[Introductory
note: Dr. Hawkins serves as the accountant consultant to Drexel
Burnham & Co., a Wall Street securities firm. His writings, books,
monographs, articles and texts, cover a wide range of critical areas
in accountancy, management, finance and economics.
Educated at Harvard, he holds the AB, MBA, and
DBA degrees. He has been a member of that institution's faculty
since 1961, attaining the rank of full professor just nine years
later in 1970.
Professor Hawkins's lecture, "Financial Accounting,
The Standards Board, and Economic Development," will consider
the ways in which accounting principles should contribute to the
economic and social well being of the nation. This goal is higher
and more pragmatic than simply requiring that corporate reports
serve the more narrow needs of investors or conforming to some theoretical
concept of business income.
This subject is especially timely since it considers
the interface between our major corporate entities and our total
environment -- a major theme of Dr. Hawkins's colleague, Professor
J. K. Galbraith. Our distinguished guest lecturer's remarks will
undoubtedly serve as a significant input for the Financial Accounting
Standards Board.]
In the winter of 1969 the California Management Review published
my article entitled "Behavioral Implications of Generally Accepted
Accounting Principles". In that article I argued that the Accounting
Principles Board should strive to create a set of generally accepted
accounting principles that was both technically and behaviorally sound.
Behaviorally sound principles were defined as those that did not encourage
corporate actions that gave the illusion of performance where none
existed or that were at variance with prudent management practices.
Tonight, after a four year hiatus I would like to pick up again this
thought and expand it to incorporate a new dimension. Now I believe
that those responsible for determining accounting standards, such
as the Financial Accounting Standards Board, should strive to set
accounting standards that are technically and behaviorally sound and
that are not at variance with the national economic goals and the
government's programs to achieve these goals.
Initially, let me give you my thinking that led to this addition
to my 1969 statement and my assessment of its significance for the
Standards Board as it tries to decide how it will incorporate the
recommendations of the Trueblood Committee into its own goals statement.
Later, I will discuss its relevance to the resolution of some of the
accounting issues facing the Standards Board.
The contents of corporate financial reports are relevant financial
data inputs to the analysis that precedes a wide range of micro economic
decisions. The data presented in corporate financial reports also
influence the behavior of the makers of these micro economic decisions.
Collectively, the economic behavior of these individuals determines
the state of our economy at the macro level. The Trueblood Committee
recommendations recognize the first fact, but not the other two. As
a result, accounting, for the Committee, is simply an activity that
measures and communicates material economic data related to business
activity that is relevant to economic decisions. Somehow, the Committee
assumes, if this is done well the correct allocation of resources
in the economy will occur in some mechanistic way. No recognition
is made of the behavioral aspects of corporate reporting.
In contrast, those in Congress and the Executive branch of the Federal
Government who are charged with managing the nation's economy are
becoming more and more aware of the behavioral aspects of corporate
reporting and its macro economic implications. Increasingly, I believe,
these policy makers will demand --particularly in times of economic
turmoil -- that the decisions of those charged with determining what
constitutes approved corporate reporting standards result in corporate
reporting standards that will lead to Individual economic behavior
that is consistent with the nation's macro economic objectives. Viewed
from this perspective, corporate reporting standards are an economic
planning tool that can be used to reinforce the effectiveness of the
other instruments used to achieve economic goals. This awareness on
the part of economic planners brings accounting standards setting
into the realm of political economics.
AN ILLUSTRATION
To illustrate the last observations I would like to refer back to
the Accounting Principles Board's last effort to adopt the deferral
method of accounting for the investment tax credit. As you all recall,
the Principles Board exposed an Opinion recommending the deferral
approach. Subsequently, several key members of Executive Department
and Congress caused the Board to withdraw its recommendation. In my
opinion, the circumstances that led to the defeat of the Board's recommendation
were: First, by denying to business the immediate boost in income
from the flow-through method, the Principles Board was blunting the
effectiveness of the tax credit as a device to stimulate the economy.
Second, at a time when the public confidence in the economy was low
and the public needed some sign of recovery, the Principles Board
was deliberately reducing corporate profits, which is one index of
the health of the economy, in a situation where there was clearly
no single right answer as to how to account for the investment tax
credit. And, finally, the principle alternative approaches each had
substantial support from responsible, knowledgeable accounting authorities.
The behavioral hypotheses implicit in these arguments are clear:
First, with the option to use flow-through accounting open to them,
businessmen were more likely to respond to the tax credit incentive
than if the deferral method was mandatory. Second, the rate at which
the public became more aware of the recovering economy and more confident
in their consumption plans and actions would be faster if corporate
profits rose significantly and sooner than if they rose slower and
less dramatically.
THE LESSONS
Now, what can we learn from this experience that is relevant to my
theme?
First, those who are responsible for economic planning believe
in the behavioral power of corporate reporting. Or if they do not
fully accept this theory they do not reject it, just in case it is
valid.
Second, when we think of the behavioral implications of corporate
reporting we must recognize we are talking of the behavior of both
the issuer and user of corporate reports. The economic planners' goal
for the investment tax credit was to influence the behavior of businessmen
to invest and the behavior of the public to consume.
Third, the economic planners believe no private body -- such
as the Principles Board or the Standards Board -- has the right or
the power to require action by its constituents that will work counter
to the efforts of our federal government to manage the economy.
Fourth, the goal of the body charged with determining accounting
standards must be different from the goal of the accounting process
itself. This is a critical difference. Let me explain. The Board has
to achieve results in an environment where it must rely on others
to gain acceptance of its recommendations. Thus, its statement of
objectives must be responsive to the interest of those who hold veto
power over its actions or whose cooperation is needed to bring about
change in accounting standards. In contrast, the accounting process
is concerned with the technical performance of tasks related to the
measurement and communication of relevant economic data. It is not
concerned with the problem of standard setting. So, those concerned
with the accounting process can ignore the political realities that
face the standard setter.
Fifth, the determination of what constitutes approved corporate
reporting standards is a political process involving the interests
of many parties, with the government as the dominant interested party.
Those who make decisions on corporate reporting standards must be
responsive to the political considerations. At this level of responsibilities
accounting becomes a branch of political economics.
In my opinion, the Trueblood Committee Report deals with the accounting
process, not the problems of the setter of accounting standards. Therefore,
I believe if the Financial Accounting Standards Board accepts and
acts consistently with the Trueblood recommendations -- all of which
flow from the primary objective of the accounting process to provide
relevant, useful data for economic decisions -- the Standards Board
will have the same fatal flaw which led in large measure to the disintegration
of the Accounting Principles Board. Namely, the APB found itself in
conflict with national economic objectives because it did not recognize
an obligation to help, in a responsible manner, the government to
reach its goals. Also, the Principles Board made the mistake of clearing
its proposals only with the SEC, which is not a planning body but
a tool of the economic planners. This approach hastened the Board's
demise. To avoid this fate, the Financial Accounting Standards Board
must add one key proviso to the overall objective expressed in the
Trueblood Committee report. With this addition, the Committee's primary
objective as adopted by the Standards Board would be that corporate
reporting standards should result in data that are useful for economic
decisions provided that the standard is consistent with the national
macro economic objectives and the economic programs designed to reach
these goals.
THE OUTLINE
Let me leave the unhappy history of the investment tax credit and
its lessons to discuss in detail some of the key assumptions upon
which my conclusions rest. Then, I will take up some of today's accounting
controversies and indicate how they might be resolved by somebody
who accepts the notion that accounting at the level of the Standards
Board is a branch of political economics. Finally, I will point out
some of the dangers that are inherent in the use by politically motivated
governments of corporate reporting standards as tools for implementing
economic planning goals.
THE KEY
Central to my belief that it would be a legitimate and wise policy
of the Standards Board to accept explicitly as part of its primary
objective to set corporate reporting standards that are not at variance
with the national economic goals and programs is the notion that corporate
reporting standards influence economic behavior.
What evidence do we have to indicate that this is so? There is very
little formal research on this aspect of corporate reporting. However,
we do have a considerable amount of expert testimony which supports
the notion that economic behavior is influenced by corporate reporting
standards.
For example, there are numerous statements in the popular press,
academic journals and responses to Principles Board exposure drafts
that indicate behavior relations such as:
Pooling of interest accounting before Opinion No. 16 encouraged
corporations to grow through acquisitions made on terms that qualified
as poolings. Non-capitalization of leases encourages leasing over
purchasing. The exclusion of warrants, options and conversion features
from the computation of earnings-per-share before Opinion No. 15
encouraged the use of such equity capital raising devices. The exclusion
of the deferred taxes earned by the Domestic International Sales
Corporation from the comprehensive tax allocation requirements of
Opinion No.11 would encourage the creation of DISC's for export
purposes.
Those are only a few illustrations of the ways accounting standards
bias behavior. I think they support my basic assumption.
Some of you may believe it is possible for the Standards Board to
set accounting standards that will not influence behavior. I believe
that is impossible. Every decision the Standards Board reaches will
make certain kinds of business activity more or less attractive. For
example, when the Principles Board defined common stock equivalents
it made the issuance of low-yield convertible debt unattractive. Similarly,
every decision will make some corporation's profits higher or lower
and its financial ratios better or worse. These differences in turn
will influence the way investors, creditors, suppliers, employees
and the public will regard the firm. For instance, it is said that
if nuclear fuel leases are capitalized, the rating services will be
forced to formally include these lease costs in their fixed charges
coverage ratios. Some members of the utility industry and some utility
security analysts believe this action would lead to both less capital
and higher capital costs for utilities.
Once my behavioral assumption is accepted, it is an easy step for
me to accept the notion that the Standards Board has a responsibility
that goes beyond the search for accounting standards that lead to
the communication of useful economic data.
Any private citizen or group of private citizens, such as the Standards
Board, has an obligation to help the government to achieve the nation's
economic goals. The Standards Board has more power than the individual
citizen to influence the trends in economic activity, since the Standards
Board can issue pronouncements that will influence economic behavior.
Therefore, its obligation is even greater. Furthermore, since economic
planning is a government responsibility, any powerful private body,
such as the Standards Board, that wishes to keep in the private sector
decision-making prerogatives that can influence the achievement of
economic goals has a right to do so only as long as its actions are
consistent with the popular elected government's goals. If the Standards
Board wishes to reserve to itself the right to set accounting standards,
it must recognize this obligation.
Some of you may question this concept of social obligation, but
substitute the words "General Motors" for the words "Standards
Board" in my last thought and ask yourself whether or not you
agree with my statement. I think you will agree. Just as the public
expects General Motors to cooperate with the government's economic
plans, so will the public expect the Standards Board to cooperate.
The Standards Board cannot duck this responsibility.
Before going on to the action implications of the proposed role for
the FASB, let me briefly summarize what I have argued to date.
First, accounting standards do influence economic behavior.
Second, the Standards Board cannot set accounting standards
that do not influence economic behavior.
Third, because the Standards Board has the power to influence
economic behavior it has an obligation to support the government's
economic plans.
Fourth, if it fails to meet this obligation the government
has no choice but to take over the determination of accounting standards
or to give the task to a more responsible and responsive private body.
Fifth, because of this fact the Standards Board as an operating
entity must have a somewhat different set of objectives than those
set forth in the Trueblood Report. The Standards Board can set as
its goal to implement the Trueblood Report, but it must also state
as an objective that it will not deliberately scuttle or weaken the
nation's economic planners programs. For the Standards Board to simply
say its objective is to implement the Trueblood Committee's major
objective for corporate reporting is to court disaster.
EXAMPLES
Now, how would a Standards Board that is responsive to its obligation
to assist in the achievement of national economic goals and is sensitive
to the fact that it must work closely with national economic planners,
if it is to achieve its own corporate reporting objectives, handle
a number of the issues confronting the Board today.
Leases: Transport and Utility. Perhaps the hottest topic on
the Board's current agenda is accounting for leases. If you look at
the transportation and utility fields, you must be struck that these
are industries that rely heavily on leasing. People from those industries
argue that it is not in the national interest to require capitalization
of leases. Alvin Zises, whose work some of you have probably read,
is a vocal proponent of this point of view. I must admit Alvin is
a highly biased proponent of it, but nevertheless he has already convinced
a number of people in Washington that leasing is critical to the continual
development of the transportation and utility industries -- industries
that have trouble attracting capital from other sources. Already there
are signs in Washington that the government officials concerned with
economic development and the balance of the development of our economy
are responding to this argument. The Financial Accounting Standards
Board has already received a number of letters from Congressmen to
this effect.
If this kind of thinking is accepted -- that lease financing is important
to the development of the transportation and utility areas -- and
the second thought that lease capitalization would make leasing and
other sources of financing more costly for this area, I think that
as the Standards Board faces up to the question of what to do about
accounting for leasing by lessees and lessors, it has to recognize
this developing concern of people at the national level. I would urge
the Board to move slowly, to be sure that they argue for lease capitalization
only in those areas where there is widespread belief that lease capitalization
is warranted. I would suspect that acceptance is going to be a critical
factor in what the Board will in fact come up with eventually.
Full and Field Costing. Another area in which we face tremendous
problems of the moment of course is the energy area. It is estimated
that between now and 1985 the oil and gas companies will have to raise
600 billion dollars in additional financing to take care of our energy
needs. Clearly this kind of an economic problem must have some bearing
on the controversy of full vs. field costing in the petroleum area.
As you know, the smaller companies have argued that they would not
have access to capital if field costing were the only way they could
account for their exploration and development costs. I think that
their argument has gained some acceptance in that the Federal authorities
who regulate natural gas transmission have already approved full costing
despite the fact that the Accounting Principles Board was leaning
towards field costing.
Again, I think the Standards Board must be careful how it proceeds.
I see good arguments for both full and field costing just as I see
good arguments for both capitalization and non-capitalization of leases.
I have my personal preferences but in both cases I am impressed by
the fact that there are knowledgeable people who have come to a different
conclusion than I did. I suggest, just as I suggested in the leasing
area, that the Board move warily and perhaps in a rather limited way,
which would certainly not satisfy some of the academic critics or
some of those from the Wall Street area. But I would argue again in
the full vs. field costing controversy that the political way to handle
this problem is for the Board to move slowly, perhaps even drag its
feet. I would think hard and long before I tried to impose field costing
knowing that there is substantial support in Washington for full costing
as a means of attracting capital to the smaller companies.
Goodwill. There are anti-trust implications in this area.
A number of people in Washington are very much concerned that foreign
companies are moving into the United States and buying up American
companies -- buying interests in them. One of the things that has
come to light is that the foreign companies are not troubled by the
requirement to account for goodwill by writing off against income.
Some of the American companies who have apparently not been able to
match the foreign companies' offers for local company interests have
said that to purchase them would have created goodwill which would
have hurt their earnings. There was an accounting research study which
suggested that goodwill ought to be written off in the capital section
rather than being run through income. The study was done by two distinguished
accountants from Arthur Anderson and their conclusion was supported
by Leonard Spacek, the former chairman of the firm. That such people
should think this way makes me have second thoughts about how goodwill
should be handled. Now I'm less sure.
The goodwill issue is surely going to be raised because the whole
area of business combinations and business purchases is one to which
the Standards Board has indicated it will give high preference on
its technical agenda. Surely we can no longer ignore accounting's
impact on the Federal government's attempts to control investments
of foreign companies in the United States and how the government wants
U.S. companies to account for goodwill. I think the Standards Board
might well begin to consider something other than present rules, perhaps
in a way that would impose less of a burden from goodwill write-offs
on a company's earnings.
Flow Through of Foreign Income Taxes. Tax accounting for
foreign income which is permanently invested overseas runs very much
counter to the whole thrust of the trade bill -- the Burke-Hartke
Act -- and some efforts of the IRS to discourage foreign investment
by U.S. companies and to bring investment back to the United States.
The accountants have encouraged foreign investment by allowing flow
through tax accounting even though it runs counter to the general
thrust of Opinion No. 11. I think this is another area in which accountants
may find themselves out of step with national economic planners, and
there may be a growing pressure on accountants to apply comprehensive
tax allocations. Personally I have trouble seeing the difference between
a permanent deferral overseas and a domestic permanent deferral, but
we seem to account for them differently. So this is an area where
current accounting which favors business may have to be changed because
it encourages business to invest overseas and therefore runs counter
to a federal tax and trade policy which seems to be evolving.
Research and Development Costs. One of the items on the FASB's
agenda is the question of capitalization or non-capitalization of
research and development expenditures. Unfortunately, this is an area
where I have seen too many disasters -- companies that have deferred
intangibles and ended up by having to write them off. Yet the Standards
Board needs to think about the interest of the nation in maintaining
technological advancements, particularly among small firms who feel
they need to have profits to enter the public capital markets. Here
again, there may be some pressure on the Board not to come up with
an opinion that would outlaw capitalization of R&D entirely. I think
what we are looking for is a policy which says R&D capitalization
is appropriate, given some sort of reasonable assurance that it is
in fact a realizable asset. That may be the present situation, you
say, and if it is implemented no better than the present rules in
this area, it may degenerate into just management's choice as to what
to do. However, if the accountants eliminate the "subject to"
opinion, I think that this particular hard choice as to whether or
not it has some future value will be made in a more realistic manner.
But I do not believe the Board can eliminate the alternative capitalization.
SAFEGUARDS
I could go on and on in these examples, but let me turn now from
the examples to another aspect of my theme. After arriving at my position
on the appropriate overall objective for the Standards Boards, I had
two nagging questions:
1. If my theory is correct, what is to stop an unscrupulous government
from trying to use accounting standards to "puff" up corporate
profits like some "go-go" company?
2. How far should the FASB go in cooperating with government economic
planners?
In my opinion, the best protection against an improper use of accounting
standards by economic planners is to keep the responsibility for determining
corporate reporting in the private sector and to insist that the responsible
group be individuals of the highest integrity, moral character and
accounting capability. It is also desirable that they have a good
dose of common sense and a sensitivity to the needs of the other groups
with a stake in corporate reporting. Such men are not likely to be
part of any scheme to use accounting standards in an unethical or
grossly misleading way. Their protests and threat of resignation should
be enough to dissuade any government planners who begin to think like
"go-go" company managers. On the other hand, such men are
likely to cooperate with reasonable demands.
In addition, I believe that a safeguard can be a well developed and
accepted theory of the reporting process. Such a theory of corporate
reporting would set a standard to judge how far corporate reporting
was being used for cosmetic purposes to reach economic goals.
Finally, the insistence upon the observations of a firm policy of
full and fair disclosure should make obvious misleading uses of accounting
standards by either government economic planners or a too sympathetic
response to the planners' pressures by the Standards Board.
How far should a Standards Board go in cooperating with national
economic plans and programs? This was my second nagging question.
First, I believe that in cases where there are persuasive
arguments for each of the most acceptable choice of solutions to an
accounting controversy, the choice that best serves the national economic
interest be selected. Of course, the identification of this alternative
should be done in consultation with the economic planners.
Second, priority should be given on the Board's technical
agenda to those controversial areas that are of highest importance
to the national economic goal priorities.
Third, in all cases where national economic development may
be an issue, the weight to be given to the national economic development
consideration in selecting the appropriate solution should be among
the most significant relative to other considerations. How significant
will be determined by the judgment of the Board given the circumstances
of the moment. The selection of outstanding individuals of the type
I feel should be members of such decision-making Boards is the best
protection against undue weight being given to national economic interests
in unappropriate ways.
Fourth, the Board should seek competent, independent advice
on the national economic significance of its proposed decisions. It
should also encourage research into the relationship between economic
analyses and behavior and accounting standards. This will provide
some expert advice and substantive data which might be used to develop
better our understanding of how and under what circumstances and to
what length the Board should cooperate with national economic planners.
These data should also be made available to economic planners so that
they may use it as a guide to making their requests for Board cooperation.
Hopefully, it would help both the board and planners to identify unreasonable,
unnecessary or ineffective proposal to use accounting standards in
the achievement of economic goals.
Let me now conclude the formal presentation by anticipating a challenge
that may be thrown at me. This will be a personal statement. However,
I believe my final observations are relevant to all of us who advise
or criticize the Standards Board in its efforts to set accounting
standards.
MEA CULPA
Some of you may dredge up some of my other earlier writings and confront
me with an inconsistency in my own position on the accounting for
the investment tax credit and my 1973 definition of the Board's objectives.
I would like to now state that, as I look back over my own efforts
to convince the Principles Board to adopt the deferred method of accounting
for the investment credit, I now believe my advice was poor and irresponsible.
Also, I now believe the cries of outrage that I published when the
government stepped in and caused the Principles Board to back off
its recommendation were naive and unfair to the government officials
involved.
I had assumed the Principles Board had to find an answer to the investment
tax credit accounting problem that was consistent with some acceptable
concept of economically useful data or a definition of business income.
Also, I assumed it was unsound behavior to adopt an accounting method
that encouraged corporations to earn material profits immediately
by purchasing assets.
Such an approach may have been acceptable and tolerated by the economic
planners if the economy was strong and untroubled. But the economy
was weak and troubled. The reinstatement of the investment tax credit
was ample evidence of this fact. Under these conditions I believe
now it was irresponsible for me to urge the Principles Board to deliberately
take action which would lessen the effectiveness of the tax credit
in a situation where sound accounting arguments could be made for
both the deferral and flow through approaches. I was advising the
Principles Board to adopt a course of action that any responsible
government concerned with the well-being of the total economy and
body politic had to reject in the public interest. If I had recognized
how accounting shifts from a micro economics measurement science,
which naively assumes that if income is measured correctly the optimum
allocation of resources will automatically follow when discussed in
the classroom, to a branch of political economics at the level of
the Principles Board, I would have argued for the approval of both
the flow through and deferral methods by the Board. Or, if only one
method was to be chosen -- my choice would now have had to be the
flow through approach.
This self realization of the political realities of the Board's
existence has led me to conclude that when I act as an advisor or
critic of the Board I have a responsibility to recognize that the
Board's objectives must be responsive to many more considerations
than accounting theory or our notions of economically useful data.
Any advice or criticism related to its actions on standards that does
not take into account these broader considerations is not very helpful
to the Board. In particular, tonight I am suggesting one of these
considerations is to fulfill an obligation to meet national economic
plans. If the Standards Board incorporates this consideration in its
goals, I believe each of us has a responsibility in our comments on
the Board's actions to help the Board to reach responsible decisions
on standards that do not lead it to run afoul of our nation's economic
goals and programs. I for one hope I will not be guilty in the future
of the same poor judgment I displayed in 1971.
Similarly, I hope the Standards Board will also not show in the future
the same poor judgment as did the Principles Board when confronted
with the interests of our economic planners. This can be avoided if
the Board faces up to its responsibility to cooperate with our economic
planners and set objectives and policy guidelines in advance of such,
confrontations. I believe the Standards Board can make a significant
start in this direction by a simple modification to the Trueblood
Committee's objective for the accounting process, namely, the adoption
as a fundamental objective of the Board, a statement similar to the
following:
The Board will seek to implement the recommendations of the Trueblood
Committee Report in such a way that its actions are consistent with
the economic goals of the nation as communicated to the Board by
those responsible for the management of the nation's economy.
