-looking behaviour by academics is that their community is no

longer an effective protector in the war of corporate financial reporting. With the exception

of a few individuals and journals, there is no consistent and coherent voice of criticism about

reporting deceit. Most recently, as indicated above, even critical researchers have begun to

look inward and dispute about the relative worth of their work ( Tinker, 2002). At leastin the US, this scenario exists within a social hierarchy of academic accounting research

and researchers. For example, American accounting and auditing research consists mainly

of projects using research designs acceptable to the editors and reviewers of the leading

journals. These individuals are doctoral graduates from a relatively few universities and have

a very narrow perception of what is legitimate research (Lee, 1997). In addition, individuals

with similar backgrounds manage the academys largest professional body, the AAA (Lee,

1999). This means that the research function in the US is effectively determined by research

preferences learned in a relatively few elite doctoral programs. Academic compensation,

promotion, reputation, and awards correlate with these preferences and biases. The result

is that leading American researchers benefit considerably from research that aims to satisfy

academic quality standards rather than challenge practice.

17 Much of this research concerns the information content of reported accounting numbers and its relationship

to capital market activity measured in terms of price and volume movements. The general claim is that, if there

are such movements in the presence of reported accounting numbers then assuming control over other possible

variables, these numbers have information content and are therefore useful. It is the contention of this paper that

this conclusion exceeds the limitations of these studies and that all that may be concluded from them is that

accounting numbers are used by market participants. Whether these numbers are useful is a different and much

more difficult question to answer. SeeSterling (1990)for a more extensively argued study of this issue.


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Evidence of a social hierarchy in UK research is not available although there is no reason

to suggest that traits similar to the US do not exist there. In any case, it is reasonable to

argue that, as a result of various research quality assessment exercises, research in the UKadheres more to the star rating system than to practical utility. In these exercises, judgment

about research performance depends on research publication numbers, perceived journal

quality, and research funding amounts (Brinn et al., 2001).There are no criteria used that

relate to the impact of research on practice. As in the US, publication in a top research

journal determines what is perceived to be quality research. In these circumstances, the

academic accounting community does not seriously challenge corporate financial reporting

deceivers, although there is one known exception to this situation. The researched criticism

of the financial reporting of specific American corporations by Abraham Briloff has had an

adverse affect on the stock market prices (Foster, 1979)and caused corporate executives to

sue him unsuccessfully (Tinker, 2002).

5. Explanations of current state

The foregoing analyses of the responses of protectors in the war of corporate financial

reporting suggest various explanations regarding its longevity and lack of resolution. They

provide a basis for discussion and appear in no particular order of importance.

5.1. Market failure

West (2003)identifies market failure in the demand and supply of corporate financial

reports as a reason often advocated for their regulation. Perceived instances of such mar-

ket failure appear to be an impetus for the proliferation of accounting rules in responseto reporting problems. Failure in this context includes the powerful position of corporate

management to deceive, the lack of comprehension of accounting by report users, and

the ambiguity and flexibility inherent in conventional accounting practice. Placed within

the context of the analyses in this essay, however, continuous regulation and persistent

rule making do not appear to remove or diminish market failure. Indeed, the experience

of reporting deceit in the 1990s suggests that regulations and rules fuel the situation

rather than resolve it. Deceivers find ways around the rules through permitted or possible

exceptions.

5.2. Confused regulation

Regulation of corporate financial reporting is the responsibility of a complex partnership

of legislators, government agencies, professional institutions, and quasi-independent boards

with strong links to public accountancy. Each has its jurisdiction and sphere of influence

to maintain and protect and there is no guarantee that it has the same focus, understanding,

and commitment to reporting deceit and protection as its counterparts. In addition, there

is the possibility that reporting issues fall between the cracks as each regulator waits for

others to respond and act. In the context of this essay, such a situation is a recipe for too

little and too late.


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5.3. Public exposure

One of the main lessons from this study of the war of corporate financial reporting isthe continuous exposure of what purports to be the bodies of knowledge of accounting

and auditing. Corporate financial reporting crises provoke public accountants to codify

their knowledge in a growing number of standards that contain practice rules, exceptions,

and guidance. This is a very different strategy from other professions where the apparent

convention is to reflect expert knowledge in abstract and general form (e.g. justice or health)

rather than in specific codes of practice. As studies of the histories of professional groups

reveal, it is exceedingly difficult for outsiders to observe the expert knowledge that converts

to practice skills and economic reward (Perkin, 1989).18 Keeping the existence of a body of

knowledge at the level of general abstraction is an effective means of preventing successful

criticism of a profession. It is also much easier for a profession to ignore or deflect criticism

than it is if its body of knowledge is in the public domain. Public accountancys knowledge

is no longer a private matter and comprehension of its foundation as a complex set of

rules without coherent theoretical justification has percolated beyond the accounting office

or classroom. For example, it is available to corporate managers who wish to practice

manipulation and deceit. For this reason, it is reasonable to suggest that the making public

of accounting and auditing knowledge is an important contributory factor in the war of

corporate financial reporting. Deceivers cannot effectively circumvent principles, standards,

and even rules that are not in the public domain.

5.4. Professional claims

The public accountancy profession is a relative newcomer to the world of professionalism

(Corfield, 1995).Its institutional history in the English-speaking world is approximatelyone hundred and fifty years old (Brown, 1905).During this period, public accountants have

spent considerable time and resources making and defending their professional claim, and

radically changing accounting and auditing practices was apparently not an economically

viable option. It is therefore unsurprising that, when accountants balance their public interest

mission with their self-interests, the latter dominate within the implicit strategy of doing

nothing. In other words, specific responses to reporting crises are defences of public

accountancy professionalism rather than protection of the public interest. Seen in this light,

theoretical studies such as conceptual frameworks become the image management of a body

of knowledge rather than steps to radical change practice, and the war of corporate financial

reporting feeds off this status quo.

5.5. Lack of challenge

Market forces drive thecapitalist system and it is unsurprisingthat itsparticipantsover the

centuriestend to regard interference in these mechanisms as unproductive. It is apparent that,

for various reasons, protectors of corporate financial reporting agree with this philosophy

of laissez faire. The previous analyses suggest that all the main protector groups have self-

18 See alsoCorfield (1995)for a study of professions prior to 1850.


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interests that cause them to attempt to protect without unduly challenging companies and

their managers. It is understandable that protectors are aware of the danger of protection

measures stifling corporate activity and management in a market economy. On the other, ahands-off approach provides incentives to deceive and there needs to be a balance in which

potential deceivers are discouraged without significantly interfering with healthy market

forces. This balance is not evident in the war of corporate financial reporting because

protectors do not challenge deceivers sufficiently to deter.

5.6. Academic bankruptcy

A specific lack of challenge that deserves separate identification in the war of corporate

financial reporting is the relative silence of the academic accounting community in recent

years andthe irrelevanceof most of theresearchproducedby it in relation to reportingdeceit.

The previous analysis reveals an academic community living the good life with research

produced for self-interested reasons and without regard to the public interest obligations

of academic accountants. The focus of teaching on procedural matters in accounting and

auditing is a further condemnation of the role of educators in the war against reporting

deceit. There is an obvious danger that future public accountancy practitioners are typically

unaware of the flawed nature of the accounting numbers in the corporate financial report. As

Sterling (1973)argues in an AICPA gold medal-winning article, most accounting research

does not inform the teaching of practice and the latter does not promote good practice.

6. Flawed public good

The above explanations of protector responses are curiously consistent. No protectorgroup has been successful in significantly reducing or eliminating reporting deceit and each

group appears to have self-interests that conflict with its public interest mission. The overall

consequence of this unhappy situation is that deceivers have sufficient freedom to practice

their manipulations. Only if deception gets outof hand do they risk exposureand punishment

as in the recent cases of Enron and WorldCom. The overwhelming conclusion from this

scenario is that, if reporting deceit is endemic to the system despite decades of protective

measures, something is rotten in the system. For this reason, it is instructive to return to the

history of corporate financial reporting and examine the most persistent features that appear

to encourage managerial deceit. The first feature appears throughout the previous analyses

and that is the domination of self-interests over public interest with respect to the various

professional groupings active in the system. There is no need to explore this feature further,although it returns in later suggestions for resolution of the war. The second feature has

also been touched on at several points in this essay and deserves additional comment. This

is the conventional system of calculating accounting numbers, historical cost accounting.

6.1. Age of normative research

The period from the early 1950s to the early 1980s is relatively short in historical terms

but represents a time of continuous, expert, and global challenge to corporate financial


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reporting. Critics of accounting practice during these decades produced a vast literature

and writers now refer to the period as the golden age of normative accounting research

(e.g. Nelson, 1973). The main focus of the criticism was the quality of historical costaccounting and particularly its inability to provide relevant and reliable information for

stewardship and decision making purposes.19 Academics and practitioners often combined

to identify the strengths and weaknesses of historical cost accounting and offer amendments

and radical alternatives. As the debate intensified, the competence, complexity, and range

of the contributions expanded.

The initial concern of critics was the inherent flexibility of historical cost accounting that

permitted the calculation of a wide range of accounting numbers based on the same set of

economic circumstances. Sterling (1966), for example, estimated there were approximately

ten thousand possible variants of the last-in-first-out calculation of inventory cost in the US

alone. The response of accounting standard-setters to this flexibility issue was to produce

standards containing specific rules of calculation to reduce the number of variants. However,

responses were ad hoc, with individual standards debated and issued on the emergence of

eachflexibility problem (Lee,1971). For example, the followingsequence of topics appeared

in the UK in the 1970sassociated companies, acquisitions and mergers, extraordinary

items, inventories, deferred taxation, government grants, research and development, and

foreign currency. Each identified practice problem became the subject of a standard that

contained rules of calculation, exceptions, and interpretations within an overall framework

of historical cost accounting.

Ad hoc problem-solving by standard-setters increased the probability of inconsistency

in accounting nu

the war of the sidewardly mobile corporate financial report 2006 critical perspectives on accounting

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