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The role of accounting in financial disclosure
Accounting, Organizations and Society. Vol. 5, No. 1, pp. 11-80. Pergamon Press Ltd, 1980. Printed in Great Britain.
THE ROLE OF ACCOUNTING IN FINANCIAL DISCLOSURE
JACOB G. BIRNBERG Graduate School of Business, University of Pittsburgh
Abstract This paper examines the various demands facing accounting in attempting to supply diverse groups with differing needs the data they desire. Beginning with the notions that, first, accounting is trying to describe a complex stewardship relation and, second, that what we call accounting is in reality many accountings, it examines several current issues in financial disclosure. Essentially, it concludes that a complex set of economic relations must simultaneously rely on several distinct accountings to properly perform the task of disclosure. In general, this conclusion is viewed as desirable.
the parties involved. Rather, greater emphasis is being placed upon prospective data and data with less than the requisite degree of objectivity in order to meet the presumed needs of the users of financial statements. The problem facing external users of financial data is similar to that facing internal users. Data of varying degrees of objectivity are needed by managers and certain attributes (e.g. objectivity and verifiability) may be sacrificed to attain greater relevance. By drawing on the analogy to internal reporting, it is hoped that the dimensions of the disclosure problem can be better understood. The solution suggested is that more and more data (whether contained in the annual report or disseminated in other ways) will fall outside the rules and definitions constituting the traditional accounting system. Such a solution is probably beneficial to accountants since it frees them from needing to continually alter the accounting rules (i.e. F.A.S.B. statements and S.E.C. pronouncements) so as to fit all manner of heterogeneous problems that frequently arise. The idea is presented in three sections. The first section discusses one of the critical implications of the modern stewardship relation the rise of various self contained or only modestly related accountings. These accountings form the whole of the discipline we call accounting (in the singular). The second section takes a retrospective point of view and examines the development of the stewardship relationship over time and compares it to managerial control. The third
The thrust of this paper is that the time has come for accountants to differentiate between “accounting” and “full disclosure of financial data”. While it may be tempting to view disclosure as the output solely of the accounting system, in our imperfect world pursuit of this ideal may be at the root of many problems facing contemporary accounting. Much financial data may be disclosed via the financial statements. However, this is different from suggesting that accounting’s goal or the goal of others for it - is that the financial accounting system continually be adapted to provide all the desired disclosure. The insidiousness of that notion is reflected by its not being referenced to a single person. Indeed, few would even consider it their own. Rather, it is the sum of a series of modest proposals for improved disclosure. Their totality is a set of data from the accounting system that constitutes “full disclosure” to everyone’s satisfaction. Moreover, the source of these proposals has not been fringe groups. They have come from a pot pourri of groups identified with the financial reporting function. The Securities and Exchange Commission has been notable among them. However, so has management and the accounting profession. (Perhaps it reflects my own prejudices, but the academic community appears lesswell represented of late than is usually the case in this activity.) In this paper the growth of the demand for greater disclosure is viewed as the rational result of the changing relationship between the “master” and “servant”. Contemporary fiduciary accounting alone would be inadequate to meet the needs of 71
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section examines some of the implications of the earlier sections with particular reference to evolving and potential research topics.
THE MULTIPLICITY
OF ACCOUNTINGS
Numerous writers have noted that what has evolved is not a single accounting but a whole series of accountings. (For an early statement see Paton, 1922, chapter 1.) In part, they represent the changing nature of the economic environment. Thus the twentieth century manager reports not only to the present equity holders, but has obligations thrust upon him to report to other groups as well. The manager is the party whom the government chooses to have fde the tax form reporting the profits earned for the owners. Similarly, other groups for practical reasons have chosen the entity and the manager rather than the equity holders as the point to enforce other kinds of accountability. Perhaps this is best viewed from the perspective of Schrader. Schrader (no date) argues that there are a whole array of accountings. He chooses to call them Accounting (1). Each particular accounting is the art of “dealing with” a particular set of data. The manner in which the data are dealt with are the rules of that accounting. Obviously, the rules for accounting (1) and accounting (2) need not be the same, for they deal with different data sets for different purposes. They may be dealing with data sets so different or have goals so diverse that differing rules are needed for each. To paraphrase an old maxim, different rules are needed for different purposes. Schrader’s arguments suggest that traditional financial accounting, he calls it accounting (1) is desirable for the fiduciary aspects but may not be the accounting that is needed for other purposes such as disclosure.’ Indeed, if one extends
Schrader’s view, disclosure may be the combination of several accountings and not an accounting of its own. This is because disclosure required the combining of a variety of data sets of very different types for communication to the user. Some of the data are consonant with traditional accounting [accounting (l)] with its emphasis on objectivity, verifiability, etc. Others require consideration of prospective data. These data are valued more for their relevance than other characteristics, and may require a different set of rules. One example of the dilemma resulting from trying to fit the latter into the framework of traditional accounting is accounting for contingencies. This particular view that disclosure is the result of several accountings is at odds with current practice of viewing financial disclosure as ideally consisting of the traditional financial statements. Yet it may be a richer view of financial reporting for it permits each data set to be dealt with in an appropriate fashion. This should result in disclosure of greater value to the user.
THE ROLE OF MODERN STEWARDSHIP Over a long period of time the form of the stewardship and reporting relationship between custodian and owner has evolved along lines related to the changes taking place in the complexity of economic activity. These changes have had a profound impact on the problems of financial reporting. The orientation reflected in this analysis of stewardship is similar to the levels of analysis in managerial control systems. That is, we can use the managerial traditional control (operational, managerial and strategic) to describe the evolution of stewardship reporting over time. This is true not
‘In the context of Schrader, disclosure presently consists of two accountings and a statement concerning their adequacy in meeting the tests of financial disclosure. One accounting is the set of rules followed for statement items and the related portion of the footnotes; that is, those footnotes that are explanatory in nature. An example of an explanatory footnote is one disclosing accounting policy or disaggregating the inventory data. The second accounting is found in those footnotes that introduce a new data set into the reporting process. Such data usually involve future activities or the economic implications of past activities that cannot be measured with the requisite degree of precision or reliability required by accounting (1). Examples of this are contingency reporting and future contractual commitments. The auditor’s certificate is a statement of the ability of these accountings to meet the C.P.A.% criteria for adequate disclosure under the present set of rules. A “clean” certificate says the statements do. Any qualification describes a limitation on the ability of the auditor to ascertain the required data or properly report them according to the rules of these accountings.
THE ROLE OF ACCOUNTING IN FINANCIAL DISCLOSURE
only because of the obvious economic analogy between master-servant and superior-subordinate relationships, but also because both are concerned with responsibility, resource utilization and the need to communicate with a remote party concerned with the activities of the actor. Four different stages of development in the stewardship relationship are discussed, However, the first two are discussed together. Thus, for practical purposes, the list consists of three. (For a more extended discussion of stewardship accounting, see Ijiri, 1975.) 1. The pure custodial period. 2. The traditional custodial period. 3. The asset utilization period. 4. The open ended period. The labels are intended merely to orient one toward the nature of the master-servant (or principal-agent) relationship existing at that time. They are intended to be broadly descriptive of nature of that relationship between the parties, the assets entrusted to the servant and the nature of the reporting problem. For practical purposes the first two periods can be viewed as one. They differ only in the need for the servant to perform certain minimal tasks to fulfil the custodial function. For example, a servant entrusted a valuable gem needed only to keep it safe from others to perform his charge. The gem required no service from him so that it could be returned intact. In contrast, not only do sheep - the traditional focus of early stewardship accounting require attention from the shepherd/steward, but so do a variety of other objects - fruit groves, planted fields, etc. The essence of the first two types of stewardship is the concern with returning the corpus intact. In the case of the gem, this implied not losing or misappropriating it or damaging it through negligence. In the case of the shepherd this means providing the due care required to maintain the flock (the corpus) in the state in which one should reasonably anticipate it would be. For practical purposes most custodial relations embody the characteristics of the shepherd’s problem. The stewardship is best described as reflecting the characteristics of operational control. The steward is faced with a resource utilizing task that is highly structured. This suggests that the servant is expected to possess the requisite knowledge and skills to perform the task. Similarly the charge is known and able to be expressed in
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(reasonably) precise terms. This enhances masterservant communication, the servant’s understanding of his task, the definition of data for reporting, and the ease with which the master can evaluate the servant. In general, a balance sheet like report, augmented with limited flow data, should provide adequate disclosure. The third form of stewardship - asset utilization orientation - suggests that the master’s corpus may be enumerated with less specificity. The charge is usually set in terms of goals and targets rather than with reference to specific assets and the manner of their utilization, i.e. plans. There is no intent on the part of either parties that the corpus remain in the same form over time. Thus the servant may be impowered to sell or barter certain assets for other assets if that action will enhance the probability of meeting the master’s charge. The differentiation between the custodial stewardship and the asset utilization stewardship is in the judgment allowed to and required of the servant. In contrast with a custodial servant, the asset utilizing servant is expected to provide initiative and insight, while the custodial servant exercised due care. In this regard the asset utilizing master-servant relationship is similar to managerial control. The master, for a multitude of reasons, feels that it is desirable to delegate both resources and certain decisions to the servant. This has implications for the disclosure function. Balance sheet data are not enough. Now data reflecting how the servant acts during the period must also be provided. Moreover, since the present assets are to some degree inputs in process for future acts, some degree of prospective data may be useful. Like management control, this form of stewardship is characterized by a significant amount of uncertainty. While the initial stock of assets can be articulated in an accounting (1) manner, it may be more difficult to ascertain the form the corpus should take at intermediate points during the stewardship process as well as when the stewardship is terminated. Moreover, because of the extent to which uncertainty and a lack of structure may characterize the servant’s environment, the evaluation process may rely on more general measures of performance to assess the servant’s performance rather than the very specific statements of resources found in the custodial setting. Such a reporting format begins the deviation from a data set of the traditional sort
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and broadens it to include other data. Thus the rules of accounting (1) become less and less appropriate for disclosure during the time between the beginning and ending of the stewardship relation. Since accounting (1) is not readily able to deal with certain of these issues, its rules must be altered to do so, or a new set of rules, say accounting (1’) must be adopted to deal with special cases. In either instance, conflicts may arise as we try to integrate the result into a single consistent body of theory. For example, the price level disclosure problem has been viewed by some as a separate accounting. However, in dealing with future contractual commitments accountants have tried to alter the rules of accounting (1) to include the problem within its scope. The “open ended” period is, at present, a situation in search of a name. However, it is easily identifiable and distinguishable from the “asset utilization” period. In the asset utilization period the master has a general idea of the course of action contemplated when the relationship was initiated. This view is underscored both by the nature of the assets entrusted to the servant and/or by the charge to him. In contrast, in the open ended period the master has financial resources for which he desires employment. These assets are quite flexible in the use to which they can be put (e.g. monetary assets) or are easily convertible into another, significantly different form without violating the charge. (For example, real estate may be entrusted to the steward for the purpose of being sold to raise the capital required by the venture.) This form of the stewardship relation is analogous to what is usually called strategic control. One of the responsibilities of the true manager is to chart the course of asset utilization. This involves not only the initial direction, but also ascertaining the critical point in time when such directions must be changed. Like strategic control the stewardship situation requires that a significant degree of responsibility be assumed by the servant. The task faced is probably characterized by a lack of structure and a significant amount of uncertainty. This suggests that we may find our reporting system to the master caught between the rock and hard place of communication ~ the need for the detail on one hand and the risk of overload and excessive complexity on the other. As is outlined below, the need for both prospective and retrospective data is heightened in
this case. The user of the statement needs to know the current situation, the formal commitments and the manager’s plans for the resources. These data sets could involve at least three different sets of rules and, therefore, three different accountings. In summary, the stewardship relation still lies at the core of the financial disclosure issue. It is because of this separation of resources and control over their utilization that communication is of such concern to accountants, investors, managers and analysts. Regardless of whether one believes that control is a fixed quantity or an expanding quantity, more and more operating authority passes from master to servant as the charge becomes more open ended and the master becomes dependent upon the servant to perform a significant proportion of the task. Thus greater emphasis has been placed on the development of meaningful communication between the parties. What now remains to be done is to bring together the stewardship notions and the accountings to ascertain what the quest for added disclosures would appear to mean in that context. Specifically, what issues appear researchable from this point of view and what knowledge have we accumulated.
SOME RESEARCH AND POLICY ISSUES In its most obvious form, the relationship between master and servant is similar to that of a superior and a subordinate in an organization chart. Given that the task is structured and well understood and that the power of the equity holder is not diluted because there are so many of them, this analogy seems appropriate. Requests, directives and comparable messages flow downward. Information about prior activities flows upward. In a diagram we would include a third party checking the servant, perhaps as a stafflike function. This separation of functions between an operating fiduciary and a reporting fiduciary provides the degree of internal control needed to enhance the probability that the masters’ assets are being preserved and that the messages they are receiving are accurate. The principal-agent A more modern probably show the horizontal rather
view of stewardship
view of this relationship would master-servant diagram as a than a vertical one. The
THE ROLE OF ACCOUNTING IN FINANCIAL DISCLOSURE
stewardship relation would be the “strategic” one. This is the environment that several researchers are examining in the principal-agent context. Watts (1977) and Watts & Zimmerman (1978, 1979) have focused upon this particular relation in an attempt to examine the rationale underlying the expanding of financial disclosure and the rise of the auditor and the attest function. Ronen (1979) takes more or less the same relationship as given and examines the efficacy of this view in providing equity holders and potential investors with (a) a valid report of past performance and (b) an accurate forecast of the firm’s prospects. What is interesting about each case is that the analysis begins by examining the willingness of the servant (agent) to provide the master (principal) with the required information in a timely fashion and without the moral hazard problem. This is exactly opposite of the point of view that the traditional stewardship relation would suggest. Stewardship would imply that the charge to the agent would be simultaneous with the transfer of custody of the resources. The two approaches - the principal-agent formulation of Watts & Zimmerman and the strategic stewardship framework - differ because the former uses as its point of departure the argument that an entrepreneur actively pursuing a business requires additional capital. Correctly or incorrectly, the power characterization of the situation that this offers is exactly the opposite of the stewardship formulation. Interestingly, each point of departure possesses a critical kernel of truth. The stewardship approach reflects the traditional legal view about the rights of shareholders - the shareholders are the owners and as such have certain rights. The principal-agent formulation described the reality for investors - a corporation run by professional managers composed primarily of the assets of others. Thus one might raise the issue that even if the auditing profession would have developed and financial disclosure been extended without the intervention of securities legislation, would the public as a pressure group accept the private sector solution? What was important in settling the regulation issue is not the realities but people’s perception of these realities. Forms of disclosure under strategic stewardship The accounting that would appear to be consistent with the fiduciary aspects is a theory of accounting for past events - some form of
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accounting for the servant’s activities permitting the summary of complex activities into relatively simple reports. This was possible during periods prior to strategic stewardship. Data of a specific sort were required to ascertain if management had discharged its obligations to the equity holders. This was due to the specific nature of the charge. Moreover, relatively simple economic activities made the periodic inventory of resources a relatively simple task. In contrast, strategic stewardship would appear to add two new dimensions to the problem facing the accounting selected. These are: 1. The need to provide greater insight into characteristics and intended use of the resource inventory; and 2. Greater need for a disclosure of future plans and/or prospects. These are necessitated by the separation of ownership and any elements of the management function. A master who is involved in the plans knows something of the value of and intended use for the resources. In contrast, the master who has delegated strategic decisions (or accepted as fact its transfer to management) has no basis for understanding the nature of the resources without added help from management or some independent expert. In many instances, the value of the resources is best described in the context of management’s plans. The upshot of all of this is that we require other accountings to supplement accounting (1) in order to render a “full disclosure” to the users. This accounting(s) must be future oriented and deal(s) with a set(s) of data embodying management’s commitments, expectations, etc. If the strategic-open ended form of the stewardship relation is taken as a starting point, it appears that three kinds of data sets are relevant for financial disclosure. These are: 1. The current state of the assets and the changes occurring in those assets over time. 2. The nature of the existing commitments. 3. The use to which the assets are intended to be put. In the manner of Schrader, each of these is a different accounting potentially requiring a different set of rules. The first is accounting (1) traditional financial accounting. The second, at present, is distinct from accounting (1) for most of transactions are viewed as executory these contracts. Certain leases would be an exception to this statement as would be the executed portion of
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any partially executed agreement. The third is also outside of accounting (1). Only under a very restrictive set of circumstances are prospective data admitted to the accounting system (see F.A.S.B.5). For the most part, such materials fall outside the scope of accounting (1). However, many authors have argued for their inclusion in the disclosure process. See Ijiri, 1975 for one example. Others include Birnberg & Dopuch, 1963. What these authors have stressed is the user’s need for these data to better assess the appropriateness of the mix of resources available to management as well as management’s plans. The need to report to equity holders at relatively short intervals (quarterly and annually) compared to the length of management’s planning horizon (about 3 years) makes such prospective data useful to the investor in interpreting the assets’ value in use to the firm. This view of the disclosure process is not entirely new. Colantoni, Cooper & Dietzer (1973) argue for a multidimensional reporting that recognizes the differences between social accounting and traditional financial accounting. Ijiri (1975) too, argues for multidimensional reporting, an idea consistent with the notion of a set of accountings that, together, constitute financial disclosure. One significant difference between these proposals and the notion discussed here is that these proposals often base their arguments on the numeraire - need to reflect certain data in physical quantities. In this case it is due to the fact that the data are significantly differing degrees of objectivity. Some of the data reported in the prospective accountings may be important to the user more as a “bell” or a “whistle” to alert the user to problems or advantages than as a cardinal measure to be utilized in some decision model. Readers of the financial statements of any firm which possesses a significant contingency or impairment of its asset values (e.g. General Public Utilities, Westinghouse or Itel) are concerned in knowing that the problem exists and, approximately, its scope. However, they may not wish to see the firm bear the cost of attempting any precise measure of it as accounting (1) requires or may recognize the impossibility of such an accounting. Moreover, any such accounting is likely to produce data less “hard” than a typical stewardship report might desire. The problem is similar to that found in capital budgeting where decision evaluators often are concerned about the
accuracy of the capital project’s cash flow analysis given that one group is both the project’s advocate and estimator of the cash flow. Some behavioral research topics It should not be surprising that the author of this paper sees a multitude of accountings being present as having behavioral implications. Particularly of interest is their impact on the user’s decision processes. These topics can be grouped into two issues: 1. Contrast between user responses to and utilization of prospective and retrospective data. 2. The effect of the increased load on the user by expanding the data reported and varying the units in which they are measured. The contrast between the quality of the data sets used leads to differing kinds of data being provided by the different accountings. These numbers will exhibit strong differences on dimensions such as verifiability, hardness, etc. One question that is worthy of investigation is the user’s implicit variance in the two types of data (prospective and retrospective). Given the nature of retrospective data, does the user presume it to be more precise? This, in turn, would suggest the possibility that decisions are more sensitive to a given percent change in retrospective data than prospective data. That is, the level of “materiality” is lower for retrospective data than prospective data. Indeed, the prospective data used may be utilized in a different manner than retrospective data. Prospective data may be more oriented to serving as indicators of trouble or merit rather than precise measures of particular resources or activities. Thus they function as a “bell” when some level is achieved; for example, when a contingent liability potentially in excess of some critical value is reported. Below the level investors may generally ignore the datum. Above the amount, certain actions are undertaken. Essentially, the decision maker may utilize prospective data in a noncompensatory decision model, while using retrospective data more typically in compensatory models. The argument suggests that the precision in the data may influence the manner in which the data are utilized. Thus as the data become more and more subject to manipulation or measurement error, the user may be less willing to utilize a compensatory model. Trade-offs become more
THE ROLE OF ACCOUNTING IN FINANCIAL DISCLOSURE
difficult to make when the decision-maker has limited insight into his true stock of a resource or anticipated level of inflow or outflow of a resource. A second aspect of the reporting of several accountings is the inclusion of multiple monetary measures of the same events or resources. Much research has demonstrated the presence of functional fixity in users of accounting data. [What Chang & Birnberg (1977) refer to as “data fixity”. See that work or Ashton (1977) for a discussion of the literature.] If this phenomenon persists, the typical user of the outputs of the system may find the richness of the system actually counter-productive to him. The most likely strategy for the user to follow is to accept one measure and reject the outputs of any other accountings. For example, a series of profit figures could be offered based upon a variety of rules - historical cost, a general price index and specific set of indices. In addition, the rules might choose to ignore or include the effects of inflation on net monetary assets in the profit calculation. Clearly these measurement rules each have their advocates and their uses. However, each has its detractors. The questions raised by presenting more than one of them are the effect of the load on the user and the ability of the user to sort out the appropriate measure. The former phrases the old information overload question in a different way. The results are not obvious. The second aspect is the ability of the user to utilize different data for different purposes. Will the user select a single measure, say the general price level, to answer all income related questions or will the user be able to shift between measures, i.e. accountings, as is appropriate? While a variety of accountants have advocated multiple measures, we have no experimental data or insights into the ability of decision makers to utilize these data. While the fixity issue may argue against their use, it may be possible that users will learn algorithms that use different numbers and use them appropriately. Between algorithms they may be flexible, but within an algorithm they may be fixated. Finally, the movement toward safe harbor rules by the S.E.C. to protect firms making disclosures the Commission wishes to encourage creates two distinct classes of data. One set has different legal implications than the other. Does this result in their being viewed differently by users? In summary, the notion that disclosure
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includes a variety of accountings raises several behavioral questions. Based upon existing research, there is good reason to believe that the outputs of these accountings may lead to conflicting data with which the fixated user cannot deal. Inductance-consequences issue The argument is being made with increasing frequency that accounting rules are altering management decisions. The manager plans his corporate acts with the same concern for external performance indicators as his subordinate shows when he struggles to achieve a targeted divisional ROI. The inductance argument as offered by Prakash & Rappaport (1977) focuses on the effects on behavior that flow from the selection of particular accounting rules. The inductance argument can be examined from two different perspectives. One is the effects on the behavior of management induced by the stewardship accounting rules. All induced behavior is not bad. Indeed, one of the purposes of the rules is to induce particular types of behavior. However, in other cases the accounting rules induce unintended behaviors that may be contrary to the best interest of the entity. The current controversy over F.A.S.B.8 (Foreign Operations) and to a lesser degree F.A.S.B.19 (Oil and Gas) are examples of this. For example, Rouse Corp. (1979) has argued that it has sold its interest in Canadian shopping centers and taken a management contract instead because of the effects of F.A.S.B.8 on its income statement. Rouse showed approximately 80% of its 1977 profits to be the result of foreign currency translation gains. If behavior is being induced, it raises questions again about the form of the accountings to be combined into financial disclosure. In this case the “as if’ translation creates an event for accounting purposes that does not have a real world counterpart. (No transfer between currencies occurred or need occur in the foreseeable future.) Accountants concerned with this problem may find the best solution in a multi-dimensional format of disclosure which permits separate reporting of different accountings. This permits management to argue for the measure it feels best describes the situation, but does provide the user with the alternative data. The second aspect of the inductanceconsequences issue goes beyond the stewardship relation as it is typically defined. This is the problem of political consequences of accounting
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data. For a publicly held corporation the reporting loops consist not only of the master-servant loop (i.e. the present investors) and one to the potential equity holder. There is a third loop linking the servant with the general public and public officials. While the last loop may not be formally serviced by the entity, data publicly disclosed will find their way into this channel as well. The results of this can readily be seen in the public’s response to the reported first quarter 1979 profits of the oil companies. At this point in time it is difficult to ascertain what consequences may follow. However, the initial response seemed to be reinforcing the public’s unwillingness to believe the existence of a gasoline shortage.* Other examples can be offered of the use of stewardship reports in areas for which they were unintended and with potentially adverse effects to the firm via the political process. What would appear to be the problem here is the use of the wrong accounting system’s profit figure. However, the numbers are not labeled as to which accounting produced them. Nor are the systems equipped with labels suggesting that their misuse may be harmful to someone’s economic health (but may be helpful to one’s political goals). Social reporting The plight of social reporting in the United States may be explained by its being, essentially, a stranger to stewardship reporting. The inclusion of these data in financial reports does not appear to have been reconciled as yet with the traditional views of stewardship accounting. Rather, it has been viewed as a separate accounting and often developed in a manner requiring presentation separate from the traditional statements. Social reporting is unique among the accountings in several ways. Initially, the impetus for much of the data it provides did not come from either the master or the servant groups. Rather it came from other sources who apparently failed to convince either of the groups of social reporting’s cost effectiveness to the primary users of the statement. This may explain some of its inability to become part of the set of disclosures. Policy implications for the F.A.S.B. The stewardship relations would appear to have
significant implications for the F.A.S.B. Initially, and perhaps most importantly, it argues for a reconsideration of the desirability of a single accounting framework. Rather, it supports the notion that we need criteria to decide issues related to the need for disclosure of given data and then the ascertaining of which accounting is appropriate. At least at first blush such an approach appears to have significant merit. It does not require the F.A.S.B. to choose one accounting over another. It does not raise as many political issues as the single accounting approach does. It permits more tentative steps toward solution of issues than the single framework approach. The first two points can best be viewed by reviewing the debate over the framework as it has progressed. Sprouse highlighted the problem at the Wharton Conference (Solomons, 1977). There Sprouse stressed two issues. One was that the two primary points of view - balance sheet and income statement - force a choice between the relative merits of the two points of view. Choosing a set of rules more appropriate for balance sheet measurement results in an accounting for income using inappropriate rules. Conversely, selecting the income approach leads to a balance sheet of residuals and suspense accounts (p. 11). Significantly, he alluded to there being “A third view about which much less is known . .“. This is what he described as the non-articulation view. Sprouse’s description of this view is in our framework the parallel and independent existence of an accounting for balance sheets and an accounting for income statements without the need for the rules of one accounting to apply outside its appropriate domain. Thus the present link between the statements via the reconciliation of retained earnings could, for practical purposes, cease to exist. It is not surprising that in the subsequent discussion of these views only the balance sheet and income statement views are covered. Such a solution would be reasonable if the F.A.S.B. is searching for truth. That is, a single accounting for all data. However, the F.A.S.B. discussion memorandum is, according to Sprouse (p. 27) searching for a constitution. Clearly, if the latter is
z Even whilst this paper was being given its final revision, the officers of Chrysler Corporation were quoted on CBS news as using the cash rebate plan on their cars to stimulate sales and offset the bad image Chrysler had developed from their financial problems.
THE ROLE OF ACCOUNTING
viewed as a popularly accepted set of rules, there is no reason why it must confine itself to a single set of rules. Rather, it should be broad enough to be politically acceptable. Such a document could incorporate more than a single accounting and specify the domain of each and the extent to which they intersect. The multiple accountings view of the F.A.S.B.‘s framework should also provide a more flexible document for it offers greater options to the Board in selecting a solution. A flexible document is less likely to fall because of solutions that lead to what user and/or producer groups feel are absurdities. Such anomalous results usually lead to conflicts either among accountants or between accountants and the producer or user groups, e.g. F.A.S.B.8. While the Board has shown a willingness to reconsider its past decisions - a positive sign to be sure - any change in the prior statements will be viewed as justice delayed by the proponents of the changes. Similarly, the existence of different accountings offers the potential for quicker resolution of thorny issues for it affords the Board the ability to make a more tentative decision by allocating the data to a set of accounting rules for more tentative data. This would appear to be the implication of the S.E.C.‘s decision on price level data and the decision initially contemplated by the S.E.C. for oil and gas accounting. In essence, the S.E.C. is developing two accountings. One is intended for traditional data and new data that meets the (unstated) test for admission to that set. These are the financial statement portion of the rules for the S.E.C. filings. In addition, other data deemed potentially useful by the S.E.C. and its staff are included separately. The intent in their inclusion is to experiment both with their feasibility and their usefulness. Obviously the existence of several accountings raises the issue of cost. Without knowledge of how the accountings would be constituted, cost estimates are impossible. To some degree the cost
IN FINANCIAL
DISCLOSURE
of our present system associated with other are already collected. cost is already hidden total cost.
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includes costs that would be accountings, for certain data However, how much of the is no more obvious than the
SUMMARY AND CONCLUSION In general it would appear that the disclosure problems being experienced are the result of contemporary economic relationships requiring more than a single accounting to properly portray their effects to the users of financial statements. The strategic stewardship relationship requires both retrospective and prospective data. It would seem that traditional historical measures of resources and activities are inadequate to assess the activities of a complex organization pictured in the midst of its activities. Anyone who expects accounting (any accounting) to dispel uncertainty from an uncertain world or render simple complex activities is setting high, if not impossible, standards. In addition, trying for the sake of trying entails risks as well. If one relies on the data fixity literature, individual investors can be led astray. In addition, rules of accounting, once set, affect behavior. Managers may find some of the rules onerous - some sufficiently onerous to alter their behavior to the detriment of the firm and its investors. Unfortunately, the obvious solution of using several accountings in the disclosure process may be fraught with human information processing problems. Will the user be able to keep the data sets separate? What will happen when the systems generate conflicting results? It may be that the problem of disclosure is more difficult than many first anticipated. While the notion of getting the right data to the investor is appealing, it clearly is extremely difficult.
BIBLIOGRAPHY Ashton, R., Cognitive Changes Induced by Accounting Changes: Experimental Evidence on the Functional Fixation Hypothesis, Studies on Human Information Processing in Accounting (Supplement to Journal of Accounting Research, 1977). Birnberg, J. & Dopuch, N., A Suggested Framework for Disclosure, Journal of Accountancy (February, 1963). Chang, D. & Birnberg, J., Functional Fixity in Accounting Research: Perspective and New Data, Journal of Accounting Research (1977).
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JACOB G. BJRNBERG Colantoni, C., Cooper, W. W. & Dietzer, H. J., Budgetary Disclosure and Corporate Social Reporting, in M. Dierkes and R. A. Bauer (eds.), Corporate Social Accounting (N.Y.: Praeger, 1973). Ijiri, Y., Theory of Accounting Measurement (AAA, Sarasota, Florida, 1975). Paton, W., Accounting theory (1922; Reissued in 1962 by ASP, Ltd, Chicago). Prakash, P. & Rappaport, A., Information Inductance and Its Significance for Accounting, Accounting, Organizations and Society (1977). Ronen, J., The Dual Role of Accounting: A Financial Economics Perspective, in J. Bicksler (ed.), Handbook of Financial Economics (North Holland, Amsterdam, 1979). Rouse Corp., 1979, Presentation to F.A.S.B. An Amending Statement pp. l-12, Dated 14 August (1978). Schrader, W., The Conceptual Framework for Financial Accounting and Reporting: Historical Approach, in J. Cramer and C. Neyhart, Jr., Conceptual Framework for Financial Accounting and Reporting: Present and Future (Center for Research, College of Business Administration, Penn State University, no date). Solomons, D., The Conceptual Framework of Accounting (Proceedings of a Conference held on 4 May, 1977) Wharton School: Philadelphia (1977). Watts, R., Corporate Financial Statements: A Product of the Market and Political Process, Australian Journal of Management
(1977).
Watts, R. & Zimmerman, J., Towards a Positive Theory of the Determination of Accounting Standards, Accounting Review (January, 1978). Watts, R. & Zimmerman, J., The Demand for and Supply of Accounting Theories: The Market for Excuses, Accounting Review (April, 1979).
THE ROLE OF ACCOUNTING IN FINANCIAL DISCLOSURE
JACOB G. BIRNBERG Graduate School of Business, University of Pittsburgh
Abstract This paper examines the various demands facing accounting in attempting to supply diverse groups with differing needs the data they desire. Beginning with the notions that, first, accounting is trying to describe a complex stewardship relation and, second, that what we call accounting is in reality many accountings, it examines several current issues in financial disclosure. Essentially, it concludes that a complex set of economic relations must simultaneously rely on several distinct accountings to properly perform the task of disclosure. In general, this conclusion is viewed as desirable.
the parties involved. Rather, greater emphasis is being placed upon prospective data and data with less than the requisite degree of objectivity in order to meet the presumed needs of the users of financial statements. The problem facing external users of financial data is similar to that facing internal users. Data of varying degrees of objectivity are needed by managers and certain attributes (e.g. objectivity and verifiability) may be sacrificed to attain greater relevance. By drawing on the analogy to internal reporting, it is hoped that the dimensions of the disclosure problem can be better understood. The solution suggested is that more and more data (whether contained in the annual report or disseminated in other ways) will fall outside the rules and definitions constituting the traditional accounting system. Such a solution is probably beneficial to accountants since it frees them from needing to continually alter the accounting rules (i.e. F.A.S.B. statements and S.E.C. pronouncements) so as to fit all manner of heterogeneous problems that frequently arise. The idea is presented in three sections. The first section discusses one of the critical implications of the modern stewardship relation the rise of various self contained or only modestly related accountings. These accountings form the whole of the discipline we call accounting (in the singular). The second section takes a retrospective point of view and examines the development of the stewardship relationship over time and compares it to managerial control. The third
The thrust of this paper is that the time has come for accountants to differentiate between “accounting” and “full disclosure of financial data”. While it may be tempting to view disclosure as the output solely of the accounting system, in our imperfect world pursuit of this ideal may be at the root of many problems facing contemporary accounting. Much financial data may be disclosed via the financial statements. However, this is different from suggesting that accounting’s goal or the goal of others for it - is that the financial accounting system continually be adapted to provide all the desired disclosure. The insidiousness of that notion is reflected by its not being referenced to a single person. Indeed, few would even consider it their own. Rather, it is the sum of a series of modest proposals for improved disclosure. Their totality is a set of data from the accounting system that constitutes “full disclosure” to everyone’s satisfaction. Moreover, the source of these proposals has not been fringe groups. They have come from a pot pourri of groups identified with the financial reporting function. The Securities and Exchange Commission has been notable among them. However, so has management and the accounting profession. (Perhaps it reflects my own prejudices, but the academic community appears lesswell represented of late than is usually the case in this activity.) In this paper the growth of the demand for greater disclosure is viewed as the rational result of the changing relationship between the “master” and “servant”. Contemporary fiduciary accounting alone would be inadequate to meet the needs of 71
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section examines some of the implications of the earlier sections with particular reference to evolving and potential research topics.
THE MULTIPLICITY
OF ACCOUNTINGS
Numerous writers have noted that what has evolved is not a single accounting but a whole series of accountings. (For an early statement see Paton, 1922, chapter 1.) In part, they represent the changing nature of the economic environment. Thus the twentieth century manager reports not only to the present equity holders, but has obligations thrust upon him to report to other groups as well. The manager is the party whom the government chooses to have fde the tax form reporting the profits earned for the owners. Similarly, other groups for practical reasons have chosen the entity and the manager rather than the equity holders as the point to enforce other kinds of accountability. Perhaps this is best viewed from the perspective of Schrader. Schrader (no date) argues that there are a whole array of accountings. He chooses to call them Accounting (1). Each particular accounting is the art of “dealing with” a particular set of data. The manner in which the data are dealt with are the rules of that accounting. Obviously, the rules for accounting (1) and accounting (2) need not be the same, for they deal with different data sets for different purposes. They may be dealing with data sets so different or have goals so diverse that differing rules are needed for each. To paraphrase an old maxim, different rules are needed for different purposes. Schrader’s arguments suggest that traditional financial accounting, he calls it accounting (1) is desirable for the fiduciary aspects but may not be the accounting that is needed for other purposes such as disclosure.’ Indeed, if one extends
Schrader’s view, disclosure may be the combination of several accountings and not an accounting of its own. This is because disclosure required the combining of a variety of data sets of very different types for communication to the user. Some of the data are consonant with traditional accounting [accounting (l)] with its emphasis on objectivity, verifiability, etc. Others require consideration of prospective data. These data are valued more for their relevance than other characteristics, and may require a different set of rules. One example of the dilemma resulting from trying to fit the latter into the framework of traditional accounting is accounting for contingencies. This particular view that disclosure is the result of several accountings is at odds with current practice of viewing financial disclosure as ideally consisting of the traditional financial statements. Yet it may be a richer view of financial reporting for it permits each data set to be dealt with in an appropriate fashion. This should result in disclosure of greater value to the user.
THE ROLE OF MODERN STEWARDSHIP Over a long period of time the form of the stewardship and reporting relationship between custodian and owner has evolved along lines related to the changes taking place in the complexity of economic activity. These changes have had a profound impact on the problems of financial reporting. The orientation reflected in this analysis of stewardship is similar to the levels of analysis in managerial control systems. That is, we can use the managerial traditional control (operational, managerial and strategic) to describe the evolution of stewardship reporting over time. This is true not
‘In the context of Schrader, disclosure presently consists of two accountings and a statement concerning their adequacy in meeting the tests of financial disclosure. One accounting is the set of rules followed for statement items and the related portion of the footnotes; that is, those footnotes that are explanatory in nature. An example of an explanatory footnote is one disclosing accounting policy or disaggregating the inventory data. The second accounting is found in those footnotes that introduce a new data set into the reporting process. Such data usually involve future activities or the economic implications of past activities that cannot be measured with the requisite degree of precision or reliability required by accounting (1). Examples of this are contingency reporting and future contractual commitments. The auditor’s certificate is a statement of the ability of these accountings to meet the C.P.A.% criteria for adequate disclosure under the present set of rules. A “clean” certificate says the statements do. Any qualification describes a limitation on the ability of the auditor to ascertain the required data or properly report them according to the rules of these accountings.
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only because of the obvious economic analogy between master-servant and superior-subordinate relationships, but also because both are concerned with responsibility, resource utilization and the need to communicate with a remote party concerned with the activities of the actor. Four different stages of development in the stewardship relationship are discussed, However, the first two are discussed together. Thus, for practical purposes, the list consists of three. (For a more extended discussion of stewardship accounting, see Ijiri, 1975.) 1. The pure custodial period. 2. The traditional custodial period. 3. The asset utilization period. 4. The open ended period. The labels are intended merely to orient one toward the nature of the master-servant (or principal-agent) relationship existing at that time. They are intended to be broadly descriptive of nature of that relationship between the parties, the assets entrusted to the servant and the nature of the reporting problem. For practical purposes the first two periods can be viewed as one. They differ only in the need for the servant to perform certain minimal tasks to fulfil the custodial function. For example, a servant entrusted a valuable gem needed only to keep it safe from others to perform his charge. The gem required no service from him so that it could be returned intact. In contrast, not only do sheep - the traditional focus of early stewardship accounting require attention from the shepherd/steward, but so do a variety of other objects - fruit groves, planted fields, etc. The essence of the first two types of stewardship is the concern with returning the corpus intact. In the case of the gem, this implied not losing or misappropriating it or damaging it through negligence. In the case of the shepherd this means providing the due care required to maintain the flock (the corpus) in the state in which one should reasonably anticipate it would be. For practical purposes most custodial relations embody the characteristics of the shepherd’s problem. The stewardship is best described as reflecting the characteristics of operational control. The steward is faced with a resource utilizing task that is highly structured. This suggests that the servant is expected to possess the requisite knowledge and skills to perform the task. Similarly the charge is known and able to be expressed in
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(reasonably) precise terms. This enhances masterservant communication, the servant’s understanding of his task, the definition of data for reporting, and the ease with which the master can evaluate the servant. In general, a balance sheet like report, augmented with limited flow data, should provide adequate disclosure. The third form of stewardship - asset utilization orientation - suggests that the master’s corpus may be enumerated with less specificity. The charge is usually set in terms of goals and targets rather than with reference to specific assets and the manner of their utilization, i.e. plans. There is no intent on the part of either parties that the corpus remain in the same form over time. Thus the servant may be impowered to sell or barter certain assets for other assets if that action will enhance the probability of meeting the master’s charge. The differentiation between the custodial stewardship and the asset utilization stewardship is in the judgment allowed to and required of the servant. In contrast with a custodial servant, the asset utilizing servant is expected to provide initiative and insight, while the custodial servant exercised due care. In this regard the asset utilizing master-servant relationship is similar to managerial control. The master, for a multitude of reasons, feels that it is desirable to delegate both resources and certain decisions to the servant. This has implications for the disclosure function. Balance sheet data are not enough. Now data reflecting how the servant acts during the period must also be provided. Moreover, since the present assets are to some degree inputs in process for future acts, some degree of prospective data may be useful. Like management control, this form of stewardship is characterized by a significant amount of uncertainty. While the initial stock of assets can be articulated in an accounting (1) manner, it may be more difficult to ascertain the form the corpus should take at intermediate points during the stewardship process as well as when the stewardship is terminated. Moreover, because of the extent to which uncertainty and a lack of structure may characterize the servant’s environment, the evaluation process may rely on more general measures of performance to assess the servant’s performance rather than the very specific statements of resources found in the custodial setting. Such a reporting format begins the deviation from a data set of the traditional sort
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and broadens it to include other data. Thus the rules of accounting (1) become less and less appropriate for disclosure during the time between the beginning and ending of the stewardship relation. Since accounting (1) is not readily able to deal with certain of these issues, its rules must be altered to do so, or a new set of rules, say accounting (1’) must be adopted to deal with special cases. In either instance, conflicts may arise as we try to integrate the result into a single consistent body of theory. For example, the price level disclosure problem has been viewed by some as a separate accounting. However, in dealing with future contractual commitments accountants have tried to alter the rules of accounting (1) to include the problem within its scope. The “open ended” period is, at present, a situation in search of a name. However, it is easily identifiable and distinguishable from the “asset utilization” period. In the asset utilization period the master has a general idea of the course of action contemplated when the relationship was initiated. This view is underscored both by the nature of the assets entrusted to the servant and/or by the charge to him. In contrast, in the open ended period the master has financial resources for which he desires employment. These assets are quite flexible in the use to which they can be put (e.g. monetary assets) or are easily convertible into another, significantly different form without violating the charge. (For example, real estate may be entrusted to the steward for the purpose of being sold to raise the capital required by the venture.) This form of the stewardship relation is analogous to what is usually called strategic control. One of the responsibilities of the true manager is to chart the course of asset utilization. This involves not only the initial direction, but also ascertaining the critical point in time when such directions must be changed. Like strategic control the stewardship situation requires that a significant degree of responsibility be assumed by the servant. The task faced is probably characterized by a lack of structure and a significant amount of uncertainty. This suggests that we may find our reporting system to the master caught between the rock and hard place of communication ~ the need for the detail on one hand and the risk of overload and excessive complexity on the other. As is outlined below, the need for both prospective and retrospective data is heightened in
this case. The user of the statement needs to know the current situation, the formal commitments and the manager’s plans for the resources. These data sets could involve at least three different sets of rules and, therefore, three different accountings. In summary, the stewardship relation still lies at the core of the financial disclosure issue. It is because of this separation of resources and control over their utilization that communication is of such concern to accountants, investors, managers and analysts. Regardless of whether one believes that control is a fixed quantity or an expanding quantity, more and more operating authority passes from master to servant as the charge becomes more open ended and the master becomes dependent upon the servant to perform a significant proportion of the task. Thus greater emphasis has been placed on the development of meaningful communication between the parties. What now remains to be done is to bring together the stewardship notions and the accountings to ascertain what the quest for added disclosures would appear to mean in that context. Specifically, what issues appear researchable from this point of view and what knowledge have we accumulated.
SOME RESEARCH AND POLICY ISSUES In its most obvious form, the relationship between master and servant is similar to that of a superior and a subordinate in an organization chart. Given that the task is structured and well understood and that the power of the equity holder is not diluted because there are so many of them, this analogy seems appropriate. Requests, directives and comparable messages flow downward. Information about prior activities flows upward. In a diagram we would include a third party checking the servant, perhaps as a stafflike function. This separation of functions between an operating fiduciary and a reporting fiduciary provides the degree of internal control needed to enhance the probability that the masters’ assets are being preserved and that the messages they are receiving are accurate. The principal-agent A more modern probably show the horizontal rather
view of stewardship
view of this relationship would master-servant diagram as a than a vertical one. The
THE ROLE OF ACCOUNTING IN FINANCIAL DISCLOSURE
stewardship relation would be the “strategic” one. This is the environment that several researchers are examining in the principal-agent context. Watts (1977) and Watts & Zimmerman (1978, 1979) have focused upon this particular relation in an attempt to examine the rationale underlying the expanding of financial disclosure and the rise of the auditor and the attest function. Ronen (1979) takes more or less the same relationship as given and examines the efficacy of this view in providing equity holders and potential investors with (a) a valid report of past performance and (b) an accurate forecast of the firm’s prospects. What is interesting about each case is that the analysis begins by examining the willingness of the servant (agent) to provide the master (principal) with the required information in a timely fashion and without the moral hazard problem. This is exactly opposite of the point of view that the traditional stewardship relation would suggest. Stewardship would imply that the charge to the agent would be simultaneous with the transfer of custody of the resources. The two approaches - the principal-agent formulation of Watts & Zimmerman and the strategic stewardship framework - differ because the former uses as its point of departure the argument that an entrepreneur actively pursuing a business requires additional capital. Correctly or incorrectly, the power characterization of the situation that this offers is exactly the opposite of the stewardship formulation. Interestingly, each point of departure possesses a critical kernel of truth. The stewardship approach reflects the traditional legal view about the rights of shareholders - the shareholders are the owners and as such have certain rights. The principal-agent formulation described the reality for investors - a corporation run by professional managers composed primarily of the assets of others. Thus one might raise the issue that even if the auditing profession would have developed and financial disclosure been extended without the intervention of securities legislation, would the public as a pressure group accept the private sector solution? What was important in settling the regulation issue is not the realities but people’s perception of these realities. Forms of disclosure under strategic stewardship The accounting that would appear to be consistent with the fiduciary aspects is a theory of accounting for past events - some form of
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accounting for the servant’s activities permitting the summary of complex activities into relatively simple reports. This was possible during periods prior to strategic stewardship. Data of a specific sort were required to ascertain if management had discharged its obligations to the equity holders. This was due to the specific nature of the charge. Moreover, relatively simple economic activities made the periodic inventory of resources a relatively simple task. In contrast, strategic stewardship would appear to add two new dimensions to the problem facing the accounting selected. These are: 1. The need to provide greater insight into characteristics and intended use of the resource inventory; and 2. Greater need for a disclosure of future plans and/or prospects. These are necessitated by the separation of ownership and any elements of the management function. A master who is involved in the plans knows something of the value of and intended use for the resources. In contrast, the master who has delegated strategic decisions (or accepted as fact its transfer to management) has no basis for understanding the nature of the resources without added help from management or some independent expert. In many instances, the value of the resources is best described in the context of management’s plans. The upshot of all of this is that we require other accountings to supplement accounting (1) in order to render a “full disclosure” to the users. This accounting(s) must be future oriented and deal(s) with a set(s) of data embodying management’s commitments, expectations, etc. If the strategic-open ended form of the stewardship relation is taken as a starting point, it appears that three kinds of data sets are relevant for financial disclosure. These are: 1. The current state of the assets and the changes occurring in those assets over time. 2. The nature of the existing commitments. 3. The use to which the assets are intended to be put. In the manner of Schrader, each of these is a different accounting potentially requiring a different set of rules. The first is accounting (1) traditional financial accounting. The second, at present, is distinct from accounting (1) for most of transactions are viewed as executory these contracts. Certain leases would be an exception to this statement as would be the executed portion of
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any partially executed agreement. The third is also outside of accounting (1). Only under a very restrictive set of circumstances are prospective data admitted to the accounting system (see F.A.S.B.5). For the most part, such materials fall outside the scope of accounting (1). However, many authors have argued for their inclusion in the disclosure process. See Ijiri, 1975 for one example. Others include Birnberg & Dopuch, 1963. What these authors have stressed is the user’s need for these data to better assess the appropriateness of the mix of resources available to management as well as management’s plans. The need to report to equity holders at relatively short intervals (quarterly and annually) compared to the length of management’s planning horizon (about 3 years) makes such prospective data useful to the investor in interpreting the assets’ value in use to the firm. This view of the disclosure process is not entirely new. Colantoni, Cooper & Dietzer (1973) argue for a multidimensional reporting that recognizes the differences between social accounting and traditional financial accounting. Ijiri (1975) too, argues for multidimensional reporting, an idea consistent with the notion of a set of accountings that, together, constitute financial disclosure. One significant difference between these proposals and the notion discussed here is that these proposals often base their arguments on the numeraire - need to reflect certain data in physical quantities. In this case it is due to the fact that the data are significantly differing degrees of objectivity. Some of the data reported in the prospective accountings may be important to the user more as a “bell” or a “whistle” to alert the user to problems or advantages than as a cardinal measure to be utilized in some decision model. Readers of the financial statements of any firm which possesses a significant contingency or impairment of its asset values (e.g. General Public Utilities, Westinghouse or Itel) are concerned in knowing that the problem exists and, approximately, its scope. However, they may not wish to see the firm bear the cost of attempting any precise measure of it as accounting (1) requires or may recognize the impossibility of such an accounting. Moreover, any such accounting is likely to produce data less “hard” than a typical stewardship report might desire. The problem is similar to that found in capital budgeting where decision evaluators often are concerned about the
accuracy of the capital project’s cash flow analysis given that one group is both the project’s advocate and estimator of the cash flow. Some behavioral research topics It should not be surprising that the author of this paper sees a multitude of accountings being present as having behavioral implications. Particularly of interest is their impact on the user’s decision processes. These topics can be grouped into two issues: 1. Contrast between user responses to and utilization of prospective and retrospective data. 2. The effect of the increased load on the user by expanding the data reported and varying the units in which they are measured. The contrast between the quality of the data sets used leads to differing kinds of data being provided by the different accountings. These numbers will exhibit strong differences on dimensions such as verifiability, hardness, etc. One question that is worthy of investigation is the user’s implicit variance in the two types of data (prospective and retrospective). Given the nature of retrospective data, does the user presume it to be more precise? This, in turn, would suggest the possibility that decisions are more sensitive to a given percent change in retrospective data than prospective data. That is, the level of “materiality” is lower for retrospective data than prospective data. Indeed, the prospective data used may be utilized in a different manner than retrospective data. Prospective data may be more oriented to serving as indicators of trouble or merit rather than precise measures of particular resources or activities. Thus they function as a “bell” when some level is achieved; for example, when a contingent liability potentially in excess of some critical value is reported. Below the level investors may generally ignore the datum. Above the amount, certain actions are undertaken. Essentially, the decision maker may utilize prospective data in a noncompensatory decision model, while using retrospective data more typically in compensatory models. The argument suggests that the precision in the data may influence the manner in which the data are utilized. Thus as the data become more and more subject to manipulation or measurement error, the user may be less willing to utilize a compensatory model. Trade-offs become more
THE ROLE OF ACCOUNTING IN FINANCIAL DISCLOSURE
difficult to make when the decision-maker has limited insight into his true stock of a resource or anticipated level of inflow or outflow of a resource. A second aspect of the reporting of several accountings is the inclusion of multiple monetary measures of the same events or resources. Much research has demonstrated the presence of functional fixity in users of accounting data. [What Chang & Birnberg (1977) refer to as “data fixity”. See that work or Ashton (1977) for a discussion of the literature.] If this phenomenon persists, the typical user of the outputs of the system may find the richness of the system actually counter-productive to him. The most likely strategy for the user to follow is to accept one measure and reject the outputs of any other accountings. For example, a series of profit figures could be offered based upon a variety of rules - historical cost, a general price index and specific set of indices. In addition, the rules might choose to ignore or include the effects of inflation on net monetary assets in the profit calculation. Clearly these measurement rules each have their advocates and their uses. However, each has its detractors. The questions raised by presenting more than one of them are the effect of the load on the user and the ability of the user to sort out the appropriate measure. The former phrases the old information overload question in a different way. The results are not obvious. The second aspect is the ability of the user to utilize different data for different purposes. Will the user select a single measure, say the general price level, to answer all income related questions or will the user be able to shift between measures, i.e. accountings, as is appropriate? While a variety of accountants have advocated multiple measures, we have no experimental data or insights into the ability of decision makers to utilize these data. While the fixity issue may argue against their use, it may be possible that users will learn algorithms that use different numbers and use them appropriately. Between algorithms they may be flexible, but within an algorithm they may be fixated. Finally, the movement toward safe harbor rules by the S.E.C. to protect firms making disclosures the Commission wishes to encourage creates two distinct classes of data. One set has different legal implications than the other. Does this result in their being viewed differently by users? In summary, the notion that disclosure
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includes a variety of accountings raises several behavioral questions. Based upon existing research, there is good reason to believe that the outputs of these accountings may lead to conflicting data with which the fixated user cannot deal. Inductance-consequences issue The argument is being made with increasing frequency that accounting rules are altering management decisions. The manager plans his corporate acts with the same concern for external performance indicators as his subordinate shows when he struggles to achieve a targeted divisional ROI. The inductance argument as offered by Prakash & Rappaport (1977) focuses on the effects on behavior that flow from the selection of particular accounting rules. The inductance argument can be examined from two different perspectives. One is the effects on the behavior of management induced by the stewardship accounting rules. All induced behavior is not bad. Indeed, one of the purposes of the rules is to induce particular types of behavior. However, in other cases the accounting rules induce unintended behaviors that may be contrary to the best interest of the entity. The current controversy over F.A.S.B.8 (Foreign Operations) and to a lesser degree F.A.S.B.19 (Oil and Gas) are examples of this. For example, Rouse Corp. (1979) has argued that it has sold its interest in Canadian shopping centers and taken a management contract instead because of the effects of F.A.S.B.8 on its income statement. Rouse showed approximately 80% of its 1977 profits to be the result of foreign currency translation gains. If behavior is being induced, it raises questions again about the form of the accountings to be combined into financial disclosure. In this case the “as if’ translation creates an event for accounting purposes that does not have a real world counterpart. (No transfer between currencies occurred or need occur in the foreseeable future.) Accountants concerned with this problem may find the best solution in a multi-dimensional format of disclosure which permits separate reporting of different accountings. This permits management to argue for the measure it feels best describes the situation, but does provide the user with the alternative data. The second aspect of the inductanceconsequences issue goes beyond the stewardship relation as it is typically defined. This is the problem of political consequences of accounting
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data. For a publicly held corporation the reporting loops consist not only of the master-servant loop (i.e. the present investors) and one to the potential equity holder. There is a third loop linking the servant with the general public and public officials. While the last loop may not be formally serviced by the entity, data publicly disclosed will find their way into this channel as well. The results of this can readily be seen in the public’s response to the reported first quarter 1979 profits of the oil companies. At this point in time it is difficult to ascertain what consequences may follow. However, the initial response seemed to be reinforcing the public’s unwillingness to believe the existence of a gasoline shortage.* Other examples can be offered of the use of stewardship reports in areas for which they were unintended and with potentially adverse effects to the firm via the political process. What would appear to be the problem here is the use of the wrong accounting system’s profit figure. However, the numbers are not labeled as to which accounting produced them. Nor are the systems equipped with labels suggesting that their misuse may be harmful to someone’s economic health (but may be helpful to one’s political goals). Social reporting The plight of social reporting in the United States may be explained by its being, essentially, a stranger to stewardship reporting. The inclusion of these data in financial reports does not appear to have been reconciled as yet with the traditional views of stewardship accounting. Rather, it has been viewed as a separate accounting and often developed in a manner requiring presentation separate from the traditional statements. Social reporting is unique among the accountings in several ways. Initially, the impetus for much of the data it provides did not come from either the master or the servant groups. Rather it came from other sources who apparently failed to convince either of the groups of social reporting’s cost effectiveness to the primary users of the statement. This may explain some of its inability to become part of the set of disclosures. Policy implications for the F.A.S.B. The stewardship relations would appear to have
significant implications for the F.A.S.B. Initially, and perhaps most importantly, it argues for a reconsideration of the desirability of a single accounting framework. Rather, it supports the notion that we need criteria to decide issues related to the need for disclosure of given data and then the ascertaining of which accounting is appropriate. At least at first blush such an approach appears to have significant merit. It does not require the F.A.S.B. to choose one accounting over another. It does not raise as many political issues as the single accounting approach does. It permits more tentative steps toward solution of issues than the single framework approach. The first two points can best be viewed by reviewing the debate over the framework as it has progressed. Sprouse highlighted the problem at the Wharton Conference (Solomons, 1977). There Sprouse stressed two issues. One was that the two primary points of view - balance sheet and income statement - force a choice between the relative merits of the two points of view. Choosing a set of rules more appropriate for balance sheet measurement results in an accounting for income using inappropriate rules. Conversely, selecting the income approach leads to a balance sheet of residuals and suspense accounts (p. 11). Significantly, he alluded to there being “A third view about which much less is known . .“. This is what he described as the non-articulation view. Sprouse’s description of this view is in our framework the parallel and independent existence of an accounting for balance sheets and an accounting for income statements without the need for the rules of one accounting to apply outside its appropriate domain. Thus the present link between the statements via the reconciliation of retained earnings could, for practical purposes, cease to exist. It is not surprising that in the subsequent discussion of these views only the balance sheet and income statement views are covered. Such a solution would be reasonable if the F.A.S.B. is searching for truth. That is, a single accounting for all data. However, the F.A.S.B. discussion memorandum is, according to Sprouse (p. 27) searching for a constitution. Clearly, if the latter is
z Even whilst this paper was being given its final revision, the officers of Chrysler Corporation were quoted on CBS news as using the cash rebate plan on their cars to stimulate sales and offset the bad image Chrysler had developed from their financial problems.
THE ROLE OF ACCOUNTING
viewed as a popularly accepted set of rules, there is no reason why it must confine itself to a single set of rules. Rather, it should be broad enough to be politically acceptable. Such a document could incorporate more than a single accounting and specify the domain of each and the extent to which they intersect. The multiple accountings view of the F.A.S.B.‘s framework should also provide a more flexible document for it offers greater options to the Board in selecting a solution. A flexible document is less likely to fall because of solutions that lead to what user and/or producer groups feel are absurdities. Such anomalous results usually lead to conflicts either among accountants or between accountants and the producer or user groups, e.g. F.A.S.B.8. While the Board has shown a willingness to reconsider its past decisions - a positive sign to be sure - any change in the prior statements will be viewed as justice delayed by the proponents of the changes. Similarly, the existence of different accountings offers the potential for quicker resolution of thorny issues for it affords the Board the ability to make a more tentative decision by allocating the data to a set of accounting rules for more tentative data. This would appear to be the implication of the S.E.C.‘s decision on price level data and the decision initially contemplated by the S.E.C. for oil and gas accounting. In essence, the S.E.C. is developing two accountings. One is intended for traditional data and new data that meets the (unstated) test for admission to that set. These are the financial statement portion of the rules for the S.E.C. filings. In addition, other data deemed potentially useful by the S.E.C. and its staff are included separately. The intent in their inclusion is to experiment both with their feasibility and their usefulness. Obviously the existence of several accountings raises the issue of cost. Without knowledge of how the accountings would be constituted, cost estimates are impossible. To some degree the cost
IN FINANCIAL
DISCLOSURE
of our present system associated with other are already collected. cost is already hidden total cost.
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includes costs that would be accountings, for certain data However, how much of the is no more obvious than the
SUMMARY AND CONCLUSION In general it would appear that the disclosure problems being experienced are the result of contemporary economic relationships requiring more than a single accounting to properly portray their effects to the users of financial statements. The strategic stewardship relationship requires both retrospective and prospective data. It would seem that traditional historical measures of resources and activities are inadequate to assess the activities of a complex organization pictured in the midst of its activities. Anyone who expects accounting (any accounting) to dispel uncertainty from an uncertain world or render simple complex activities is setting high, if not impossible, standards. In addition, trying for the sake of trying entails risks as well. If one relies on the data fixity literature, individual investors can be led astray. In addition, rules of accounting, once set, affect behavior. Managers may find some of the rules onerous - some sufficiently onerous to alter their behavior to the detriment of the firm and its investors. Unfortunately, the obvious solution of using several accountings in the disclosure process may be fraught with human information processing problems. Will the user be able to keep the data sets separate? What will happen when the systems generate conflicting results? It may be that the problem of disclosure is more difficult than many first anticipated. While the notion of getting the right data to the investor is appealing, it clearly is extremely difficult.
BIBLIOGRAPHY Ashton, R., Cognitive Changes Induced by Accounting Changes: Experimental Evidence on the Functional Fixation Hypothesis, Studies on Human Information Processing in Accounting (Supplement to Journal of Accounting Research, 1977). Birnberg, J. & Dopuch, N., A Suggested Framework for Disclosure, Journal of Accountancy (February, 1963). Chang, D. & Birnberg, J., Functional Fixity in Accounting Research: Perspective and New Data, Journal of Accounting Research (1977).
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JACOB G. BJRNBERG Colantoni, C., Cooper, W. W. & Dietzer, H. J., Budgetary Disclosure and Corporate Social Reporting, in M. Dierkes and R. A. Bauer (eds.), Corporate Social Accounting (N.Y.: Praeger, 1973). Ijiri, Y., Theory of Accounting Measurement (AAA, Sarasota, Florida, 1975). Paton, W., Accounting theory (1922; Reissued in 1962 by ASP, Ltd, Chicago). Prakash, P. & Rappaport, A., Information Inductance and Its Significance for Accounting, Accounting, Organizations and Society (1977). Ronen, J., The Dual Role of Accounting: A Financial Economics Perspective, in J. Bicksler (ed.), Handbook of Financial Economics (North Holland, Amsterdam, 1979). Rouse Corp., 1979, Presentation to F.A.S.B. An Amending Statement pp. l-12, Dated 14 August (1978). Schrader, W., The Conceptual Framework for Financial Accounting and Reporting: Historical Approach, in J. Cramer and C. Neyhart, Jr., Conceptual Framework for Financial Accounting and Reporting: Present and Future (Center for Research, College of Business Administration, Penn State University, no date). Solomons, D., The Conceptual Framework of Accounting (Proceedings of a Conference held on 4 May, 1977) Wharton School: Philadelphia (1977). Watts, R., Corporate Financial Statements: A Product of the Market and Political Process, Australian Journal of Management
(1977).
Watts, R. & Zimmerman, J., Towards a Positive Theory of the Determination of Accounting Standards, Accounting Review (January, 1978). Watts, R. & Zimmerman, J., The Demand for and Supply of Accounting Theories: The Market for Excuses, Accounting Review (April, 1979).