Accounting: How to Meet the Challenges of Relevance and Regulation

Edited by Eugene H. Flegm
Published by JAI (Elsevier), 2004; ISBN: 0-7623-1078-2
314 pages; $95 (hardcover)

Reviewed by Robert H. Colson

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OCTOBER 2005 - In 1984, when this book was first published, it was a challenge to the new mark-to-market approach that accounting standards setters were using. Its republication in 2004 with a new foreword comes at a particularly auspicious time, because FASB and IASB are embarking on revisions to their conceptual frameworks and considering whether their standards adequately address all entities to which they currently apply.

The 1970s’ accounting environment differed significantly from today’s. Then, there was mostly an income statement–oriented, revenue-recognition, and expense-matching approach to accounting. The balance sheet was viewed as a residual of costs, sometimes adjusted for net realizable value, but the focus was on the income statement.

Two events changed the perspective of many accounting thought-leaders, and by the late 1970s many were clamoring for various types of current value accounting. The first event was the hyperinflation during the middle part of the decade. The business community was concerned that capital was being taxed because replacement costs were escalating so rapidly, and the accounting and regulatory communities were concerned about the relevance of reported numbers. Even the SEC, which had held vigorously to historical transaction cost as the measurement standard, initiated replacement-cost disclosure for fixed assets and reserve-recognition accounting for oil and gas, both significant departures from historical cost accounting.

The second event was the savings-and-loan crisis. Many thrift institutions held real-estate investment portfolios at cost when their market values dropped significantly. FASB attempted to apply lower-of-cost-or-market standards to those portfolios, only to lose in a heated debate with savings-and-loan industry lobbyists in Washington. Eventually, the American taxpayer had to bail out the failed savings-and-loan institutions.

These events were paramount in the minds of accounting thought-leaders as FASB adopted the conceptual framework that would guide how it set future standards. The debate in academia over fair value or historical cost was especially interesting and sometimes rancorous. The events of the times even had the “father” of historical cost accounting second-guessing his role: Bill Paton, who along with A.C. Littleton had written the 1940 monograph that became the basis for modern historical transaction cost accounting, told me in 1981, “I was always a value man. Look at all my writings before A.C. talked me into that monograph. Why did I let him do that?”

Paton also debated privately and publicly with Bob Mautz about the continuing suitability of the historical cost model. At the time, Mautz, whose career included a distinguished professorship at the University of Illinois and an equally distinguished partnership in Ernst & Ernst, was the director of the Paton Center for Accounting Research. Mautz was also retained by General Motors in the early 1980s to monitor and influence FASB members in their deliberation on the conceptual framework. Mautz was particularly concerned about the impending change to an asset-and-liability recognition and measurement approach and about accounting for not-for-profit organizations in the same way as profit-seeking businesses. He expressed his concerns in terms of the traditional stewardship role of accounting.

It was in the aftermath of what had been essentially a losing battle for his point of view that Flegm originally published his book in 1984. He presented an interesting and illuminating history of the development of accounting thought and its relationship to the times. Flegm’s work represented the counterargument about whether accounting was primarily about the value of the entity or the performance of management. When the accounting world had shifted to the viewpoint that accounting was mostly about entity value, Flegm’s book made the case for accountability and stewardship. Most important, Flegm made a case for the role of accounting professionals both in business and in public accounting and for the importance of their roles in assuring an investing public of the integrity of the managements of organizations they fund.

The book’s new foreword, “Relevance, Reliability and Top Management Fraud,” integrates the core of his 1984 argument with the recent financial scandals. When reading the foreword and delving into the substance of the original work, a sense of timelessness is clear. The practical outcome of the century-long debate over whether to organize financial reporting around value in use or value in exchange has always depended on good-faith efforts to solve the most proximate crisis. We can too easily go to extremes, pursuing value in use to the exclusion of value in exchange (as was probably the case by the 1970s) or the other way around (as is likely the case now).

Flegm spent much of his career at General Motors, as the executive responsible for financial reporting and other accounting functions. When I first met him in the early 1980s, his high sense of professionalism and ethics impressed me profoundly. The high value he places on professionalism and ethics comes through very clearly in his book, and it is an important message for every businessperson. Accountants, business leaders, government regulators, and standards setters would all be wise to read and digest Gene’s thesis. It will help them immensely in dealing with the financial reporting challenges of the next quarter century.

Robert H. Colson, PhD, CPA, is a partner of Grant Thornton LLP. From June 2000 to August 2005, he was Editor-in-Chief of The CPA Journal.




















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