Accounting and the Public Interest Volume 11, 2011 Pages 116129

American Accounting Association DOI: 10.2308/apin-10122

The Accounting Identity and the Identity of Accountants: Accountings Competing Paradigms through the Prism of Professional Practice
James M. Cataldo and J. Morris McInnes ABSTRACT: The Accounting Identity, Assets = Liabilities Equity, is emblematic of the quest for a concise and universal conceptual framework for the discipline of accounting. This essentially idealistic aspiration stands in opposition to more contextsensitive perspectives, such as socio-historical and postmodern schools of accounting thought. We examine these competing paradigms on both the macro level of standards setting and on the more intimate level of professional identity. In this paper, we argue that the practice of accounting finds stronger support and commonality with context-sensitive intellectual traditions than with idealist approaches. We advocate a vision for the identity of accountants grounded in appreciation of our own intellectual heritage and accountings distinctive role in society. Keywords: fair value; representational faithfulness; conceptual framework; profession of accounting.

INTRODUCTION
All inquiry is colored by the background of the investigators, and ours collectively reflects nearly 30 years in financial practice and 40 years in academic accounting. Although scholarship ultimately won the contest for our vocational allegiance, we still view accounting theory through a distinctly pragmatic prism. For us, the main value of a conceptual framework lies in how well it both supports and symbolizes the challenging, often thankless, role accountants play in the economic affairs of society. Although this view is common to many academicians and professionals, our years in industry bring a particular personal cast to the link between theory and practice. Recent sentiment seems to associate the intellectual and professional respectability of accounting with the promotion and promulgation of an authoritative conceptual framework.

James M. Cataldo is an Assistant Professor and J. Morris McInnes is a Professor, both at Suffolk University.
The authors acknowledge the many helpful comments and suggestions of Barbara Merino, Val Mulcahy, Laurie Pant, Miriam Weismann, Paul Williams, Alex Yen, Heather Byer, and two anonymous reviewers.

Published Online: December 2011

Cataldo and McInnes

117

According to this view, elevating the pragmatic guidelines of SFAC 17 to a more unified and intellectually elegant conceptual framework is an essential stage in the transition from a diffuse, practice-based foundation to a new principles-based foundation.1 Key to these aspirations is the effort to consolidate accountings disparate measurement frameworks around a unifying principle of Representational Faithfulness (IASB and FASB 2007; FASB 2007). These efforts have major personal and practical significance for the profession. Long-established accounting attributes such as conservatism, reliability, and verifiability carry strong personal overtones and intertwine with the professional self-image of many practicing accountants. Idealist doctrines such as Representational Faithfulness entail excision or radical demotion of such attributes from accountings conceptual cannon (Barth 2008), drawing their inspiration instead from theoretical principles. Ravenscroft and Williams (2009) elucidate the broad influence of neoclassical economics on accounting thought in the post-World War II era. Neoclassical economics offers concise concepts such as competitive equilibrium and efficient pricing as attractive alternatives to the disparate and often arbitrary-seeming collection of conventions that have traditionally characterized the profession. We often observe the sense of assurance and exceptionalism that mastery of these concepts can lend to their acolytes in economics and finance. Thus, emulation of these disciplines may hold considerable personal appeal for the often beleaguered and underappreciated accountant. We will broadly refer to this aspirational stream within the accounting profession as the neoclassical or idealist attitude. Relationships between professional identity and accounting theory and practice have been explored elsewhere in the accounting and sociology literature. Carruthers and Espeland (1991) discuss how the double-entry technique advanced the notion of rationality in business affairs, which, in turn, played an important role advancing the social legitimacy of commerce. Similarly, we find broad personal and economic significance in attempts to replace transaction and accrual methods with the paradigm of Representational Faithfulness. Critics of the neoclassical attitude (Lee 2006; Macintosh 2006) argue that the pursuit of Principles-Based Accounting Standards is inconsistent with the practical function of financial reporting in the contemporary economic setting. Alexander and Archer (2003) argue that the principles-based approach rests on an excessively literalist view of markets and wealth. The literalist view impedes the development of effective accounting standards by neglecting the multifaceted and socially contingent nature of economic reality. Tinker (1988) and Shapiro (1997) offer trenchant critiques of the accounting professions reluctance to acknowledge the social and historical foundations of accounting practices. We will broadly characterize these views as representing context-sensitive or socio-historical (Shapiro 1997) approaches. Figure 1 summarizes our broad perspective on Idealist and Context-Sensitive intellectual traditions and their relationships to accounting practice. We advocate a stronger context-sensitive emphasis in both the intellectual and practical dimensions of the accounting profession. We discuss how the neoclassical attitude, originally adopted as a means to elevate the reputation and intellectual status of accounting, works in many ways to the detriment of our profession. We consider some of the barriers to the broader acceptance of the context-sensitive traditions of accounting thought, including some inflicted by its own proponents. Where possible, we seek to find common ground in the fundamental aspirations of both idealist and context-sensitive traditions.
1

This view is clearly expressed in Bullen and Crook (2005, 1): A common goal of the FASB and IASB . . . is for their standards to be principles-based. To be principles-based, standards cannot be a collection of conventions but rather must be rooted in fundamental concepts. Accounting and the Public Interest Volume 11, 2011

Cataldo and McInnes

118

FIGURE 1 Idealist versus Context Sensitive Intellectual Traditions and Links to Accounting Practice

TENSIONS BETWEEN THE SOCIO-HISTORICAL AND NEOCLASSICAL ATTITUDES IN THE ACCOUNTING PROFESSION
Neoclassical economics and quantitative finance rely heavily on theoretical constructs that emulate physical science or natural law. Competitive markets are often associated with natural selection, while the mathematical framework for equilibrium pricing was borrowed directly from engineering.2 The socially contingent foundations of accounting curtail the applicability of mechanistic approaches, as writers in the socio-historical tradition often remind us. For example, Tinker (1988, 1) identifies three sources of re-presentational distortion applicable to the theory and practice of accounting: [T]hose emanating from failing to acknowledge the constitutive potential of theorizing (stressing instead its natural and law-like character); those arising from overstating the empirical validity of theories; and those emerging from neglecting the interests that benefit from research. Such representational distortions arise from and take shape under the influence of deeper social, political, and economic motivations. As Tinker argues (1988, 1), a meaningful understanding of financial reporting issues requires comprehension of the social underpinnings of accounting practices and of the social allegiances of different forms of theorizing.
2

As the nineteenth-century market theoretician Leon Walras famously wrote, Je ne suis pas un economiste, je suis un architecte. Mais je sais mieux leconomie politique que les economists (I am not an economist, I am an architect. But I know economics better than the economists) (Walker 1983, 78). The influence of physical science is abundantly clear in contemporary finance as well. For example, Fisher Black initially pursued physics at Harvard before earning his Ph.D. in applied mathematics. Robert Merton studied engineering and applied mathematics before earning an economics Ph.D. at MIT. Accounting and the Public Interest Volume 11, 2011

Cataldo and McInnes

119

The role of social factors on the professions conceptual framework is widely, though not universally, conceded. However, one form of social allegiance that often goes unacknowledged is the allegiance of the accountant to his or her own self-image. Associations between economic interests and conceptual frameworks can, for better or worse, exert a powerful influence over how accountants regard both themselves and one another. Taken to an extreme, proponents of neoclassical economic theory become corporate shills in the eyes of their adversaries. Conversely, it can be tempting to characterize socio-historical or postmodern commentators as radicals or self-absorbed iconoclasts. Contempt for the other finds an insidious complement in elevated conceptions of our own views as morally, socially, or intellectually superior. Recognizing the accountants personal stake in the choice of conceptual framework does not necessarily resolve such conflicts, but might just help keep our worst human instincts at bay. Perhaps there is more common ground than we typically acknowledge. We often perceive a strong desire for accounting to serve, in variously defined ways, the social good. The long struggle for fuller recognition of pension liabilities, a goal widely shared across accountings intellectual spectrum, may be seen as one example. Social concerns seem most transparent in context-sensitive accounting approaches. For example, by illuminating the role of competing economic and social interests, the socio-historical analyst might seek to make accounting standards more resistant to exploitation by powerful interest groups. In this tradition, the link between personal and intellectual paradigms is clear: the goal of accounting, and the accountant, is to serve public welfare through the design and execution of the financial reporting system. Followers of idealist approaches, while quite different in emphasis, share some of these basic aspirations. Conceptual frameworks based on neoclassical principles are often advanced as a means of resisting harmful political and financial interests. For example, proponents of Fair Value and Representational Faithfulness consider this approach less susceptible to subversion and manipulation than the complex collection of conventions and procedures that make up our current system.3 Thus, we see an important sense in which socio-historical and neoclassical approaches offer competing vehicles for achieving similar aspirations. It also seems clear to us that the acceptance or success of a conceptual framework depends on its personal appeal as well as its intrinsic utility. Accountants, like everyone else, want to feel good about both what we do and who we are.

CHALLENGES TO BROADER ACCEPTANCE OF CONTEXTSENSITIVE APPROACHES

Considering accountings bland image in society at large, we find it remarkable that some of the most insightful and vital commentaries on the profession in recent years have emerged from postmodern and poststructuralist streams of thought (for example, Alexander and Archer 2003; Macintosh et al. 2000; Yamaji 2005). Though we believe these perspectives have much to offer the profession, we also find they present some troubling issues for the identity of accountantsissues that may impede their potential to inspire and guide the profession. Postmodern and poststructuralist discourse can quickly rise to a level of abstraction that is alien, and alienating, to the sensibilities of the accounting profession at large. We commonly find references to accounting
3

For a recent example, see Edward Trotts comment letters on FASBs recent exposure draft on financial instrument measurement (FASB 2010a). Trott repeats the often heard argument that fair value measurements are more objective and less susceptible to second guessing than traditional loan loss and impairment estimates. He also asserts that accounting standards should not be influenced by government policy or financial system regulatory objectivesa stark contrast to what we characterize as Context-Sensitive attitudes toward accounting theory. Accounting and the Public Interest Volume 11, 2011

Cataldo and McInnes

120

standards as fundamentally arbitrary and assertions that accounting and market signals lack any grounding in external reality. While these statements might be unremarkable in their original contexts, they do not, to put it mildly, travel well in policy and professional spheres. Much to the frustration of the practical-minded accountant, context-sensitive interpretations resist neat summation and satisfying resolution. Key insights tend to have a negative cast and can sound at first more like abdications than inspirations. Consider, for example, Macintoshs (2006) statement that perhaps the profession would be better off to face up to the distinct possibility that accounting may never rest on a rock-solid foundation of fundamental concepts and set aside the search. In a somewhat similar vein, Alexander and Archer (2003) offer a challenging critique of the correspondence theory of truth as a basis for accounting standards and emphasize the function of accounting in relation to a complex and multifaceted social reality. As we later argue, we believe that these two ideasthe limited relevance of an accounting conceptual framework, and that accounting cannot be conceived as a direct representation of economic truthare essential to the character of accounting and its distinctive contribution. Although poststructuralists may have the right medicine for our profession, we often see it administered in distinctly unpalatable forms. Consider, for example, two alternative paradigms for accounting standards setters offered by Macintosh et al. (2000, 43): (1) Willful myopia, or ignorance is bliss. Under this paradigm, an enlightened regulator might appoint myopic standards setters who truly believed they could apply outmoded notions of capital and income. Users, however, would know standards setters were myopic. Such a system would work on the theory that it does not matter where the anchor is sunk as long as it is stable.4 (2) Full rationality. This somewhat more palatable paradigm entails an acceptance of the notion that accounting standards are arbitrary and hyperreal. The function of standards setters would be facilitated by the recognition that the determination of accounting standards is a decision that makes the numbers useful, not a definitive answer to a question of what is real. Another noteworthy passage appears in Yamaji (2005, 149). Yamaji provides a compelling vision of accounting as a mechanism for promoting responsibility among organizations and individuals. However, the inspirational qualities of Yamajis conception of the profession are apt to be overshadowed by the pejorative overtones of the myth analogy: So while we cannot recognize any consistent logic within individual American accounting theories, we are able to recognize one when we treat them in their entirety as a myth. Notwithstanding the intrinsic merit of these arguments, they carry distinctly unflattering overtones in ordinary discourse. The difficulty with the myth analogy is more one of perception than substancethe underlying point about the contingent and narrative character of accounting standards is by no means a pejorative one. The issue of arbitrariness raises more substantive concerns. We fully agree that many potential sets of standards or systems might provide equally useful information to stakeholders. However, we think it is equally important to recognize that a set of standards now extant reflects a significant accumulation of professional, political, economic, and social experience. The process of arriving at these standards is chaotic but hardly arbitrary. Casual use of the term devalues the considerable substantive content embodied in the accounting discipline.
4

This choice seems intended not so much as a serious policy alternative, but rather as a way to illustrate the difficulty of arriving at a satisfactory accounting paradigm. Accounting and the Public Interest Volume 11, 2011

Cataldo and McInnes

121

The issue of arbitrariness merits particular attention as it seems a focus of criticism from all persuasions of accounting thought. However, while the previously cited authors use the term in a circumscribed, contextual sense, for those of the idealist school, arbitrariness is a general term of derision. Context-sensitive approaches view arbitrariness as a fundamental characteristic of accounting systems, to be engaged and assessed in context. Idealist commentators typically reserve the term for the traditional, and presumably outmoded, collection of current accounting conventions. The agenda behind the latter usage is self-evident, thus we turn our attention to the more substantive challenges presented by the former.

ARE ACCOUNTING STANDARDS ARBITRARY?

In poststructuralist analysis, the concept of arbitrariness expresses the dependence of financial reporting on social and historical conditions, and, more fundamentally, the indeterminate nature of both reality and representational paradigms. However, there is a vital distinction between this meaning and the one more commonly conveyed by the well-known legal term, arbitrary and capricious, that is, a lack of content, meaning, or justification. An interesting parallel to the poststructuralist perspective may be seen in the traditional accounting dictum that depreciation methods must simply be systematic and rational to qualify as acceptable reporting practice. To us, this exemplifies the essentially modest attitude of traditional accounting toward representational systems. Depreciation methods gather and organize information according to a set of defined procedures, but the value of the procedures lies more with their history, documentation, and broad acceptance than with any special claim to truth. The observational and procedural focus of traditional accounting is consistent with the poststructuralist notion of hyperreality insofar as it avoids any pretentions to absolute or unitary truth. Financial statements rarely provide definitive answers. Instead, it is widely accepted that they require an extensive interpretive process (peer comparisons, business and contextual analysis, various methods of valuation and credit analysis) in order to inform stakeholder decisions. Among the most basic lessons of accounting education is that the balance sheet is not, nor is it intended to be, a literal or comprehensive representation of value. The alternative paradigm of Representational Faithfulness holds out the possibility of achieving unambiguous, authoritative representations of economic reality through accounting measurement.5 In its attitudes toward truth, we find that traditional accountingostensibly the most literal of financial disciplinesand the doctrine of hyperreality make strangely compatible bedfellows. Ultimately, however, we view the choice of conceptual framework as a pragmatic one. What is the appropriate response to the challenges of the economic and political environment? Is the challenge best met by a more unified and authoritative conceptual framework, inspired, perhaps, by the spectacular success of theoretical methods in the physical sciences? Or should we embrace social and contextual understanding as the genuine foundation of our discipline and the best guide to policy and theory? If we hold that a central element of the identity of accountants is the desire to serve a useful role in society, then our goal is to find the balance of emphasis that best empowers the profession and inspires the individual.

We risk a form of the straw man fallacy (Shapiro 1997) by ascribing a literal conception of External Realism or Correspondence Theory of Truth to the elements we criticize within the profession. Nonetheless, it still seems fair to say that most proponents of Representational Faithfulness appear quite far from Shapiros nuanced and context-sensitive perspective on economic reality. For example, see CPA Journals interview with IASB member and Fair Value proponent Tom Jones (Murray 2008). Accounting and the Public Interest Volume 11, 2011

Cataldo and McInnes

122

ARBITRARINESS RECONSIDERED: THE ROLE OF EARNINGS IN THE VALUATION NARRATIVE

We see lifting the stigma of arbitrariness from practice-based accounting as a key to reaching a better balance between idealist and context-sensitive perspectives. One of the most difficult challenges faced by the profession stems from the poststructuralist insight that no single representational system has a preferred claim to economic reality. If so, how can we find a basis for many choices required for an effective financial reporting system, and how do we confer the requisite degree of authority and stability on the standards that are chosen? We will explore this question through analysis of the function of accounting earnings in firm valuation models. Equity valuation constitutes a type of narrative, a major purpose of which is to inform decisions about investment in a firm. At the most elementary level, equity investment decisions involve comparing a stocks current market price to some estimate of intrinsic economic value. Conventionally, the stock price times shares outstanding is taken to represent the firms market valuation, while an estimate based on all future earnings or cash flows is taken to represent the firms stand-alone economic value.6 Deviations between market price and such estimates of value serve to direct capital toward good investments and away from less desirable ones. Equity investors require long-term forecasts of future value flows to estimate value, and net income is the primary accounting representation of such flows. Thus, the usefulness of the net income measure for equity investment is best seen through its role in the operation of firm valuation models.7 Our presentation stresses the substantive import of conventional boundaries between capital and income as they have developed over time in the financial reporting system. We build on the exposition of the clean surplus valuation model developed in Macintosh et al. (2000). However, while Macintosh et al. (2000) use this framework to illuminate the interchangeable characteristics of capital and income, we observe that, in an operational context, the conventional boundaries between these two measures are far from accidental or arbitrary.8 We begin with the basic representation of the excess earnings model of firm valuation as: ! X E1 rBV0 Et rBVt1 1 MV0 =BV0 1 r 1 rt
t=2

where: MV = market value of firm equity;

6

As Paul Williams commented in response to an earlier version of this paper, the objective of stock valuation models (i.e., enterprise value) is seldom if ever directly observed. Current stock price is a valuation at the margin rather than a pro-rata share of total value. Acquisition prices reflect many factors unrelated to the target firms earnings potential, such as the market power of the acquirer in the transaction or the value of direct and indirect benefits resulting from the combination of the two particular firms. 7 While firm valuation is critical to equity investors, we acknowledge that other objectives, including assessment of financial institution solvency, may have equal or greater importance to other constituencies. Fair value representation of assets and liabilities can play a highly useful role in this regard. However, solvency represents a distinct dimension of financial condition, and we contend that Fair Value is best presented separately from earnings in its own narrative frameworkfor example, a statement of Fair Values (Cataldo and McInnes 2007). 8 This distinction is largely one of emphasis. For example, MacIntosh et al. (2000) also assert that the arbitrary characteristics of the capital versus income distinctions do not negate the usefulness of these categories for accomplishing financial reporting and valuation objectives. Accounting and the Public Interest Volume 11, 2011

Cataldo and McInnes

123

BV = book value of equity; E = accounting net income; and r = the cost of equity capital. In the implementation of this model, BV0 represents the current accounting estimate of equity or capital, and the series Et represents the investors forecast of future earnings. We depart from Macintosh et al. (2000) by positing that d, the increment to the valuation of BV0, is not arbitrary but instead arises from changes to projected earnings from the revalued capital asset: ! X DEt d= : 2 t 1 r t=1 Earnings Et are commonly expressed as the product of BVt and ROE (Palepu and Healy 2007). If we assume growth in BV is equal to a constant g, then the above expression translates to: ! X ROE r BV0 ROE r 1 gt1 BV0 MV0 =BV0 ; 3a 1 r 1 rt
t=2

expressed more simply as:

MV0 =BV0 @1

1 X t1 ROE r 1 g
t =2

1 r

A:

3b

From inspection of Equation (1), it can be seen that the equivalent revaluation of MV0 is obtained if either the amount d is applied to BV0 or the earnings forecasts are revised by DEt, but not both. We also note that in the ROE formulation, the same revaluation is obtained by either a downward revision in projected ROE ( BV0 constant) or a downward revision of d in MV0 with projected ROE held constant. While these alternative representations of changes in expected returns are mathematically equivalent, their presentation and classification are critically important to the consistency of the valuation narrative. Fair Value and accrual measures function very differently within the narrative of firm valuation. The introduction of unrealized Fair Value changes into the category of income subverts the usefulness and coherence of financial statement information to the common user. Through a long process of education, acculturation, and experience, the financial community has come to understand net income as an indication of expected future flows of value from the basic business operations of the firm. This interpretation is grounded in the matching principle, and its importance is seen in the close attention paid to changes in earnings as harbingers of future prospects.9 The critical issue centers on the accounting classification of the Fair Value increment d. Earnings, as the concept has developed since the transition of commerce from discrete ventures to going concerns, refers to a flow of value over a defined time interval rather than the impact of all
9

Accounting research exhibits a rare degree of consensus in supporting the value of net income as a predictor of both future cash flows and future net income. Specifically, net income and its various components have repeatedly been shown to outperform operating cash flows themselves as a predictor of future cash flows (Jordan et al. 2007). Therefore, while firm value is more tangibly associated with discounted cash flows, accounting earnings generally serve as a more effective basis for applied valuation models. Accounting and the Public Interest Volume 11, 2011

Cataldo and McInnes

124

future flows collapsed to the present. For the all-important purpose of forecasting future value flows, unrealized Fair Value changes must be clearly segregated from other elements of income so as not to exaggerate their implication for future outcomes. In other words, Fair Value changes must be interpreted as something fundamentally different from income to avoid confounding projections of future value flows. Advocates of Fair Value accounting seem intent on discarding such distinctions. This is evidenced by the standards setters promotion of Comprehensive Incomea haphazard combination of accrual income and unrealized changes in Fair Value. Income and Fair Value are two different measurement categories: the former is a measure of flow over a defined time interval, and the latter is an instantaneous measure encompassing all future projected flows. The two categories are fundamentally incommensurable; their sum has no coherent interpretation or application in standard models of firm valuation. By employing a variety of somewhat ad hoc rules and conventions, accounting has traditionally sought to preserve the usefulness and coherence of the income measure by limiting the impact of unrealized fair values on the income statement. Examples include FAS 115s classification of unrealized investment gains and losses into equity, complex pension accounting provisions designed to restrict the impact of pension asset value changes on net income, and impairment tests that employ undiscounted cash flows in preference to supposedly more economically realistic discounted cash flows (Cataldo and McInnes 2009). Departures between the book value and Fair Value of equity, while abhorrent to the notion of Representational Faithfulness, pose no great impediment to the application of excess earnings valuation methods. In the context of the excess-earnings model, BV0 may be misestimated if increments to unrealized Fair Value (d) are unrecognized. However, changes in subsequent earnings associated with d will produce an offsetting change in ROE. Thus the excess-earnings model is well capable of producing appropriate valuation results without the necessity of continuous revisions to balance sheet equity (BV0) from fluctuations in Fair Values. Book value of equity does not even enter as a relevant variable in P/E valuation models, and has limited importance for discounted cash flow valuation models.10 Reporting unrealized Fair Value changes through the income statement/balance-sheet framework distracts from financial statement usefulness by compromising the coherence of the income signal. The conventions of traditional transaction-based accounting, such as impairment rules, restrict the impact of Fair Values on income unless the change is negative, egregious, and not self-reversing. In a broader sense, the relationship between equity valuation and the seemingly haphazard set of conventions comprising the measurement of net income illustrates a kind of method behind the madness that can emerge from accounting traditions. Often, however, the logic of accounting standards is apparent only in retrospectas befits a system developed as much through an evolutionary process as by intelligent design.

IS ACCOUNTING GOOD ENOUGH? ACCOUNTINGS EMULATION OF NEOCLASSICAL ECONOMICS AS A PATH TO INTELLECTUAL RESPECTABILITY
While accounting had long been grounded mainly in the accumulation of experiential wisdom (Williams 2002), the entry of accounting into the academy in the mid-twentieth century seemed to
10

Demirakos et al. (2004) find DCF and P/E models to be most prevalent in industry applications. Excessearnings-based models are less widely used. Accounting and the Public Interest Volume 11, 2011

Cataldo and McInnes

125

demand the cultivation of a more elevated intellectual basis for the field. Among the social sciences, economics seemed the obvious aspirational model for accounting, if only for its high intellectual status and its apparent commonality of subject matter. Inspired largely by the Nobel Prize-winning work of the economist Sir John Hicks (1939) on capital and income, the Asset-Liability approach emerged as a radical alternative to the traditional accrual accounting framework. According to this approach, the entire framework of transaction-based accrual accounting would be replaced by a system that records every asset and liability at an estimate of its current economic value. Traditional concepts of revenue, expense, and matching have no place in this vision. What we currently understand as net income would be redefined as the change in book equitythat is, the difference between the estimated fair values of assets and liabilities, adjusted for primary capital flows. To its proponents, the main obstacle to this approach is the development of comprehensive and economically realistic measure of value. Given such a measure, the simple equation of Assets Liabilities = Equity supposedly becomes a literal and sufficient representation of enterprise value. The Hicksian model of income has considerable intuitive appeal and has the added advantage of dispensing with the vast and noisome collection of conventions required for the application of accrual accounting. However, remaking accounting in economics image carries with it the risk of misapprehending the principles of a distinct and notoriously difficult field. Furthermore, since the mid-twentieth century, economics itself has undergone significant changes that affect its suitability as a model for accounting. Having reached a kind of pinnacle in the 1960s, economics reputation was seriously challenged by its failure to provide effective responses to the stagflation phenomenon of the 1970s. Later, with the growth of financial engineering in the 1980s, quantitative finance gained some of the social and intellectual prestige previously reserved for economics.11 The increasingly open worship of the dollar and the embrace of deregulation and free-market ideology during the Reagan era seemed to make government, and economic economists, less relevant. By the mid-1980s, corporations were beginning to disband their economics departments, and the profession seemed to be in decline. Quantitative finance now offered nearly equal mathematical sophistication for the intellectually minded, with the additional promise of vast riches for the skilled acolyte. With the growing admiration of finance and financial engineering, much of the subtly in the economic foundations of both finance and accounting was lost. The beguiling precisionand apparent profitabilityof quantitative financial models made it easy to forget economic fundamentals. For generations, economists have struggled with fundamental issues of the stability and determinacy of market prices first raised by nineteenth-century market theoreticians, most notably Leon Walras Elements of Pure Economics in 18741877. Walras established that prices generated by market equilibrium processes are not unique, nor is their stability assured, even within the purest of neoclassical paradigms. These basic results remain fundamental to the study of economics to this day. Any well-trained economist in the neoclassical tradition is well versed in the daunting implications of issues such as imperfect competition (Robinson 1933), partial versus general equilibrium (Lipsey and Lancaster 1956), and questions as to the very existence of equilibrium (Arrow and Debreu 1954). Notwithstanding ample theoretical and experiential evidence to the contrary, healthy skepticism about the stability and rationality of markets has repeatedly given way to fascination with
11

For example, since 1985 (Franco Modigliani ), Nobel prizes in economics were frequently awarded for work in finance. Accounting and the Public Interest Volume 11, 2011

Cataldo and McInnes

126

mathematical models and theoretical constructs.12 Turmoil in the accounting profession occasioned by a series of scandals leading to the Sarbanes-Oxley Act of 2002 only seemed to increase the desire to find salvation in a new path of conceptual clarity based on the Asset-Liability Approach. This impulse found clear expression in the 2003 SEC study on the adoption of a principles-based accounting system: Since we believe that the FASB should maintain the asset/ liability view in continuing its move to an objectives-oriented standard setting regime, we also believe that the FASB should eliminate the inconsistency by removing the need to assess the earnings process in the determination of revenue recognition. FASBs goal of replacing transaction and accrual-based measurements with Fair Value has been apparent for some time now. The Fair Value Option (FASB 2007) represented a major step in this direction. More recently, FASB proposed mandatory Fair Value reporting of loans and all other financial instruments (FASB 2010a). For the moment, however, widespread objections from the financial community have evidently forced a retreat (BNA 2011). The Asset-Liability approach and the doctrine of Representational Faithfulness seem, in many ways, a reactionary response to the challenges of our profession. The Asset-Liability approach recalls a distant time when accounting signs of income and capital functioned as counterfeits of the proprietors true liquidation proceeds (Macintosh et al. 2000). This relationship became outdated long ago with the predominance of business organizations as going concerns rather than as a series of discrete, self-liquidating venturesa process that seems to have originated in Renaissance Italy and reached fruition during the industrial revolution of the nineteenth century. These changes in the nature of business activity put measurement of enterprise value beyond the scope of simple subtraction of liabilities from assets. The mercurial character of modern commerce seems to have been forgotten in the enthusiasm for a more representationally faithful accounting framework. In his translation and commentary of Luca Paciolis famous 1494 treatise on accounting, John Geijsbeek (1914) displays a sophistication of attitude toward the reality of assets and liabilities that is worthy of any contemporary poststructuralist commentator: What we now term liabilities, and some of which some of us are almost tempted to call near liabilities very much the same as we define near silk, never are and never will be liabilities, for at the time the financial statement is prepared these amounts are not supposed to be due, hence the proprietor cannot possibly be liable for them at that time. At most he is trusted for them by his creditors . . . Neither are assets at any time, in a going, solvent business, real assets. From 1932 comes another succinct statement on the elusive nature of equity (Berle and Means 1932), as quoted in Macintosh et al. 2000: The nature of capital has changed. To an increasing extent, it is composed not of tangible goods, but of organizations built in the past and available to function in the future. Even the value of tangible goods tends to become increasingly dependent upon their organized relationship to other tangible goods comprising the property of these great units.
12

The experience of Long Term Capital management is one of several examples of impressive mathematical systems brought down by the mercurial nature of economic law. Elaborate risk measurement systems likewise failed miserably to signal impending disaster in the investment banking industry because their impressive mathematical constructs failed to acknowledge (or perhaps served to obscure) the elephant in the room. Accounting and the Public Interest Volume 11, 2011

Cataldo and McInnes

127

Even a cursory look back at accountings intellectual history quickly reveals that traditional accounting thought is anything but unsophisticated. In the impulse to remake accounting in the image of finance and neoclassical economics, seekers of a more theoretically satisfying accounting framework risk neglecting the genuine conceptual foundations of the discipline.

COMMON GROUND: EMPOWERING THE PROFESSION

Notwithstanding our differences in outlook, we think most would agree that the broad social mission of our profession is to advance the common good through the design and execution of the financial reporting system. Key to this mission is the capacity to resist undue influence of powerful, possibly corrupting, political interests. From an idealist standpoint, adherence to conceptual principles grounded in neoclassical economics holds promise as an effective bulwark against such forces. Scholars in more context-sensitive traditions take an opposite approach. Giving central place to social factors and power relationships, they are apt to consider preoccupation with economic theory as a distinctly unhelpful distraction. The FASB seems inevitably caught in the middle. Recent amendments to Fair Value and Impairment guidelines (FASB 2009, EITF 99-20-1) were widely viewed as a compromise of Fair Value measurement principles in the face of industry pressure (see, for example, the dissenting board member views in the FASB statement). Although political influence is generally held in low regard, it can also act to avert the consequences of misplaced adherence to conceptual orthodoxies. For example, Franklin Roosevelts New Deal may be seen as a case of political pressure acting to alleviate unemployment by trumping the principle of balanced budgets. While socio-historical analysis may reach a range of different conclusions on such issues, such lack of consensus simply reflects the many faceted dimensions of accounting issues. Ultimately, we think that keeping fundamental social, political, and economic factors in constant view best enables the profession to grapple with the forces at hand. In contrast, the neoclassical attitude asserts the primacy of abstract principles, diverting focus from the interplay of social forces. We believe that this makes accounting more, rather than less, vulnerable to harmful political influence. Wherever the most effective balance of emphasis may lie, differences in method should not be allowed to override the commonalities in our aspirations for the profession.

THE CHALLENGE OF OUR PROFESSIONAL IDENTITY

The elements of our professional identity and the choice of an accounting conceptual framework are closely interrelated. Integrity is a nearly universal good, but other attributes are more contingent. Modesty (in the form of deference to observable and verifiable events), conservatism, and skepticism are well suited to a transaction-based system, but are largely ill suited to a Fair Value-based system. Fair Value, except for a small subset of actively traded instruments, involves the projection of cash flows over unbounded horizons, discounted by rates contingent on a multitude of market- and enterprise-dependent factors. Such forecasts require impressive financial skills and creative exercise of judgment, but are almost antithetical to an observation-centered, fundamentally modest personal outlook. In any event, it is doubtful that accountants, or anyone else, possess the requisite skills for such a forecast-based reporting system. As Williams (2002, 9) observes, The current dominant discourse of accounting is one of a technical, economic expertise that is more alleged than real. At the heart of the matter is a healthy skepticism on the part of investors and accountants of the intentions and veracity of management. While, by far, most managements are honest and above board in reporting their judgments of how well their firms have fared, investors, especially creditors,
Accounting and the Public Interest Volume 11, 2011

Cataldo and McInnes

128

must be wary. The problem is that management generally has an economic, and most likely psychological, vested interest in the reported success of the firms activities; thus, it may be predisposed to abandon the prudently pessimistic approach to measuring income in favor of erring on the optimistic side. One of accountings indispensible roles is to serve as a counterbalance to the no less indispensible exuberance and confidence of an optimistic, entrepreneurial management. While accountings identity, let us hope, will always entail an essential modesty, its distinctive contributions give us much reason to take pride. Attributes such as conservatism, reliability, and verifiability have held a central place in both accountings conceptual framework and the personal qualities associated with the identity of accountants. Accounting creates useful information through its distinctively evolved process of observation, compilation, and disciplined interpretation. The accounting exercise entails an uncommon subordination of the investigators preconceptions to the well-ordered assemblage of information. While judgment and skill are undoubtedly required, the process is still essentially an inductive one. The resultsprofit or lossemerge only at the conclusion of the process. While far from foolproof, the accounting process is designed to produce a result as free as possible from the influence, intentional or otherwise, of the practitioners prior hypotheses. The accountants role is at once both modest and creative, and we would do well to acknowledge this. The intensely political character of the standards setting process shares much of the blame for accountings shortcomings. However, we have also sought to show that accountants own misplaced enthusiasm for Idealist approaches such as Faithful Representation can pose equally serious threats to the financial reporting system. Nonetheless, Idealist approaches address a real need for accountants to find inspiration and meaning in their work, and the cultivation of an apt and compelling identity of accountants remains a difficult challenge. Genuine appreciation of our discipline on a practical or conceptual level requires focused effort and dedication over an extended period of time. Most in the financial world, often abetted by the dismissive attitudes of the finance professorate, learn only enough about accounting to dismiss it as backward or incoherent. However, further emulation of idealist traditions of neoclassical economics and finance seems contrary to the lessons of recent history and is certainly not needed to confer intellectual respectability on the accounting discipline. We find that the inherent modesty of traditional accounting has much in common with the intellectual stance of postmodern thought and is far more sophisticated than is commonly recognized. The old paradigm of accounting might just be about to have its day. Let us not rush to adopt a new one.

REFERENCES
Alexander, D., and S. Archer. 2003. On economic reality, representational faithfulness and the true and fair override. Accounting and Business Research 33 (1): 317. Arrow, K. J., and G. Debreu. 1954. Existence of equilibrium for a competitive economy. Econometrica 22: 265290. Barth, M. E. 2008. Global financial reporting: Implications for U.S. academics. The Accounting Review 83: 1159. Bullen, H. G., and K. Crook. 2005. Revisiting the Concepts: A New Conceptual Framework Project. London, U.K.: International Accounting Standards Board (IASB), and Norwalk, CT: Financial Accounting Standards Board (FASB). Bureau of National Affairs, Inc. (BNA). 2011. FASB Shifts to Cost Treatment of Loans Away from Proposed Fair Valuation. January 26. Arlington, VA: BNA. Carruthers, B. G., and W. N. Espeland. 1991. Accounting for rationality: Double-entry bookkeeping and the rhetoric of economic rationality. American Journal of Sociology 97 (1): 3169. Accounting and the Public Interest Volume 11, 2011

Cataldo and McInnes

129

Cataldo, J. and M. McInnes. 2009. The role of fair value and transaction based accounting measures in providing information on firm value. Accounting Research (Beijing, China). (July). Cataldo, J., and M. McInnes. 2007. FAS 157: The fair value option. CPAs at a crossroads? The CPA Journal 77 (8). Demirakos, E. G., N. C. Strong, and M. Walker, 2004. What valuation models do analysts use? Accounting Horizons 18: 221. Financial Accounting Standards Board (FASB). 2007. The Fair Value Option for Financial Assets and Financial Liabilities. SFAS 159. Norwalk, CT: FASB. Financial Accounting Standards Board (FASB). 2009. Amendments to the Impairment Guidance of EITF Issue No. 9920. Staff Position No. EITF 99-20-1. Norwalk, CT: FASB. Financial Accounting Standards Board (FASB). 2010a. Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities. Exposure Draft 1810-100. Norwalk, CT: FASB. Financial Accounting Standards Board (FASB). 2010b. Trott, Edward W. 1810-100. Comment Letter No. 45A and 45B. Norwalk, CT: FASB. Geijsbeek, J. B. 1914. Ancient Double-Entry Bookkeeping. Denver, CO. Hicks, J. R. 1939. Value and Capital. Oxford, U.K.: Oxford University Press. IASB and FASB. 2007. Summary Report of the Conceptual Framework Measurement Roundtables. IASB-FASB, January and February. Hong Kong; London, U.K.; and Norwalk, CT. Jordan, C. E., M. A. Waldron, and S. J. Clark. 2007. An analysis of the comparative predictive abilities of operating cash flows, earnings, and sales. The Journal of Applied Business Research 23 (3). Lee, T. A. 2006. The FASB and accounting for economic reality. Accounting and the Public Interest 6 (1). Lipsey, R. G., and K. Lancaster. 1956. The general theory of second best. The Review of Economic Studies 24 (1): 1132. Macintosh, N. B. 2006. Truth, lies, or bullshit? A philosophical investigation. Accounting and the Public Interest 6 (22). Macintosh, N. B., T. Shearer, D. Thornton, and M. Welker. 2000. Accounting as simulacrum and hyperreality: Perspectives on income and capital. Accounting, Organizations and Society 25 (1): 1350. Murray, A. 2008. Global integration of accounting standards: An interview with Tom Jones. The CPA Journal 78 (10). Palepu, K. G., and P. M. Healy. 2007. Business Analysis and Valuation Using Financial Statements. 4th ed. Cincinnati, OH: South Western. Ravenscroft, S., and P. F. Williams. 2009. Making imaginary worlds real: The case of expensing employee stock options. Accounting, Organizations and Society 34 (67). Robinson, J. 1933. Economics of Imperfect Competition. London, U.K.: Macmillan. Securities and Exchange Commission (SEC). 2003. Study Pursuant to Section 108(d) of the Sarbanes-Oxley Act of 2002 on the Adoption by the United States Financial Reporting System of a Principles-Based Accounting System. Washington, D.C.: SEC. Shapiro, B. P. 1997. Objectivity, relativism, and truth in external financial reporting: Whats really at stake in the disputes? Accounting, Organizations and Society 22 (2): 165185. Tinker, T. 1988. Panglossian accounting theories: The science of apologizing in style. Accounting Organizations and Society 13 (2): 165189. Walker, D. A., ed. 1983. William Jaffes Essays on Walras. Cambridge, U.K.: Cambridge University Press. Walras, L. 1954. 1874-77. Elements of Pure Economics. Homewood, IL: Irwin. Williams, P. F. 2002. Accounting and the moral order: Justice, accounting, and legitimate moral authority. Accounting and the Public Interest 2 (1): 121. Williams, P. F. 2006. Accounting for economic reality: Whose reality, which justice? Accounting and the Public Interest 6 (1): 3744. Yamaji, H. 2005. Accounting discourse as a process of implanting a social consciousness into the public mind: A rereading of American accounting theories as mythology. Critical Perspectives on Accounting 16 (2): 137150.

Accounting and the Public Interest Volume 11, 2011

Copyright of Accounting & the Public Interest is the property of American Accounting Association and its content may not be copied or emailed to multiple sites or posted to a listserv without the copyright holder's express written permission. However, users may print, download, or email articles for individual use.