Mapping GAAP’s Route

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JULY 2005 - For Mother’s Day this year, my wife wanted to see the documentary “Enron: The Smartest Guys in the Room.” We came into the Jacob Burns Theater in Pleasantville, New York, just as the film began, and I became immediately engaged because Enron’s story began with the Valhalla Oil scandals of 1986. Not the Valhalla of Norse mythology, but Valhalla, New York, a small community nestled between White Plains, where we live, and Pleasantville, where we were viewing the movie. Newspaper headlines of the guilty verdicts flashing across the screen, superimposed over the front of the familiar federal courthouse in White Plains, brought the whole experience chillingly close to home. Another series of scenes underscored for me the fundamental problem of current financial accounting principles.

Mark to Market

The audience in the movie theater that afternoon reacted to some parts of the film with groans, snickers, and laughter, but two related scenes created buzz and outrage. Every accountant should take to heart the scenes where Enron’s management announces to its assembled employees that the SEC had granted the company the right to account for trades at “mark to market.” The employees erupted in cheers and danced on their chairs, and management stood before them beaming, arms around each other, all evocative of a New Year’s Eve gala. The next scene is a clip from a video produced by Enron, with Jeff Skilling playing himself in what was probably intended to be funny but what was in fact chillingly predictive of the end game, explaining how “mark to market” would work to enrich Enron’s traders and management.

Of course, many of those individuals indeed become amazingly wealthy, but many more Enron employees, investors, and creditors lost substantial sums, including life savings and pensions, in what became one of the largest scandals in American business.

Even though then–FASB chair Ed Jenkins argued convincingly during Congressional hearings that GAAP had not contributed to the accounting problems at Enron, the shifting paradigm in accounting principles from an accountability model to a valuation model created an environment for “creative accounting” that had not existed since before World War II. The glee with which Enron’s employees embraced mark-to-market accounting brought home to me the fact that individual financial accounting standards have increasingly reflected a fairly narrow orientation toward asset and liability valuation.

Measurement and Behavior

Economically rational managers will generally pay close attention to what is being measured. If asset and liability values are the focus of recognition and measurement, then most managers will spend their time and efforts making sure that their reported measurements reflect positively on their behavior, because their personal economic success depends on it. Indeed, such a focus is probably appropriate in companies whose business consists of trading financing instruments. On the other hand, such an orientation for companies whose primary business is producing or delivering goods and services may not motivate attention in the right direction.

The painful irony of the Enron documentary, however, is the cautionary reminder it provides that accounting should be more fundamentally about accountability than about valuation. Without regard to the type or size of entity, virtually all external constituents have as a primary purpose restraining insiders from transferring unearned or unauthorized value to themselves at the expense of less powerful outsiders. It’s becoming increasingly difficult to demonstrate how the current trend in accounting standards supports this purpose.


David Solomons, a moving force behind FASB Concept Statement 2, Qualitative Characteristics of Accounting Information, reminded us as frequently as possible that relevance and reliability were necessary but not sufficient conditions for data to be useful because “it could be unrelated to use at hand.” Solomons was also fond of comparing accountancy to cartography, the science and art of mapmaking. Cartographers have no difficulty reconciling their representations of different facts in different ways. They match the scale of a map to its purpose, and an individual map represents only a selection of what it could, because showing political divisions, terrains, agriculture, minerals, ethnicity, and wealth distribution all on the same map would make it unintelligible.

Contemporary accounting standards should address (at least) two maps in GAAP. The first, accountability, would be useful for virtually all entities. The second, valuation, would possibly be useful in situations where an entity’s equity is continuously traded. Our current problem is that accountability has been neglected for 25 years or more, and those that prefer its neglect dismiss it as irrelevant to valuation. They’re wrong.

Robert H. Colson, PhD, CPA




















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