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A return to basics.

A Return to Basics

Realized vs. realizable, historical cost vs. replacement cost, LIFO vs. FIFO, straight-line depreciation vs. accelerated depreciation. This list, while not all inclusive, has led to some of the most hotly debated issues - accounting for income taxes and accounting for retiree health care benefits - currently facing contemporary accounting today.

While the determination and reporting of income is the primary concern of the financial accountant today, it also creates the most troublesome problems. The figures obtained by any two accountants, even under identical circumstances, will rarely ever be exactly the same. There are two basic reasons for this: 1. Accounting is primarily and

always will be an art and not

a science. It deals with and is

based on fair estimates and

sound judgment. 2. Despite the many regulations,

recommendations and opinions

issued by the various

regulatory bodies, there still

remain many gray areas for

the exercise of the accountant's

professional judgment.

An example might best illustrate the dilemma of contemporary accountants. Suppose two accountants compute net income for a firm. Accountant A employs straight-line depreciation and the FIFO method of inventory pricing and computes net income to be $500,000. Accountant B uses an accelerated depreciation method and the LIFO method of valuing inventories and determines net income to be $300,000. One might ask which accountant is right? According to contemporary accounting, both are right because both followed accepted methods of accounting.

Income Determination - A


The important concept in the determination of income is not the bottom line but rather the ritual used in obtaining the bottom line. Both accountants in the above example followed the ritual of inventory accounting and depreciation accounting. But suppose the president of the firm makes an estimate of net income at $400,000. He bases his estimate on recent sales, cash receipts and disbursements, current inventories, etc. According to contemporary accounting procedures this figure is wrong. Even though it falls well within the range of the figures already presented, it is incorrect because the president didn't go through the ritual prescribed by accountants.

One might well ask, why is contemporary accounting so replete with ritual? The first reason is the way in which accounting has evolved from simple bookkeeping for simple firms to complex accounting for complex corporations. The second reason is the fiscal period hypothesis: because accounting has adopted an arbitrary time span, its reporting techniques must be based on a fiscal year rather than on business decisions.

Logic vs. Random Choice

The implication here is not that there should be one set of procedures to be followed in determining net income, but that there should be some logic for selecting the individual procedure followed in particular circumstances. To date, the contemporary accountant has only to choose an accepted method of depreciation or inventory valuation and apply it on a consistent basis, regardless the best choice among the alternatives available. It is questionable that the objective of accounting is being achieved through this random selection of alternatives.

Objective of Accounting

The primary objective of good accounting is that it be useful. As obvious as this may seem, the contemporary accountant has become so engrossed in the details and intricacies of his profession that he may not realize that the users of accounting data are paying less and less attention to his work.

This premise can be substantiated by selecting the annual report of most any firm and observing the number of footnotes and interpretive comments attached to the financial statements. While it is true that a word or two can often throw new light and meaning on a financial statement, one must question whether the statements fulfill their purpose when the number of words and figures in the footnotes exceeds those in the statements! If an artist drew a picture on the top half of his canvas and then had to explain nearly every detail on the bottom half of the canvas, surely he would begin anew. As accountants we must do the same.


If financial statements are not meeting their objectives, particularly in the art of income determination, it is due to something major and fundamental which approaches the very essence of the financial statements. It is not something related to the methods or techniques or even to the principles, but rather it is related to the conceptual framework of accounting.

For many years accounting has been accused of putting the cart before the horse; it is now time to rectify this position. Accountants should develop a conceptual framework upon which accounting principles and opinions can rest. Through the development of a framework, the accounting profession can develop a preventive approach - avoiding problems before they occur - rather than a remedial approach - attempting to correct problems after they have already surfaced.

Financial Accounting

Standards Board (FASB)

One of the major goals of the FASB at its inception was the development of a conceptual framework. The framework project would be a long-range goal to develop qualitative standards that would guide companies in reporting transactions for financial accounting purposes. The framework would also be a conceptual guide for individual practicing accountants faced with reporting a new type of transaction for which no generally accepted accounting principles existed.

To this end the FASB has issued five statements on accounting concepts - one in 1978, three in 1980 and the last in 1984 - but as of yet it is still not finished with the project that began in 1973. (In reality, there are six statements. Number six replaces and expands number three to include not-for-profit organizations.) One of the major reasons the framework project remains incomplete is the controversy over which approach the board should take. Specifically, should the framework project be prescriptive or descriptive in nature?

Prescriptive Approach

The prescriptive approach is seen as advantageous because of its abandonment of the notion that current practice should be reflected in the standards. The prescriptive would set theoretical guides that establish what ought to be reflected in financial statements. This approach would allow the questioning and examining of current standards based on a study of what ought to exist rather than assuming that current practice must be correct simply because it is being used.

A proponent of the prescriptive approach was the Trueblood Committee. The objective of this committee was to investigate the long-range objectives of accounting and financial reporting. The committee concluded that a prescriptive approach to a framework project would be preferable because of the overall theoretical soundness. The committee hoped a conceptual framework established on a prescriptive approach would "move the accounting profession away from problem-solving on a piecemeal or brushfire basis."(1) It would also be a guide to practicing accountants setting future standards where no authoritative standards existed.

Descriptive Approach

The descriptive approach entails developing standards by studying and summarizing current practice. Practicing accountants tend to favor this method because it is likely to cause very little change in their practice. This is due to the fact that a conceptual framework descriptive in nature would be a reflection of accountant's current decisions and practices. The primary advantage of this approach would be the practicality of the resulting standards.

There are two major disadvantages in simply using a descriptive approach: 1. It assumes that what is happening

in practice is the right

and most useful technique.

This assumption limits the

standard-setting body to

studying and developing

theories on current practice

only and questioning the

usefulness of the practice. 2. Even though consensus can

be reached in regards to current

practices, great difficulty

exists in reaching agreement

on why that practice is employed.

Without knowing

the reasoning behind a practice

and achieving a general

consensus on that reasoning

it would be difficult to use

the concept in setting new



It is important to realize that the FASB was created in response to specific criticisms of the Accounting Principles Board (APB). Some of the criticisms ranged from being too "cookbookish" in its pronouncements and high costs associated with implementation to financial statements which do not serve the end users.

Also, at the FASB's inception, many business executives noted that the FASB was a do-or-die effort to keep the standard-setting process within the profession. This was so noted in an article from Business Week which stated, "Financial executives recognize that the FASB may be the last chance to avoid government control of accounting."(2)

Deja Vu. The same complaints directed toward the APB resemble the criticisms directed toward the FASB today. Also, Representative John D. Dingell of Michigan held hearings on a number of accounting and auditing matters, one of which was the issuing of effective and timely standards.

While a delicate balance exists between the private and public sector, the profession must address the conceptual framework project and change from the descriptive to the prescriptive approach for standard setting or risk the increased threat of regulation. If self-induced change is not forthcoming, can intervention and regulation by some government standards-setting body be far off?


(1) "A Report to Change the Accounting Profession," Business Week, March 25, 1972: pp. 86-87.

(2) "The Accountant's Last Chance," Business Week, March 31, 1973: p. 91.

Anthony L. Tocco, PhD, is associate professor of accounting at Rockhurst College in Kansas City, Missouri.

Christina L. Verling, CPA, is currently employed as a tax staff accountant with Ernst & Young in the Kansas city, Missouri. office. Christina joined Ernst & Young after graduating summa cum laude from Rockhurst College. Her performance on the November CPA examination earned her the Elijah Watts Sells Certificate of High Distinction.
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Title Annotation:accounting standards
Author:Tocco, Anthony L.; Vierling, Christina L.
Publication:The National Public Accountant
Article Type:column
Date:Dec 1, 1990
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