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Accountability standards for corporate reporting.


Six new assertion reports would provide more information about corporate stewardship.

The chief executive officer of the ABC Corporation met with the chief financial officer to discuss the agenda for the annual stockholders' meeting. "Let's see," began the CEO. "After the board chairman's opening remarks, we have to have enough time to cover all our assertion reports."

"That's right," the CFO said. "And since this is the first year we have a complete set available for the stockholders, we want to leave enough time for questions and answers."

The reports the company will present are

* The annual financial statements.

* The report on control structure.

* The report on overall compliance with contracts and applicable laws and regulations.

* The operations report asserting resources were used efficiently and economically.

* The goals and objectives report on the progress made this year.

* The fraud deterrence report, which summarizes the status of activities preventing fraud.

Is the scenario too far-fetched? Or are we closer to this situation than we care to imagine? This article argues that, before the end of this century, this scene could--and should--take place before a typical stockholders' meeting.


There are many pressures for greater accountability today. Public officials, product manufacturers and medical practitioners are being scrutinized by a skeptical public. The public also has found numerous reasons to question corporate responsibility. The Federal Deposit Insurance Corp. reported to the House Banking Subcommittee that one-third of all bank failures result from fraud, embezzlement or theft. Well-publicized business failures caused by unethical behavior include ZZZZ Best Company, Penn Square Bank, ESM Government Securities and the many savings and loan and bank failures. A Wall Street Journal survey of business executives found one-quarter believe ethical behavior can impede a successful career. The public wonders: Can business be held accountable for its actions or is government intervention the only solution?

When faced with demands for broader accountability, the General Accounting Office expanded its audit standards and programs to include performance audits. In business, internal auditors examine more than financial information to meet corporate needs. Is it time for the accounting profession to acknowledge demands for accountability and promote the establishment of a more comprehensive reporting structure in the business community?


Being held accountable means being obligated to explain one's actions--to justify what one does. Fifteen years ago, the Accounting Objectives Study Group (the Trueblood commission) broadly defined management accountability to include providing information for decision making and stewardship. It described financial statement reporting as a subset of accountability. Financial statements provide an overall summary of the consequences of management's activities and thus supply information investors, creditors and others can use to make decisions. However, evaluations of stewardship require information on operations management--how well resources were managed and whether appropriate systems and processes were used to ensure efficient and effective accomplishment of the stewardship function.

Current evidence of demands for stewardship information includes the following:

* The nature of stockholder litigation. A study of lawsuits against auditors shows they are not necessarily triggered by bankruptcy alone. Lawsuits are more frequent and the settlements larger when fraudulent activities are involved.

* The report of the National Commission on Fraudulent Financial Reporting (the Treadway report). The Treadway report said, "When a company raises funds from the public, that company assumes an obligation of public trust and a commensurate level of accountability to the public. One of the most fundamental obligations of the public company is the full and fair public disclosure of corporate information, including financial results."

The report increased the responsibility of top management to oversee the financial reporting process and maintain internal controls. It recommended

1. Establishment of informed, vigilant audit committees to oversee financial reporting and internal controls.

2. A Securities and Exchange Commission rule that all public companies include in their annual reports a management statement that acknowledges management's responsibilities for the financial statements and internal control and assesses the latter's effectiveness.

3. An SEC rule that all annual reports include a letter signed by the audit committee chairman describing the audit committee's responsibilities and its activities during the year. Subsequent to Treadway, the SEC proposed annual reports contain statements from management on its responsibilities for the financial statements and the internal control system and provide an assessment of the effectiveness of internal control.

The SEC clearly agrees with the Treadway commission's call for increased accountability by management and audit committees.

* The hearings of the Oversight and Investigations Subcommittee of the House Commerce Committee (headed by Congressman John Dingell [D-Mich.]) and the persistent expectation gap that prompted these hearings.

* The GAO's urgings that the accounting profession expand the attest function. U.S. Comptroller General Charles A. Bowsher has recommended that public company auditors adopt some of the policies of government reporting, including reporting on internal controls as well as on compliance with laws and regulations.


A possible model for expanded corporate accountability is the generally accepted government auditing standards (GAGAS), which contain standards for performance audit reports on compliance, efficiency and effectiveness, as well as financial audit reports. The standards are grounded on the following basic premises about accountability:

* Management is required to render a full account of its activities to the public.

* Public officials are responsible for using resources efficiently, economically and effectively to achieve the purposes for which they were furnished.

* Public officials are accountable and should report both to the public and to other levels and branches of government for the resources provided them.

* These officials must establish and maintain an effective internal control system to ensure appropriate goals and services are met; resources are safeguarded; laws and regulations are followed; and reliable data are obtained, maintained and fairly disclosed.

GAGAS assume when public money is "invested" in an activity, management is broadly accountable for exercising proper stewardship.

One could argue that the accountability links between government activities and taxpayers are clearer than those between businesses and their stockholders and creditors. However, the Trueblood commission implied a stronger measure of accountability when it stated the following: "The enterprise itself is accountable to those who furnish resources, that is, to its creditors and its owners. . . . [It] is accountable for its actions, or inactions, in discharging a wide range of responsibilities."


Given the demands for greater accountability, shouldn't corporate officials also give a broad accounting of their activities? Will the profession continue to restrict its efforts to amendments of financial statement reporting standards or should it direct its energies toward the adoption of a bold, innovative approach to new accountability standards?

Critics say the historical, cost-based financial statement model no longer fully satisfies statement users' varied needs to make business decisions and evaluate managers' performance. Too frequently, the response has been to focus on the inadequacies of traditional financial statements presented under generally accepted accounting principles.

Perhaps the time has come for the profession to admit that typical financial statements can't serve all the information needs of interested outside parties. Rather than fit all needed information and disclosures into the financial statement and footnote structure, the profession should embrace other forms of assertion reporting by management. The American Institute of CPAs should take the lead in organizing the development of an integrated set of accountability standards for corporations. Perhaps a blue-ribbon commission could evaluate the need for broader accountability and develop recommendations.

The scope of the new standards could go well beyond current accounting and financial reporting standards. The areas most frequently cited by the SEC and the Treadway report--reporting on the structure of internal controls and on compliance with laws, regulations and other requisites--would be good starting points. The sidebar on page 96 illustrates a conceptual framework for broadening management accountability reporting.


The profession can use many existing accounting, financial reporting and auditing standards to serve as the basis for an expanded set of accountability standards. They include

* Government Auditing Standards, 1988 revision (the yellow book).

* The new AICPA "expectation gap" Statements on Auditing Standards nos. 53 through 61.

* SAS no. 62, Special Reports and no. 63, Compliance Auditing.

* The AICPA statement on standards for attestation engagements.

* The AICPA MAS special report, Comparing Attest and Management Advisory Services: A Guide for the Practitioner.

Expanded reporting standards likely will not be received enthusiastically by corporate management. The profession will have to gain support and join with corporate financial leaders to explore approaches to developing standards. Although assertions on areas outside the financial statements are not required, some corporate managements do make explicit assertions about control structure, compliance and fraud in letters accompanying financial statements. Many also include comments about goal achievement and economy and about efficiency in the management discussion and analysis section. The existence of these disclosures implies that some managements acknowledge the importance of accountability information.

If accountability standards for corporate reporting are established, the next step will be to extend the attest function to include the new assertions. CPAs already attest to assertions not included in financial statements, such as assurances to computer software developers that software will perform as advertised; assurances to advertisers that circulation data of newspapers and radio stations are reliable; and assurances to unions that productivity indicators in labor union contracts are credible. Existing professional standards provide an excellent basis for expanding attest standards for broader accountability reporting.


Full accountability--not just financial statement reporting--is what audit committees, equity and debt investors and government entities seem to need. A full set of accountability standards covering all areas obviously could not be developed overnight. Rather, a gradual, deliberate process seems more desirable, but with a clear focus on accountability. By assuming the leadership role in developing new standards, the AICPA could address the needs of many constituencies interested in corporate performance. This initiative will be perceived as a substantive response to the questions raised by the Dingell hearings and the Treadway commission.

The effort also could open new markets for CPA services in the private sector and strengthen existing capabilities in state and local government audits. The accounting profession is better equipped than any other to undertake this action and to perform the expanded services required for its full implementation. These new opportunities deserve serious consideration if the profession is to meet the challenges facing it in the 21st century.


Exhibit 1 on page 98 shows a conceptual framework for broadening management accountability reporting. This "umbrella concept" identifies the primary recipients of reports on accountability. Each recipient has specific objectives that can be satisfied using information management provides through assertions made about the six areas of accountability. Exhibit 2 on page 100 matches the forms of accountability with the various constituents.

If audit committees assume the responsibilities recommended by the Treadway report, they will need information from all six areas to assist them in evaluations. Many managements may already provide this information privately to their audit committees. Making assertions publicly will not only provide useful information to external users but also prove the audit committee fulfilled its responsibilities.

The second group of constituents--stockholderss, creditors and investors--wants information on past, present and future financial performance and on management's overall performance. Financial statements may help them judge past and present performance, but evaluations of future performance could require additional assertions on internal control, compliance, economy and efficiency, effectiveness and program goals. An assessment of management's overall performance also would be enhanced by reports on all six areas of accountability.

Government entities that have contracts with businesses want information on an organization's financial health, its ability to allocate costs to contracts and its compliance with applicable lawss and regulations. They would use the same assertion reports as corporate debt and equity investors, but they would also look to reports on compliance and fraud to monitor compliance with applicable laws and regulations.


Management accountabilities

Management issues reports asserting it has fulfilled its responsibilities for achieving overall results and for the manner

in which operations are carried out:

Financial statements: Presents statements in accordance with GAAP. Control Structure: Establishes and maintains a control structure sufficient to ensure that assets are safeguarded and management policies and procedures are followed. Compliance: Ensures the organization's compliance with applicable laws, regulations, policies and procedures. Economy and efficiency: Uses resources and operates the organization in an economical and efficient manner. Goal achievement: Affairs the company's specified goals and objectives. Fraud: Maintains proper control framework and processes to deter fraudulent activities and results. To whom is management accountable? Audit committees Stockholders, creditors and potential investors [Exhibit 2 Omitted]

ERNEST J. PAVLOCK, CPA, PhD, is a professor of accounting at the Northern Virginia Graduate Center of Virginia Polytechnic Institute and State University, Falls Church, and a former member of the American Institute of CPAs future issues committee. FRANK S. SATO, CPA, is national director of federal audit services at Deloitte & Touche in Washington, D.C., and a former member of the future issues committee. JAMES A. YARDLEY CPA, PhD, is an assistant professor of accounting at Virginia Polytechnic Institute and State University in Blacksburg.
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Author:Yardley, James A.
Publication:Journal of Accountancy
Date:May 1, 1990
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