Accounting and the Continental Vending Decision
- Having been associated for over 40 years with the firm that
audited Continental Vending and being well-acquainted with
the three defendants, I read with great interest the article
“Principles-Based Accounting” by professors Ron
Mano, Matt Mouritsen, and Ryan Pace (February 2006 CPA
Journal). I would like expand upon and clarify the circumstances
of this unfortunate case and its implications.
article states that the auditors knew that Valley would
be unable to repay the receivable carried as an asset by
Continental Vending and that there was only a “relatively
obscure” footnote explaining the circumstances. In
fact, before signing off on the financial statements, the
auditors required the debtor to pledge collateral whose
value exceeded the carrying amount of the receivable. In
addition, the auditors continued to follow the value of
the collateral after their audit report was issued and withdrew
the report when the value of the collateral declined below
the carrying amount of the receivable.
is surprising for accounting professors to refer to footnotes
as “relatively obscure.” Furthermore, in this
case, the footnote was anything but obscure, because it
formed the basis for the jury’s decision. The jury
accepted carrying the receivable as an asset but thought
the footnote should have been more expansive. As the authors
point out, while the accounting experts thought the footnote
disclosures were adequate, the lay jury did not.
judge’s views on the case are also important. At the
sentencing (which I attended), the judge (applying his own
instructions to the jury) said he would have acquitted the
defendants if he had been the trier of the facts; that is,
if there had been no jury. He further stated that he did
not know why the government had brought the case and that
the matter of the extent of footnote disclosure (if thought
important enough) should have been dealt with by the SEC
issuing a pronouncement on the subject. The judge’s
views on the case were supported by New York State. After
a thorough investigation, the defendants retained their
CPA certificates because the state concluded they had done
last point regarding the authors’ conclusions. While
I am not a lawyer, it is my understanding that the decisions
of one circuit court are not binding on the others unless
the Supreme Court has affirmed the decision (the authors
are silent on this point). Thus, it may be that the decision
in this case is not binding in all 50 states, although courts
may certainly be influenced by the decision if they think
it is well-grounded, and auditors should certainly be mindful
sum up, the authors should be commended for reminding us
about the importance of the principle established by the
Continental Vending decision. However, to be fair
to the individuals involved, it should also be remembered
that many people, including the judge and New York State,
believe the case itself was wrongly decided.
J. Murray, CPA (Retired)
Note: The writer is a former member of the FASB
Emerging Issues Task Force (EITF) and Advisory Task Force
on the Consolidation Project, the International Accounting
Standards Committee (IASC), and the AICPA Accounting Standards
Executive Committee (AcSEC).
thank the letter writer for his amazing and insightful comments
regarding our article and the Continental Vending
case. They are extremely helpful in clarifying our understanding
of some additional issues relating to the case. We certainly
will remember these comments whenever we refer to the case
in the future.
Mano, Matt Mouritsen, and Ryan Pace
Weber State University
Messages About the Accounting Profession
Mary-Jo Kranacher’s April editorial (“Regulating
the Accounting Profession”) sends several mixed messages
that merit comment.
editorial first asks why accountants are allowed to practice
accounting without passing the CPA exam, observing that
there is no parallel in medicine or law. But “accountant”
covers a wide range of individuals, from clerical personnel
to true professionals, filling a range of societal needs.
We don’t have a similar situation in medicine or law;
there is no need for generic but unlicensed doctors or lawyers.
Accounting is more like engineering, where the term “engineer”
may signify a janitor (custodial engineer), construction
worker (operating engineer), or a licensed professional
editorial further states that the only function that distinguishes
a CPA from any other accountant is the ability to sign off
on a public audit report. But this is precisely the nature
of our licensing. While CPAs claim and indeed possess expertise
in many areas of accounting, auditing and attestation is
our one licensed function. Some years ago, during the consulting/“XYZ
credential” era, some wanted the initials CPA to mean
“certified professional adviser.” Maybe that
general idea is good, and we should emphasize ourselves
as “certified public auditors.”
the profession is attempting to narrow the gap, making it
easier to get a CPA by downgrading experience requirements.
The need for diverse audit and attestation experience is
questioned on the grounds that many (most?) CPAs do not
currently engage in such work. But won’t broadening
the experience requirement reduce the average qualifications,
skills, and experiences of CPAs, leading ultimately to diminished
prestige for the profession?
editorial further compares starting salary ranges for accountants,
attorneys, and physicians, suggesting that our field lags
behind. When starting salaries are related to post-baccalaureate
education—zero to one year for accountants, three
years for lawyers, and three years plus an internship and
residency for physicians—maybe the differentials are
the next paragraph bemoaned the cost of the extra year of
education, asking if it is any “wonder why we’re
having difficulty attracting the best and the brightest
to our profession?” Yet I see no shortage of lawyers,
despite the requirement of three years of post-baccalaureate
education. Nor would I suggest that most of those attracted
to medicine are not bright.
constant harping on not getting the best and brightest is
an insult to large numbers of our accounting graduates.
As a long-time faculty member, I’ve seen plenty of
very bright people enter the profession. But I also see
most of them leave public practice within five years. They
go from being totally focused on landing a Big Four position
to “I can’t wait to leave.” Our problem
is not in attracting the best and brightest, but
in keeping them. Why is the profession so unattractive
as a long-term career option? Interestingly, while the post-Enron
era has enhanced enrollments in accounting education, it
has also seemed to enhance departures from public practice,
especially within the partner ranks. Why do we have so much
movement out of the profession? Certainly there is great
demand for the skills and experiences gained during public
accounting employment—far more demand than exists
for the experiences of law or medical practice—but
it also strongly suggests that there is something about
the profession that is not very attractive.
the question will be whether accounting continues to merit
its status as a profession. One hallmark of a profession
is the existence of a body of technical knowledge that the
members of a profession have and laypeople don’t.
Virtually anyone can pursue an accounting degree, so the
technical expertise extends far beyond the ranks of licensed
professionals. Anyone can go to an office supply store and
buy considerable tax expertise in a $29 software package.
If licensed CPAs possess something that non-CPAs do not,
it is the great diversity of experiences that comes from
client service gained through public practice. Once again,
we should think carefully before we eliminate this distinction
by expanding the experience base for licensure.
J. Huefner, PhD, CPA
Distinguished Teaching Professor
State University of New York at Buffalo
Hopeful About the Profession’s Future
message of Editor-in-Chief Mary-Jo Kranacher’s May
editorial (“Litigation Risk Management: Has the CPA
Become the CYA?”) is right on target. Compounding
the problem is that the Big Four and other large firms are
quite comfortable, and more than adequately compensated,
by doing defensive work. “Verify but don’t be
creative” is their mantra. The notion of providing
value-added services is a low priority—if it is a
concern at all.
like to think that CPAs can once again become trusted professionals,
valued as a business resource, but I am not hopeful. Going
down such a path would be too risky. Institutionally, we
are evolving into something much less than what we once
were. The task of arresting the decline can be nothing short
of Herculean. Where is the leadership with the courage to
accomplish the task?
for speaking out. How refreshing!
V. Bencivenga, CPA
Bencivenga Ward & Co. CPAs, P.C.
Accounting: What’s So Fair?
read with interest the article “Fair-Value Accounting:
Analyzing the Changing Environment” (April 2006).
One area of the debate should receive close scrutiny: conservatism.
Historical-cost accounting is liberal with liabilities and
tight with assets. To that end, contingencies, probable
liabilities, and other “bad” things are measured,
recognized, and always disclosed.
accounting intentionally puts the onus on conservative measurement
so that the worst-possible scenario will be reported as
the financial position. Fair-value accounting allows managers
to present more “good” information to investors,
effectively ignoring the concept of conservatism.
transparency’s sake, investors who are interested
in the fair value of a company can use a cost-to-market
ratio and create their own fair-value report (basing it
on the investor’s own judgments). The management’s
financial report and its auditors should not be in a position
to decide about the fair-value judgment on behalf of the
Rechtman, CPA, CFE, CITP, CISM
New York, N.Y.
the concern that a shift toward fair-value accounting might
violate the accounting tenet of conservatism. In responding,
I would like to discuss three issues related to the reader’s
concerns: the relevance of historical-cost versus fair-value
accounting; the meaning of conservative reporting in FASB’s
viewpoint; and the role of conservatism in fair-value reporting.
of historical-cost accounting versus fair-value accounting.
The current system of historical-cost reporting
is not meeting the needs of investors. According to NYU
professor Baruch Lev, the relationship between market values
and book values of companies on the S&P 500 was approximately
1:1 in the late 1970s and early 1980s. Today that relationship
is approximately 6:1. The historical-cost system, created
during a time of fixed-asset–based companies that
obtained financing primarily from creditors, does not provide
a good representation of value in our knowledge-based economy.
Reporting our best estimate of the current values of assets
and liabilities and disclosing information about ranges
of possible outcomes seems to provide more complete information
than simply relying on historical-cost financial information
that is conservative and reliable but not very relevant!
financial statement preparers, standards setters, and users
would concur that the primary characteristic of financial
information is that it should be useful in the decision-making
process. The two primary characteristics that contribute
to usefulness are relevance and reliability. Our article
discussed these characteristics at length, and, to summarize,
it is frequently necessary to trade relevance for reliability.
In the ideal world, we would like to increase relevance—the
ability of information to affect a decision—and increase
reliability—the fair representation of the financial
information reported. New accounting standards and proposals
place greater emphasis on providing relevant financial information
to users, perhaps at the expense of reliability. This shift
is evident in FASB’s recent activities that increase
the use of fair-value accounting. A recent example of FASB’s
focus on fair value is the exposure draft on business combinations.
definition of conservatism in an accounting environment.
Where does conservatism fit into the primary
accounting qualities of relevance and reliability? In practice,
the idea of conservatism has been altered from FASB’s
original intention. Statement of Financial Accounting Concept
2 defines conservatism as “a prudent reaction to uncertainty
to try to ensure that uncertainty and risks inherent in
business situations are adequately considered.” This
suggests that if the reliability of a measurement is not
certain, the preparer should carefully consider how uncertainty
would affect users’ decisions and, thus, how information
about the uncertainty should be portrayed. This definition
does not imply that financial statements should always be
pessimistic. The role of conservatism is for preparers to
acknowledge that risks and uncertainties are present in
financial information and to adequately account for those
risks in the information that is presented to decision makers.
in a fair-value environment. Based on the
above discussion, how does conservatism impact the current
movement toward measuring assets and liabilities at fair
value? In an environment clearly moving toward fair-value
measurements, the importance of conservatism, as originally
intended by FASB, may be even more important than in an
historical-cost environment. Specifically, conservatism
was meant to encourage accountants to consider the uncertainties
surrounding their measurements and the impact those uncertainties
and risks might have on decision makers. This is critical
in today’s marketplace.
a fair-value environment, financial statement amounts are
determined by using estimates of discount rates, cash-flow
streams, income streams, and others to establish the fair
value of a particular asset or liability. When choosing
between alternative assumptions, accountants should be conservative
and consider the inherent uncertainties and risks of the
asset or liability they are measuring. Furthermore, after
establishing the best estimate of current value, the uncertainty
and risks inherent in the fair-value estimates should be
reported through detailed disclosures about the assumptions
used and the range of possible outcomes if alternate assumptions
were used. This is the approach followed in the fair-value-measurements
exposure draft. The objective of the exposure draft is to
improve the consistency and comparability of fair-value
measurements and to require increased disclosures so that
investors can adjust the reported values as they see appropriate.
This process provides relevant financial statements with
detailed information that would allow users to assess risks
and thus allow them to create more-conservative estimates
of corporate value.
summarize, the current system of financial reporting frequently
seems to focus on providing reliable information that is
conservative, if not pessimistic, in nature. This focus
on reliable information has resulted in an accounting system
that produces financial information that is frequently not
relevant to investors and other users of financial information.
FASB’s current focus on fair-value accounting would
provide users with much more relevant information that may
not be as reliable. One critical component of this new system
is that preparers will have to be vigilant in disclosing
information about the assumptions made to determine values,
and report the uncertainties involved in those assumptions.
Thus, accounting is shifting the focus of conservatism from
reporting the worst-case scenario to providing detailed
information about assumptions and uncertainties surrounding
those assumptions, so that users can make informed decisions
about corporate measures of fair value.
Toppe Shortridge, PhD, CPA
Northern Illinois University, DeKalb, Ill.