How to Meet the Challenges of Relevance and Regulation
by Eugene H. Flegm
by JAI (Elsevier), 2004; ISBN: 0-7623-1078-2
pages; $95 (hardcover)
by Robert H. Colson
- 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.
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.
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.
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.
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?”
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.
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
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).
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.
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.