The Rise of “Economic Consequences” – Notes
The impact of accounting reports on decision making may be the most challenging accounting issue of the 1970s.
By Stephen A. Zeff
Notes by Tyler Shivers
Introduction
There are increasing “outside forces” in the standard setting process since 1960s.
Two parallel developments marking this trend * Individuals and groups rarely had shown interest in setting accounting standards but then started intervening actively & powerfully in the process * New arguments had be brought up and the term “economic consequences” has been used to describe them
Economic consequences – the impact of accounting reports on the decision making behavior of business, government, unions, investors, and creditors. * Accounting standards setters must take into consideration of detrimental consequences when deciding on accounting questions.
Until recently, accounting policy making was deemed neutral in effect or was considered not responsible.
Policy makers have been aware since 1960s that there was a third party intervention issues but not the Economic Consequences argument till 1970s
When management began intervening, its true position was probably disguised
This is the tactical rhetoric suggested by examination of arguments 1. The traditional accounting model, where management was genuinely concerned about unbiased and “theoretically sound” accounting measurements. 2. The traditional accounting model, where management was really seeking to advance its self-interest in the economic consequences of the contents of published reports. 3. The economic consequences in which management was self-interested.
It can be assumed the 1st point has seldom been used in 3rd party interventions as it would take a lively imagination to believe that management cares about fair presentation.
Two factors in why economic consequences did not become a major issue till 1970s 1. Management and other parties tended to use the second argument above, encouraging the standard-setting bodies to confine themselves to traditional accounting model 2. The CAP and APB were determined to solve controversies in context of traditional accounting.
Early Uses of Economic Consequences Arguments
Earliest possible use of economic consequences reasoning in policy pronouncements was possibly in 1941. Accounting Research Bulletin no. 11, Corporate Accounting for Ordinary Stock Dividends required fair market value be used to record issuance of stock dividends where fmv was significantly higher that bv.
A clear used was made in 1958 when the American Electric Power Company sued the AICPA to stop the CAP from issuing a letter that said the deferred tax credit account should be classified as a liability. They said that it would mess with their debt-to-equity ratios and make them unable to issue debt securities. In the end the letter was issued. “The SEC accommodated the companies by consenting to exclude the deferred tax credit from both liabilities and stockholders’ equity for purposes of decisions taken under the Public utility Holding Company Act.”
Several examples of cases were given on page 59
Economic consequences have shown up far more in the short life of the FASB.
The Standard-Setting Bodies Respond
1940s & 1950s the CAP enhanced with wider circulation of exposure drafts and subcommittee reports
1958-1971, the APB acted to bring interested organizations into the standard setting process so that their views would be given full consideration and they’d be more satisfied. During 1971 in deliberations of Opinions no. 16 & 17, companies asserted that economic consequences were a valid concern but the APB’s committee neither asked for proof nor questions relevance.
Since not coping quickened the APB’s demise, it’s worth noting that the FASB includes the Financial Executives Institute (FEI) among its cosponsors. The FEI is incorporated in the formal structure of the Financial Accounting Foundation (FAF and the parent of the FASB)
The FASB has more elaborate procedures than the final years of the APB. The object is to expand and intensify interactions between: * The board * Companies * Industry associations * Government departments & agencies
A task force is made of a wide range of people from interested groups and made before each Discussion Memorandum. The DM is bulkier than APB ones, and it contains neutral discussion of the entire policy issues of the controversy at hand. The Financial Accounting Standards Advisory Council (FASAC) was supposed to be a sounding board for the FASB and composed of people the accounting practice, universities, companies, and government.
In 1977 in response to criticisms, the FAF studied the entire FASB operation. They made many recommendations. They said the Board should expand its formal and informal contracts with interested groups, and that it should include an economic impact analysis in important exposure drafts. The later point, the FAF committee concluded
“The Board need not be unduly influenced by the possibility of an economic impact, but it should consider both the possible costs and the expected benefits of a proposal.” By mid 1970s, it was decided that the FASB needed to add economic and social consequences to the substantive issues it normally addresses. The economic consequences changed from just being a procedural implication to being part of the standard setters’ substantive policy framework.
Economic Consequences as a Substantive Issue
Economic consequences have finally become accepted as a valid substantive policy issue for a number of reasons: * Society has changed and has made institutions responsible for their social, environmental, and economic consequences of their actions. * The sheer difficulty to change the accounting problems being addressed. Many managers are loathe to change the way they make decisions because of changes in accounting standards. * The enormity of the impact. Some issues are so massive, just discussing them leads to incessant arguments over probably economic consequences. * The growth in the information economics-social choice, behavioral, income smoothing and decisions usefulness literature in accounting. * The insufficiency of the procedural reforms adopted by the APB and the FASB. The conclusion has evidently been reached that procedural remedies alone will not meet the problem. * The Moss and Metcalf investigations. The congressman and senator conducted investigations of the accounting profession and the standard setting body and inferred that the responsiveness of the standard-setting bodies to economic and social effects of their decisions would be an issue. * The increasing importance to corporate managers of the earnings figure in capital-market transactions. This figure was important to corporations when the capital markets intensified and merger movement was fast paced * Accounting figures came to be viewed as an instrument of social control. * The realization that outsiders could influence the outcome of accounting debates. Before the 1960s, accounting controversies were rarely reported in financial press. It was believed that it was a fixed parameter. With rising publicity in ’62-’63, managers and others are starting to view the rules of accounting as a variable that can be changed * The growing use of the third argument, advanced earlier in the article, in accounting debates. True reasons came out into the open, and accounting policy makers could no longer ignore their implications.
The Dilemma Facing the FASB
What are the implications of the economic consequences movement for the FASB? Governments and other entities are increasingly assuming that standard-setting bodies are taking into consideration possible adverse economic effects of accounting standards. The FASB must take this information and compare it with the proposed policy to see if the benefits of the policy outweight the adverse economic and social effects.
To what degree should the FASB have regard for economic consequences? The FASB is recognized as a group of accounting experts and should focus their efforts where their expertise will be useful and acknowledged.
The Board has to balance accounting issues and nonaccounting variables. It must be based mostly on accounting considerations but must also study and be seen studying the possible adverse economic and social consequences of proposals.