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Volume 08

An Exploratory Content Analysis of Terminology in
Public Accounting Firms' Response to AICPA Peer Reviews

Wanda A. Wallace and Karen S. Cravens

Despite peer reviewers' issuance of an unqualified report, the AICPA oversight committee has frequently called for particular voluntary actions to be taken by the reviewee. Related communications between the peer reviewee and the AICPA become part of the public file. This research explores the nature of such public files through content analysis, both in a computerized form and in a more informal subjective analysis form. All non-boilerplate AICPA cover letter accompanying SEC Practice Section (SECPS) public files for the period from 1980 through the first quarter of 1986 are the population. The findings suggest that the AICPA cover letter and accompanying reviewee's response, through much shorter than the peer review report and related letter of comments, are reasonable surrogates for such detail in the public files. Of interest in evaluating the regulatory process is the findings that reviewee's response letters that have been removed by the AICPA from the public files to "prevent any confusion on the part of the public as to the purpose of such letters" were far more likely to contain competency-treated findings. Volume 8, 1994, pgs. 3-32.

An Empirical Investigation of Problem Audits

Bhanu Raghunathan, Barry L. Lewis, and John H. Evans III

This research is motivated by the continuing concern among regulators, the public, and the accounting profession about the role of auditors in the financial reporting process. Auditors have an obligation to develop norms of competence and ethical conduct while society has the right to continually monitor auditors to ensure they are meeting those obligations. This paper analyzes "problem audits" and concludes that when a client pays large audit fees, is in good financial condition, is management-controlled, and the engagement is either in the first year or beyond the fifth year, the auditor is more likely to fail to detect and/or report a misrepresentation by management. This view of audit failures was tested using publicly available data. Implications for auditors and regulators are discussed. Volume 8, 1994, pgs. 33-58.

Cost-Benefit Analysis and Accounting Regulation

Steven Maijoor

A large number of publications in the 1970s and the 1980s on accounting regulation suggested cost-benefit analysis as an area of further research. The expectation was that cost-benefit-analysis could help in the assessment of the social value of accounting regulation. In their past two decades, only a small number of cost-benefit studies have been published in the accounting literature. This paper discusses the problems and limitations of the cost-benefit technique. The discussion will focus on three aspects of the cost-benefit analysis: the potential Pareto criterion, revealing preferences of individuals, and the distributional effects of accounting regulation. Volume 8, 1994, pgs. 59-70.

Toward a Global Reporting Model:
Culture and Disclosure in Selected Capital Markets

Robert J. Kirsch

The absence of intentionally agreed upon securities regulations and financial reporting and disclosure standards has led to calls for international accounting harmonization. The International Accounting Standards Committee has undertaken a major affect enhance harmonization by amending existing International Accounting Standards to reduce the number of acceptable accounting treatments. Care needs to be taken in international efforts to establish uniform accounting regulations and disclosure requirements to avoid superimposing alien structures and concepts on business entities in various cultural areas. What is appropriate for one culture is not necessarily proper for another. In the paper, the author attempts to employ a conceptual framework for analyzing various regulatory environments in two major cultural blocks, the Anglo-American and the Chinese-Asian. Major cultural differences exist in these blocks which may account for the vast differences in regulation and accounting disclosure found in them. Such differences have serious implications for international harmonization efforts. Volume 8, 1994, pgs. 71-109.

Consolidation Policies and Procedures Discussion Memorandum:
An Examination of the Potential Impact on Reporting Quality

Robert E. Hoskin and Andrew J. Rosman

This paper examines issues presented by the FASB in its discussion memorandum (DM) on consolidated policy and procedures (FASB 1991). The purpose of this examination is to provide the FASB and its constituents with information that could be used in deliberating the DM, consistent with calls for conducting ex ante research. Two major issues, when to consolidate and how to consolidate, are considered. Our analysis is guided by the criteria set by the board for deciding whether to add a project to its agenda (persuasiveness, alternative solutions, technical feasibility, and practical consequences). Based on a review of the literature and empirical data analysis, we reached two conclusions. First, the board's concern over whether to change the criteria for when to consolidate from majority ownership to economic control does not appear to be persuasive. Nonetheless, the board still may be intent on changing the rules, if only to become more compatible with international standards. If the FASB chooses to move toward economic control, we urge that its learns from history. Like SFAS 94, the change from majority ownership to economic control is likely to increase the number of companies that are included in consolidation, which, by definition, results in a loss in information. When SFAS 94 was implemented, no changes were made to provide users of financial statements with enhanced disaggregated disclosure, although disclosures made prior to SFAS 94 were continued. We recommend that the board not proceed with another standard that results in increased aggregation (i. e., consolidation of more companies) without also providing at the same time more useful disaggregated disclosure. Second, the issue of how to consolidate, which is a choice from among three competing theories (parent company, economic unit [which itself has two forms], and proportionate consolidation), also is not persuasive. Furthermore, our empirical analysis shows that changing practice from the commonly used method (parent company) would not dramatically alter current reporting. Thus, we recommend that the Board not proceed further on this issue. Volume 8, 1994, pgs. 111-134.

Commentary on "Consolidation Policies and Procedures Discussion Memorandum: An Examination of the Potential Impact on Reporting Quality"

 Paul Pacter

…Are the authors correct in contending that users will be worse off with revised consolidation policies and procedures due to “a loss of information for users such as analysts”? The accounting alternatives to consolidation are equity method or cost method. Either way, the investee shows up as one line on the balance sheet and one line on the income statement. Consolidation replaces that one line with a spreading of investee amounts among all the lines in the financial statements on grounds that the investor’s management controls the investee assets, liabilities, and operations. Is this the loss of information the authors fear—trading one line for spreading? Or is it the loss of supplemental disclosure of separate financial data for the unconsolidated investees that they fear will hurt analysts? Supplemental disclosures can accompany consolidated financial statements just as they can accompany the equity or cost methods.

Moreover, the flip side should not be ignored—that consolidation can add important information, for example, by putting “off-balance sheet” financing onto the balance sheet or by enhancing the ability to compute an appropriate return on assetsVolume 8, 1994, pgs. 135-140.

The Accounting Thoughts of Newman T. Halvorson

Robert Bloom, Marilynn Collins, and Jayne Fuglister

Halvorson exercised considerable influence in accounting standard setting. This paper deals with his philosophy of accounting and examines his views on the pronouncements he played a role in formulating or disapproving. While he stressed the importance of verifiability in financial reports, he observed the need for flexible accounting standards to allow accountants and auditors professional judgment in their applications. Volume 8, 1994, pgs. 141-160.

Agency Cost Explanations for the Demand for
Differentiated Monitoring Activity

Michael T. Dugan and Cindy D. Edmunds

Researchers investigating hypothesized relationships between agency costs and differentiated monitoring activities (e. g., presence of an audit committee) have reported conflicting findings (e.g., Francis and Wilson, 1988). This paper examines evidence that studies using post 1970 data may have been affected by non-agency regulatory and legal influence factors. These potentially confounding variables may have contributed to the inconsistent findings reported in these studies. Pre-1971 data were gathered from COMPUSTAT tapes, Disclosure Incorporated's proxy statements, and surveys in the effort to minimize the effects of regulatory and legal influence. The final sample consisted of financial data from 1970 fiscal years of 284 New York Stock Exchange firms. Four agency cost proxies were found to be associated with the voluntary operation of an audit committee of the board of directors. These proxies include: (1) level of manager ownership, (2) presence of an accounting-based incentive compensation plan, (3) financial leverage, and (4) firm size. Two other variables, entrenchment and diffusion, were not found to be significant. Entrenchment theory suggest that the risk and reward structures associated with some levels of manager ownership are insufficient to encourage optimal performance. Diffusion refers to the motive for opportunistic activity that arises when ownership becomes so widely dispersed that it reduces the likelihood of management displacement. A review of recent research indicates that these two variables are rarely found to be significant even whether agency proxies in the same model are significant. Accordingly, the findings as a whole call to question the validity of these two variables as agency cost proxies. When the impact of entrenchment and diffusion is placed in such a perspective, the data provides strong support for the theory that the level of monitoring activity is affected by agency costs. To the extend that the findings of this study provide the conclusive evidence of agency theory explanations for differentiated monitoring activity, future research should investigate the cost-benefit relationships associated with existing requirements for audit committees in order to improve accounting policy research. Volume 8, 1994, pgs. 161-189.

Slaying the Sacred Cow:
Ridding Ourselves of Conservatism

Donald R. Nichols and Larry M. Parker

The purpose of this study was to investigate the meaning and usefulness of the concept of conservatism from review of the official and quasi-official literature prescribing or describing generally accepted accounting principles. The definitions and descriptions varied considerably from source to source and were not easily interpreted. Statements of Financial Accounting Concepts (SFACs) contain a particularly obtuse discussion of the concept of conservatism. The auditors conclude the meaning of conservatism cannot be determined. Furthermore, the SFACs contain a loss recognition principle and other concepts which supplant conservatism as a basis for analyzing current issues involving uncertainty of recovery carrying value. Consequently, the authors determined that the concept of conservatism is not useful, and should be eliminated from accounting theory. Volume 8, 1994, pgs. 193-205.

Regulatory Barriers to a Financial Innovation:
Single Stock Mutual Funds and Some Related Disclosure Issues

Arthur J. Wilson and Stephen J. Young

We examine trading costs for individual investors and propose a financial innovation that may be able to significantly reduce those costs. That innovation, single-stock funds, is effectively prohibited by the Revenue Act of 1936. After considering some reasons for this prohibition and relating later changes in the market conditions, we argue that the Act be revised to allow this innovation. In addition, some suggestions for investor friendly financial disclosures are also sketched out. Volume 8, 1994, pgs. 207-226.

The Future of Financial Reporting

Edmund L. Jenkins

In November 1993 the initial published report of the AICPA Special Committee on Financial Reporting's Study of the Information Needs of Today's Users of Financial Reporting was published. On February 19, 1993, Edmund L. Jenkins, chairman of the Committee and a partner in the national office of Arthur Anderson & Co., presented the following remarks at Case Western Reserve University about the status of the committee's work at the start of 1993:

  1. the reasons for criticisms of financial reporting
  2. thoughts on how financial reporting might change in the future
  3. AICPA special committee on financial reporting

    Volume 8, 1994, pgs. 227-238.

The Noblesse Oblige of Accounting

Gehard G. Mueller

The discipline of accounting has a broader social consequence that is readily acknowledged in public circles. Our discipline is sustained by its ability to adapt and remain useful. In this sense it fulfills its moral imperative to serve society, its "noblesse oblige." In Spain, over the last two centuries, the progress in education for commerce is best understood in terms of the context of the founding of the Bilbao School of Commerce in 1818. Just as education has moved from technical to professional over time, developments in accounting have also transpired. Accounting has developed from a skill to an increasingly independent intellectual discipline, a vibrant field which serves as a store of human knowledge. The author provides two sets of propositions to detail the manner in which our discipline responds in its role to adapt and to serve, including the monographic growth of accounting professionals, the sophistication of valuation and reporting, and the movement from rote action based on individual judgment to complex theories, developed and shared and debated as part of a common body of knowledge. Today, accounting continues to adapt, to become more operations oriented and more future oriented while facing still other new environmental influences and addressing relative cultural interfaces which affect its disciplinary role and its human agents. Volume 8, 1994, pgs. 239-256.