Noble Accounting, or Accounting Nobles? - The Government Created Accounting Fiasco

Noble Accounting, or Accounting Nobles?
THE GOVERNMENT CREATED ACCOUNTING FIASCO
First of Three Parts
by Ted Lang

July 2, 2002

Columnist Ted Lang According to the collaborative work by PhDs and CPAs Philip E. Fess and Carl S. Warren in their 14th edition accounting text entitled "Accounting Principles," published by South-Western Publishing Co., © 1984, "The evolution of the system of record keeping which came to be called 'double entry' was strongly influenced by Venetian merchants. The first known description of the system was published in Italy in 1494. The author, a Franciscan monk by the name of Luca Pacioli, was a mathematician who taught in various universities in Perugia, Naples, Pisa and Florence. Evidence of the position that Pacioli occupied among the intellectuals of his day was his close friendship with Leonardo da Vinci, with whom he collaborated on a mathematics book. Pacioli did the text and da Vinci the illustrations."

Fess and Warren continue: "Goethe, the German poet, novelist, scientist, and universal genius, wrote about double entry as follows: 'It is one of the most beautiful inventions of the human spirit, and every good businessman should use it in his economic undertakings.' Double entry provides for recording both aspects of a transaction in such a manner as to establish equilibrium. For example, if an individual borrows $1,000 from a bank, the amount of the loan is recorded both as cash [asset] of $1,000 and as an obligation [liability] to repay $1,000.[Clarification added]. Either of the $1,000 amounts is balanced by the other $1,000 amount." [Debits equal credits].

Fess and Warren explain "…that 'double entry' provides for the recording of all business transactions in a systematic manner. It also provides a set of integrated financial statements reporting in monetary terms the amount of (1) the profit (net income) for a single venture or for a specified period, and (2) the properties (assets) owned by the enterprise and the ownership rights (equities) to the properties."

The financial statement reporting profit is known by the terms "profit and loss statement," or P&L" or "income statement." The financial statement reporting assets, liabilities and net worth [equity or capital], is the balance sheet. In the example offered by Fess and Warren, the balance sheet would be the only financial statement that could be prepared, and would show asset value of a $1,000 debit, and a liability credit of $1,000 listed as a loan payable.

The balance sheet adds up all the asset values to show an overall total, and then adds up all the liabilities, such as accounts payable, loans, mortgages, etc., and totals them too, and then subtracts the total liabilities from the total assets to show the difference, which is the net worth of the entity being financially reported on. Operations, the purpose of the entity or business, are measured by showing all the revenue taken in by the business during the year, and subtracting from that total revenue figure all the costs and expenses of doing business. Hopefully, there is a "net" profit.

The balance sheet and income statement are prepared monthly, quarterly, semi-annually and annually, to provide management, creditors, banks and investors important financial information about the monetary health of the business. Here are Fess and Warren again: "The development of the corporation also created a new social need - the need for an independent audit to provide some assurance that management's financial representations were reliable. This audit function, often referred to as the 'attest function,' was chiefly responsible for the creation and growth of the public accounting function. Unlike private accountants, public accountants are independent of the enterprises for which they perform services."

Fess and Warren go on to explain that certified public accountants [CPAs] are licensed in each and every state. CPAs and CPA firms are used to audit the books of client firms, and provide "expert" opinion that the numbers on the financial statements [balance sheet, income statement, statement of retained earnings for corporations, source and application of funds, etc.], are representative of the numbers shown on the company's books. In other words, CPAs are supposed to attest that appropriate accounting procedures were followed in the bookkeeping methods used, and that the numbers from the books were properly shown on the financial statements. The stick in the hands of government is the licensing of CPAs.

Here's where things start going south: "Auditing is still a major service offered by CPAs," say Fess and Warren, "but presently they also devote much of their time assisting their clients with problems related to planning, controlling, and decision making. Such services, known as management advisory services, have increased in volume over the years until today they comprise a significant part of the practice of most public accounting firms." Planning, controlling and decision-making are functions of management, not independent auditing.

The emphasis on the "professionalism" of CPAs versus that of degreed private accountants who are employees of corporations, has lead to both a demand for CPAs over non-licensed, non- government certified accountants in corporate hiring and recruitment strategies, as well as permitting for the expansion of CPAism such that management consulting by accounting firms has totally compromised their former independence. And this is evident in a 1984 college accounting textbook!

Gene Lyons, a columnist for the Arkansas Democrat-Gazette, and neither a Republican nor a George Bush fan, observed in his piece entitled "Corporate Utopianism," that the watchdog for corporate financial reporting, the Securities and Exchange Commission [SEC], tried to put the brakes on the growing conflict of interest situation a while back.

Lyons offers: "In 1998, Arthur Leavitt, Clinton's chairman of the SEC wanted to prohibit accounting firms like Arthur Anderson from serving as both consultants and auditors of the same company - a blatant conflict of interest roughly equivalent to college biology teachers taking consulting fees for helping their own students get into medical school. Leavitt … was shot down after the Big Five accounting firms led an indignant campaign against him.

In the next installment, I will examine more closely how this conflict of interest issue is further complicated by some good old boy maneuvers, costing taxpayers, investors and employees a fortune. ***

Photo of Columnist Ted Lang courtesy of the author