The Crisis in Financial Reporting

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The Crisis in Financial Reporting

• Rick Antle
• Senior Associate Dean and Professor of Accounting
• Yale School of Management

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Criticized Parties

• Government regulators
• Standards setters (FASB EITF)
• Management
• Boards of directors
• Accounting profession

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Debacle

• A sudden, disastrous collapse, or defeat a rout

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Fiasco

• A complete failure

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Failure

• Cessation of proper functioning or performance

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I am not an accountant.
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Basis of Financial Reporting

• Economic concepts
• Accounting conventions
• Institutional context

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Accounting Identity
Assets Liabilities Equity
Assets Liabilities Equity
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How it Works

• 0 0 0?
• 5 3 2?
• RECOGNITION CRITERIA!!

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Building Example

• Original cost 6 million
• Accumulated depreciation 4 million
• Sales price 3 million
• Does selling the building add to shareholders
  wealth?

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I Am Not An Accountant

• Professes confusion of the aspirations of
  accounting with the practical results of applying
  its conventions and techniques.

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Standards Setters

• FASBs elaborate due process means
• Details and loopholes are there because someone
  wants them there.
• Just look at the treatment of executive stock
  options.

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Special Purpose Entity - Problem
Risky Corp
Office Corp
A special purpose entity. Will issue debt,
construct the office building, and lease it to
Risky Corp
Wants to borrow 100 to build an office building,
which it will occupy
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Special Purpose Entity - Consolidated
Big Bank
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Special Purpose Entity - Off Balance Sheet
Outside investors
Loan guarantee
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Dialog One

• How about 0.1 of equity for Office Corp?
• Not enough? How about 0.02?
• Still not enough? Ok, you tell me, how much
  equity is enough?

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Two Choices

• Dont answer questions
• Pick a cut-off number or a rule for determining a
  cut-off number
• Pre-Enron, number was 3. Now I believe it is 10.

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Not Feasible to Refuse to Answer

• Another dialog
• How about 100 of equity?
• That will do it? Then how about 99?
• Thats OK, too? Then how about 98?

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Categorizations

• Use of categories as a basis of aggregation is
  too handy to abandon.
• Requires methods for assigning things to
  categories.
• Creates the possibility of playing games to
  manipulate the classification.

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Principles-Based Standards

• Some think less detailed rules are the answer.
• I think not.
• Rules for assigning things to categories fall
  somewhere in the following box

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Logical Possibilities for Classification Rules
Explicit Implicit
Uniform
Varied
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Accounting Profession
During the recent past, however, the profession
has not always lived up to its duties and
responsibilities. Because of the growing list of
substandard audits, the profession is slowly
losing its credibility. We have seen too many
recent instances of flawed accounting reports
that simply have been chalked up to the
overworked explanation that a certain amount of
poor financial reporting is inevitable. Judge
Sporkin
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Accounting Profession
We are not confronted with a liability crisis. We
are instead confronted with an identity crisis.
We dont know for what, to whom, and the when of
our responsibility. Abraham Briloff
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Professions Response

• Tightened internal control of Big 4
• Emergency response teams
• Pro-active before the Public Company Accounting
  Oversight Board requires changes

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You cant regain credibility by only doing things
you are required to do.
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