| Mapping
GAAP’s Route
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.
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
Editor-in-Chief
rhcolson@nysscpa.org
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