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The last two days have been busy, fielding calls from reporters.  One called asking my thoughts on convergence, the other asked about my thoughts on whether accounting can forestall the next financial crisis.

Long time readers know what I said.

Convergence of accounting standards is a bad idea.  The academic theory is that market participants benefit from detailed information tailored to that specific market.  Given that capital markets are local (but are linked around the world) it makes sense that local accounting standards (that force companies to disclose as much detail as possible) would provide the greatest value.

What is the impact of accounting rules and auditors on the next financial crisis?  Because auditors don’t do the job that investors wish they would do, the accounting rules hardly matter.  The academic theory is that if companies are not required to secure an audit opinion, then the act of hiring an auditor signals a company’s intention to obey the accounting rules.  However, if companies are required by law to secure an audit opinion, there is no theory that these audits provide value.  There is a theory paying more signals intent to follow the accounting rules, but then paying more might mean that the company wants to get away with more.  Therefore we are in uncharted waters.  There is no theory to suggest that audit opinions will be trustworthy.  If audit opinions aren’t trustworthy, then there is no effective check on the numbers reported by companies in their financial statemeents.

The two work together.  If converged accounting standards are company friendly, and auditors are paid to be company friendly, then it is likely that accounting and auditors will not delay, by even a day, the next financial crisis.

I hope the reporters heard my message.

Debit and credit – – David Albrecht

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The annual conference of the Ohio Region of the American Accounting Association is hosting a debate between Francine McKenna (journalist/commentator on the audit industry) and Andy Bailey (Grant Thornton).  It is scheduled for Friday, May 13, 2011, in Dublin (Columbus), Ohio.  Conference registration is $180 on site.

The topic of the debate is, “An Examination of the Audit Business Model.  Presumably, McKenna will talk about the flaws in the current audit model and the many problems that result, and Bailey will talk about the importance of the model and how audit forms function smoothly and effectively.

4:30 PM – 5:45 PM Concurrent Session
Panel 5 – An Examination of the Audit Business Model
A critical examination of the function of the public accounting based audit model.

Francine McKenna, Litigation Consultant
Andy Bailey, Grant Thornton

As my readers know, I have been studying this topic for 25 years.  There is no theory in the accounting field that predicts that audits and auditors will serve the public interest IF companies are required to secure audits (whether they want them or not), are free to select the auditor they want, pay them for their opinion, and audit firms are large, can restrict competition and shareholder litigation.

Many industry observers have noticed the many instances when audit firms did not act in the public interest, and are asking what can be done to fix the audit model.  My response is that a new audit model needs to be developed.

But what will McKenna and Bailey say?  Presumably McKenna will say that the current model is seriously flawed (if not fatally), and has resulted in the current environment of auditors not serving the public interest.  Presumably Bailey will say that all is well in the auditing world, but can be even better if a few small tweaks are made.

I’ll be there, hanging on every word.  I hope to see you all there.


Francine McKenna

Francine McKenna is a freelance writer with credits in the Financial Times, Accountancy Age, Accountancy Magazine, the FEI Blog, and various financial, media, and technology blogs. She also blogs at Forbes.com under the heading “Accounting Watchdog.” Her blog is occasionally reposted at the The Huffington Post and she had a weekly column at GoingConcern.com

Ms. McKenna has more than twenty-five years of experience in a range of industries in the consulting and professional services environment. McKenna directed the Y2K PMO for JP Morgan in Latin America and was the first female Managing Director for BearingPoint in Latin America, responsible for the Industrial, Automotive and Transportation practice. She was a RVP for Jefferson Wells/Manpower and a Director for PricewaterhouseCoopers LLC, auditing the PwC the firm itself. She held various positions in accounting and financial management prior to her career in professional

Ms. McKenna was recently named a finalist for the Gerald Loeb Award for Distinguished Financial and Business Journalism in the online commentary and blogging category.

Francine has been quoted in the New York Times, Wall Street Journal, Chicago Tribune, Financial Times, Forbes, BusinessWeek, The Deal, The Times of London, the Guardian, and the Financial Chronicle (India) amongst many others. She has been profiled by accounting and social marketing/media sites. Her public speaking credits include private training, university teaching, and speeches for the Institute of Internal Auditors, the Information Systems Audit and Control Association, and the Maryland Association of CPAs.


Andrew Bailey

Andrew D. Bailey was appointed Senior Policy Advisor to the Grant Thornton National Public Policy and Strategy Group in September 2006.

From January 2004 to December 2005, Dr. Bailey was a Senior Officer of the United States Securities and Exchange Commission (SEC), serving as the Deputy Chief Accountant in the Commission’s Office of the Chief Accountant. In this capacity, Dr. Bailey managed the day-to-day operations of the office, overseeing the accounting aspects of the resolution of registrant issues, rulemaking projects and private sector standard-setting efforts. Earlier, from August 2000 to July 2001, Dr. Bailey had served as an Academic Accounting Fellow in the SEC Office of the Chief Accountant.

Professor Bailey spent a long and distinguished career in academia, with numerous visiting professorships abroad, and culminating with his being named Emeritus Professor of Accountancy at the University of Illinois at Urbana-Champaign.

Debit and credit – – David Albrecht

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Audit Credibility

Credibility is based on trust

Bob Jensen poses a question on AECM (listserv for accounting professors), “Credibility? Do credible CPA audit firms add benefits to clients that exceed the audit costs?”

It’s an interesting question, I suppose, to narcissists (Big 4 auditors, government regulators and accounting professors) who believe that the world revolves around the audit function.  It isn’t a question that floats my boat, for I’m concerned with a different question, “Credibility?  Do credible CPA audit firms add net benefits to investors?”

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Senator Joe Lieberman has announced his plans not to seek re-election.  This means that January 3, 2013 will be his last day to serve as the 112th Congress is replaced by the 113th.  Gail Collins, Op-Ed columnist for the New York Times is thrilled, announcing tongue-in-cheek plans for a new book, “Everything Bad Is Joe Lieberman’s Fault.”

Floyd Norris

Piling on, respected New York Times business columnist Floyd Norris suggests that Collins include a chapter on Joe Lieberman’s opposition to an accounting rule on executive stock options.  Norris says that not having a rule to expense executive stock options caused the stock market bubble of the late 1990s.  Floyd, I love you, but you should check with me before you write your next piece on accounting.

Surely Lieberman was promoting his personal interests in fighting the rule, and had no altruistic purpose in mind such as improving the world of accounting.  However, he was correct on this one issue.

Adding the value of executive stock options as an expense on the income statement was a bad idea in the 1990s when Lieberman fought it, it was still a bad idea in 2005 when the FASB adopted it, and it will continue to be a bad idea for as long as the rule is on the books.

Here’s why Norris and the FASB are wrong about expensing stock options.  Traditionally, the income statement has been reserved for (1) the value received from selling products and services, and (2) the money spent (costs) to generate these revenues.  An executive stock option causes no money to be spent by the company.  It is merely a vehicle to increase (potentially) the wealth of the receiving executive by a grant of ownership from the company’s owners.  The current owners take a hit, but that hit has nothing to do with the profit from company operations.  No money is being spent by the company on the executives, and no money will ever be spent by the company on the executives.

The expensing rule is but one example of the the use of accounting rules to accomplish societal objectives.  When executives are granted stock options, the current group of stockholders have been robbed by the company’s board of directors, with the receiving executives as willing co-conspirators.  Crying foul, investors have looked for a way to curb this practice.  Their solution is to add a charge to current earnings, thereby making it more difficult for executives to qualify for their annual bonus.  Unfortunately, the only result accomplished is to diminish the importance of the income statement.

It would be so much more powerful to simply vote out the directors who voted in the executive stock option.  If a few boards were voted out because of granting these options, the practice would dry up in a hurry, I assure you.

Mr. Norris, thanks for writing about accounting.  This time, though, you got it wrong.

Debit and credit – – David Albrecht

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J. Edward Ketz is my round tuit.  ???  A round tuit is anything that unlocks your sense of inertia, allowing you to start working on some task that has been delayed far too long.

An example helps.  Have you, like me, ever been nailed for procrastinating?  All the time.  It probably followed this thought, “I’ll get a round tuit when there’s a free moment.”  But everything else doesn’t get done and there’s no free time, so you never get a round to it.

Ed is my round tuit.

On February 25, 2010, the Securities and Exchange Commission (SEC) released a formal Commission Statement in Support of Convergence and Global Accounting Standards.

I never got around to reacting.  Yesterday (March 29, 2010), Ed Ketz published his reaction, “The Iffiness of IFRS“.  It’s better than anything I can  write (anything Ed writes is always better than anything I can ever write, just take it for truth).  Better late than ever, here are my personal reactions.

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On February 25, 2010, the Securities and Exchange Commission (SEC) released a formal Commission Statement in Support of Convergence and Global Accounting Standards.

I never got around to reacting.  Today (March 29, 2010), Ed Ketz publishes his reaction, “The Iffiness of IFRS” at SmartPros.   It’s better than anything I can write (anything Ed writes is always going to be better than anything I can ever write, just take it for truth).  For those of you new to The Summa, Professor Ketz is a charter member of the group of IFRS critics.

For years, Ketz has railed (Merriam-Webster: to revile or scold in harsh, insolent, or abusive language) at the corporate practice of financial reporting.  He has repeatedly said that the number one problem is that corporations simply don’t follow the rules.  If ever they were all to be in a general state of compliance, then we could talk about about the structure of accounting standards.  But first, we need compliance.  Generally speaking, he favors specific accounting rules that permit no wiggle room.  Such rules make it easier to crack down on wrong-doers.

Professor Ketz’s latest editorial is “The Iffiness of IFRS.”  He responds to the SEC and suggests several issues that still need to be worked out before IFRS adoption.  Although the context for his remarks is opposing IFRS adoption, he believes the biggest problem with the proposed transition is:

… whether IFRS statements can be audited and what will happen in the courtroom after a firm experiences severe declines in its stock price.

Ketz concludes with:

… I again marvel at the rush to IFRS. The benefits do not appear to match or exceed the costs of the adoption.

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Over on AECM, good friend Bob Jensen has written a letter seemingly addressed to me.  I’m posting it, then replying to it.

This is my reply to somebody on the AECM who is becoming increasingly cynical about our profession in the wake of the Lehman Report.

Dear XXXXX

As with most things in life, especially in accounting, law, medicine, politics, and war, it’s easily to get discouraged and even cynical because of all the bad things that are in the media.

However, all of our academic background has convinced us to balance everything. In virtually every instance we must balance the bad things with the countless good things that counterbalance the bad. For example, Sarbox has failed us in the publicized articles, but the countless successes of Sarbox just don’t get balanced in the media. The bad is seldom counterbalanced by the good in the media, including our listserv messaging.

The thing to pass on to students is to build on the bad and not get buried under it.

There is one writer in accounting and finance, Prem Sikka, that particularly gets my goat in his published Guardian articles, because he is always one sided. I often learn things from his articles and sometimes pass them along in my tidbits, but just once I would like to hear him say one thing positive about the auditing profession, banking, business, capitalism, and politics.

I write a lot of negative things, but if you carefully examine all of my writings you will find what I hope is more academic counterbalancing (http://www.trinity.edu/rjensen/threads.htm).  I even, with great effort and a clothes pin on my nose, write some positive tidbits about accountics.

We must agree to disagree but not always disagree in the academy.

If we become too one-sided in the academy, it’s a big turn off for students and colleagues.
I once had a colleague in the political science department who was known for constantly bashing multinational corporations. My students who took his courses hammered him in course evaluations for preaching rather than ing. The university tired of his rants and persuaded him to retire early.

Bob Jensen

Now, for my response.

Bob,

I’ll probably get over my “cynical stage.”  However, I’m asking these questions in good faith. I’m searching for answers.  In this day and age, of what value are financial statements? audits? regulation?

To be sure, events over the past few years have injured my belief and confidence in the system.

We know that there’s financial statement manipulation going on, lots of it.   We know that there are unrecorded assets and liabilities that GAAP and IFRS don’t address, and valuation bases in the standards are inconsistent.  Audit firms act like they can be bought.  SEC regulators have so little respect for accounting that it’s delegating the task of standard setting to people from around the world with no interest in making the U.S. system of capital markets the best it can be.

There’s a lot here to get discouraged about.  I think accounting can matter.  Perhaps it did in the past.  But does it matter in 2010?

Is financial reporting robust enough that none of these problems matter? As long as financial statements show the general flow of corporate performance is that enough?

Or is it, as a few have suggested, a ponzi scheme? There’s a rising value to stock markets as long as new money keeps coming in. Because humans are industrious and make progress, there’s always going to be new money (new money = human advancement).   Current investors will be able to cash out as long as new investors keep coming in.   Because of human-kind’s progress, future cash flow seems assured.

Is that all there is?  Will the system keep working no matter how high a charge is exacted by the system’s leeches?

I’m still teaching financial statements. It’s my job and society still deems it important enough that people are paid pretty well to do it.  And I”m still commenting on the system.

I’ve gone down this path of criticism because there are questions I simply can’t figure out the answer to.

If you think I’ve done too much rocking in the boat, then I must consider that I might have.

From this day on I’ll resume looking for answers.  It is tough, given that the SEC and the Big 4 are deaf to suggestions for improvement in standard setting.  I mean, what good ever came about from our calls not to move to a single set of global accounting standards.  However, I’ll try to be more positive.

Debit and credit – – David Albrecht

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It is said frequently by politicians, SEC and other regulators, journalists and special interests that the accounting standard setting process should and must be insulated from politics.  As I explain in this essay, this runs counter to everything we understand about accounting theory.  For decades it has been taught in every graduate accounting program in the country that accounting standards have economic consequences.  As a result, I contend it is natural and predictable that competing economic interest attempt a political solution to proposed accounting standards.

This is an important issue at this time, because they are proposing major changes in the accounting regulatory landscape that run counter to this conventional wisdom of the financial reporting and capital market world.

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