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Volume 01

The Economic Role of the Audit in Free and Regulated Markets: A Review

Wanda A. Wallace

Since 1980, research has enhanced our understanding of the economic role of the audit in free and regulated markets. This paper discusses how this research ties into key sources of demand for the audit, supply issues, and regulatory activities. In addition, changes in the audit environment and cost function faced by the CPAs and auditees alike are described. Implications of recent research are summarized and suggestions for future research are provided. Volume 1, 1987, pgs. 7-34..

Recent Episodes in the "Oversight Cycle" of Accountancy Self-Regulation

Joanne H. Turner and Daniel L. Jensen

Recent changes in the self-regulation of accountants, including the Division for CPA firms within the AICPA, coincide with increased public pressure on the profession, including Congressional investigatory hearings in both the 1970s and 1980s. However, these two initiatives are more than coincidental. Rather, the path of professional self-regulation in accounting is seen as a response to external forces. These forces appear predictable, if not with respect to the time at which they are active, then at least with respect to the direction in which they are moving the accounting profession. However, clear predictions of the future course of professional self-regulation cannot be made until the institutional interactions and relationships within the regulatory process are more fully understood. Volume 1, 1987, pgs. 35-50.

Common Law Accounting: The Case of Goodwill

Orace Johnson

This study is both conceptual and historical with regard to two institutional systems in the United States for reaching social consensus on accounting standards - the political alternative of statute law passed by Congress, and the judicial alternative of common law adjudicated by the court. Through a strict construction of the United States Constitution, the hypothesis is deduced that common law is more effective and more efficient than statute law for resolving issues of accounting as a language. The null hypothesis is that there is no efficiency difference between the two institutions. From current accounting textbooks as a consensus core of 16 elements in accounting for goodwill is uncovered and assumed to be generally accepted current accounting practice. These consensus elements are then traced back to their separate origins under either common law adjudication before 1933 or statue law legislation after 1933. Goodwill accounting thus becomes a metric for "measuring" the relative efficiency of common law and statute law. Since 15 of the 16 elements were formed under common law and not reversed under statute law, the hypothesis of no difference between the two institutions is rejected. The alternative hypothesis, relative effectiveness and efficiency of common law, is conditionally accepted. The conclusion is that more attention should be given (in textbooks, in research, and in the FASB pronouncements) to the common law origins of current accounting standards. We should not ignore the judicial alternative for social control of accounting as a language. Volume 1, 1987, pgs. 51-77.

SEC Accounting-Related Enforcement Actions 1934-1985: A Summary

Walter K. Kunitake

This paper outlines the SEC enforcement activity brought against independent auditors and the CPA firms as documented in the 1934-1985 Accounting Series Releases and Accounting and Auditing Enforcement Releases under Rules of Practice 2(e). One hundred and sixteen releases documented the investigation of 130 CPAs and 47 CPA firms. Approximately 50 percent of the CPAs either resigned from practice at a Commission hearing or received permanent suspensions; another 37 percent received temporary suspensions of 30 days to 18 months. Other CPAs received censure, agreed to engage in continuing education programs or received no sanction. Approximately 15 percent of the firms were either permanently suspended or dissolved. About 40 percent received temporary suspensions by accepting new SEC audit clients for a stated time; and about 28 percent of the firms that were cited received censure. Since 1973, the SEC has emphasized the firm's role to expand upon the peer review process. Volume 1, 1987, pgs. 79-87.

An Analysis of Ernst & Ernst V. Hochfelder: Legal and Market Effects A Decade Later

Kent St. Pierre and James M. Reeve

Ernst & Ernst v. Hochfelder was considered a landmark legal decision for the accounting profession. The Supreme Court's interpretation of the level of wrongdoing necessary for filing an action under Section 10b-5 of the Securities Exchange Act of 1934 was critical to the profession due to the number of suits filed against accountants under this rule. Unfortunately, several important legal and regulatory issues were not addressed by the court in the decision. This paper attempts to (1) summarize the initial controversies surrounding the Hochfelder case, (2) analyze where the controversies stand ten years after the decision, and (3) examine the effects of Hochfelder from both a legal and information market perspective. The conclusions reached with regards to points (1) and (2), emphasize that an allegation of simple negligence is no longer adequate to bring an action under 10b-5. It now appears that "scienter" must be proven for a 10b-5 filing. Securities and Exchange Commission (SEC) injuctions against the accountant must also be based on "scienter," although the courts have not been as clear on what is included in the definition for SEC actions. The potential information effects for the market from the legal discovery process (point 3) have been previously ignored in the accounting and legal literature. This issue is addressed in regard to the damages that could occur to an auditing firms' reputation and credibility regardless of the court's finding. Volume 1, 1987, pgs. 89-101.

Self-Regulation, Public Interest and the Accounting Profession

Ted O'Leary and Richard J. Boland, Jr.

This paper begins with a review of some of the major features of the period 1890-1920 as they affected the formation of the accounting profession in the United States. We argue that the development of accountancy was altered by two features of this period: the rise of professionalism and the need to create new forms of trust in the economic institutions. We also argue that accounting emerged at this time as a professional form of social regulation. The profession of accounting was imposed on corporations and municipalities as a promise to restore order and provide a new basis for the trust in economic transactions that had been shattered by the rapid industrialization and urbanization of the period. These positive, trust-based and inherently regulatory roots of the accounting profession are then contrasted to the way the profession views its relation to economic and professional regulatory processes today. We argue that the profession has, since the turn of the century, altered its self image and its vocabulary of official disclosure to dilute its positive, regulatory role, and, as a result, to threaten the very basis for its present institutionalized status. The concepts of public interest and self-regulation, as revealed in our present day professional discourse and the Anderson Committee's attempt to restructure the profession's code of ethics and standards of performance, are used as examples to demonstrate how the profession has redefined itself from an active agent of societal regulation into a more passive element in a system that displays market efficiency. This analysis draws attention to the fact that our understanding of the ethical nature of a profession and its responsibilities are far from immutable, and, in the case of accountancy, have been radically transformed since the turn of the century. Volume 1, 1987, pgs. 103-121.

Accounting Regulation-Based Expert Systems

Daniel E.O'Leary

Expert systems are being used to solve accounting regulation problems. The tasks performed by these systems include developing financial statements, examining proxy statement information as in EDGAR (Electronic Data Gathering Analysis and Reporting), developing financial ratios from EDGAR and assisting in the computation of the provision for income tax for financial reporting. This paper discusses those systems and some extensions to those systems as well as some of the advantages and limitations of expert systems in accounting regulation. Volume 1, 1987, pgs. 123-137.

The Expectations Gap: An Added Dimension-The Case of Governmental Auditing

Richard E. Brown

In March 1986, the U.S. General Accounting Office (GAO) released a study, CPA Audit Quality: Many Governmental Audits Do Not Comply With Professional Standards, the last in a series of such reviews spanning nearly two decades, all quite critical of the governmental audit work conducted by the accounting profession. The latest GAO report is different from many of its predecessors in two important respects: first, by using widely accepted sampling techniques which include large and small CPA firms, in many regions of the nation; the current study counters earlier charges by profession that the GAO's previous reports and critical findings were "unrepresentative"; second, the report, definitive in nature, comes at a time when the accounting profession has been criticized for commercial sector audit deficiencies. The paper addresses three main issues: the validity of the GAO's findings and their degree of acceptance by the accounting profession; responses to the GAO-alleged deficiencies and attempts by the profession to correct them the implications of the above for self-regulation of the accounting profession. The author concludes that the case made regarding substandard governmental audit work by CPAs in the current GAO report, and in earlier GAO reviews, is difficult to refute and is agreed to by key representatives of the profession. The response to date by the profession, while commendable in many respects, has been slow in developing, partial, and still uncertain in outcome. Finally, while it is by no means certain that regulation of the accounting profession is really designed to be self-regulation, as is so often assumed, the continuation in the current regulatory mode of the profession's peer regulation with government oversight very much depends upon the profession's willingness and ability to take decisive and publicized disciplinary actions against recalcitrant members who do not comply with professional standards for governmental audits. Volume 1, 1987, pgs. 139-164.

The SEC and the Profession: An exercise in Balance

Robert J. Sack

What I would like to do is to give you my perspective on the role of the SEC in the regulation of the accounting profession. Please understand my stress on that qualifying phrase "my perspective." The standard disclaimer I am obligated to give you as a matter of SEC policy absolves the Commission and all my friends on the staff on the SEC from any responsibility for the views I may express here. But I want to go beyond that disclaimer: for the moment I would like to step out of my role in the Enforcement Division at the SEC and share with you my personal perspectives on this matter. Volume 1, 1987, pgs. 167-175.

Informing Stockholders:
A Job for Public Accountants in Preference to the Federal Trade Commission

Alexander S. Banks

(This letter originally appeared in the New York Herald Tribune, November 4,1925 and was reprinted in the Certified Public Accountant, January 1926.Banks was a former President of the American Society of CPAs which was later merged into the American Institute of CPAs)

Professor W.Z. Ripley of Harvard University suggested last week at the annual meeting of the Academy of Political Science an enlargement of the scope of the Federal Trade Commission to protect the millions of investors who, he said, were helpless at the present time.

...No Federal commission would, in my opinion, be able to judge in each particular case what information should not, be made public. After all, too much information furnished for the benefit of particular stockholders may actually do them more harm than good, ... Volume 1, 1987, pgs. 177-179.

Sec Enforcement of Insider Trading Laws

David W. Burchmore

The recent spectacular developments in the case involving arbitrager Ivan Boesky are only the latest in an excalating series of actions taken by the Securities and Exchange Commission (SEC) to curb the practice of insider trading in the past few years. The SEC's campaign against insider trading can largely be attributed to a personal crusade by its former Chairman, John R. Shad.

                                                   I.    Shad's Crusade
                                                   II.    Detection of Insider Trading
                                                   III.    International Enforcement Problems

  Volume 1, 1987, pgs. 181-189.

A Selected Glossary of Securities Offering 
and SEC Accounting Terms

J.W. Martin

The study of the Securities and Exchange Commission has been impaired by esoteric terminology. Over several years of following SEC accounting developments, the author has collected many definitions of the terms that relate to the SEC or security offerings. The list below includes over 200 brief definitions that should prove useful to SEC researchers.

The glossary is intended as a quick reference source. Common accounting terms have been excluded because students can easily refer to the many excellent reference sources that discuss these terms. While the definitions are not exhaustive, they should prove useful, especially to students, by allowing one to quickly grasp the essence of the term. Toward this end, legalistic phrases have been avoided, where possible, in the hope of clarifying the word. Volume 1, 1987, pgs. 191-224.