Editorial Note: It’s time to go “back to school” as we begin the traditional academic year! In the spirit of the season, we’re pleased to feature the following piece by Contributing Columnist Steve Mintz on accounting education.
Steve is one of three regular columnists who have agreed to author a blog post every quarter. All posts are distributed via email, and are published online at AAAPublicInterest.org.
We welcome contributions by all members of the academic and business communities who maintain an interest in Accounting and the Public Interest. Please direct your queries to Michael Kraten at mkraten@hbu.edu.
As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.
It’s time now for accounting educators to rethink the scope of decision-making models used to teach accounting ethics. If ethical issues that arise in the context of organizational culture are not dealt with properly then it is less likely ethical conflicts can be resolved. Consideration of the internal systems within organizations is what’s missing from traditional decision-making models and should be given a more prominent role.
Ethical Decision Making
Accounting educators typically use an ethical decision-making model to teach ethics to accounting students. Ethical decision models provide a systematic way to think through ethical issues, identify alternative courses of action, evaluate the ethics of each alternative and decide what to do.
Traditionally, the decision-making models used to teach ethics to accounting students have focused on applying philosophical reasoning methods to the analysis of what should be done. These models tend to downplay or ignore the importance of organizational culture in the decision-making process including internal policies and practices, the code of ethics and individuals in the organization who might serve as supporters to help resolve conflicts.
Given the added focus on organizational ethics since passage of the Sarbanes-Oxley Act and the profession’s recognition of the importance of the control environment, accounting educators should look for new ways to incorporate organizational factors to make the ethics curriculum more relevant. Moreover, the AICPA Code of Professional Conduct now addresses ethical conflicts and describes the process to resolve them including internal steps.
The PLUS Ethical Decision Making Model
The PLUS Ethical Decision Making Model was developed through The Ethics Resource Center, the research arm of the Ethics & Compliance Initiative (ECI). The ECI is a community of organizations that are committed to creating and sustaining high quality ethics and compliance programs to assist organizations in building strong cultures. The mission of ECI is to assist its members across the globe to operate their businesses at the highest levels of integrity.
The PLUS Model is based on a seven-step process described below. The word PLUS refers to ethics filters that facilitate the analysis of ethics considerations and implications of the decision at hand. The filters ensure that ethical issues rise to the forefront in ethical decision making. The mnemonic PLUS refers to four considerations that apply to the analysis in steps 1, 4 and 7 of the decision-making model as follows.
P = Policies
L = Legal
U = Universal
S = Self
A description of each filter and its role in decision-making follows (Ethics Resource Center of the Ethics & Compliance Initiative, The PLUS Decision Making Model, https://www.ethics.org/resources/free-toolkit/decision-making-model/).
Policies. Is it consistent with organizational policies, procedures and guidelines?
Legal. Is it acceptable under applicable laws and regulations?
Universal. Does it conform to universal principles and the values of the organization?
Self. Does it satisfy my personal definition of right, good and fair?
The advantage of the PLUS model is it relies heavily on organizational ethics. This is important because no matter how good one’s ethical judgment may be, ethical decision-making is not likely to occur unless support for the position exists in the organization. A summary of the seven-step model follows.
Step 1: Define the problem. Determine why a decision is necessary and identify the desired outcome(s). This helps to clearly state the problem and where to look for alternatives to resolve it. Consider the PLUS factors to ensure the existing situation does not violate any of them.
Step 2: Seek out relevant assistance, guidance and support. Identify the available resources within the organization to help resolve the problem. This helps to define the guidelines and individuals within the organization that may help to resolve the problem.
Step 3: Identify available alternative solutions to the problem. Consider all relevant solutions to avoid the dichotomy of one choice versus another (i.e., either this or that).
Step 4: Evaluate the identified alternatives. This step in the model uses a decidedly consequence-based criteria. Positive and negative consequences are evaluated with fact-based consequences weighed more heavily because the expected outcome is more likely to occur. The PLUS factors are an integral part of the evaluation to supplement outcomes-oriented considerations, which are teleologically based, with universal principles (deontology) and virtue ethics as represented by organizational values.
Step 5. Make the decision. After evaluating all the alternatives, it’s time to decide on a course of action. The reasons for choosing one alternative over the others should be explained especially if the decision is by a work team that recommends a solution to higher-ups.
Step 6. Implement the decision. Putting the decision into effect is essential to change the situation and resolve the problem identified.
Step 7. Evaluate the decision. A determination has to be made whether the decision fixes the problem identified. Questions to ask are: Did it go away? Did it change appreciably? Is it better now, or worse, or the same? What new problems did the solution create? In making these determinations it’s important to incorporate the PLUS factors to ensure the solution conforms to organizational policies, laws and regulations, universal principles and values adopted by the organization.
Advantages of the PLUS Model
The “S” component of the PLUS factor is a feature of the decision-making process that requires explanation because it’s not recognized explicitly in traditional decision-making models although virtue considerations come close. To implement the “self” factor, the decision maker should consider whether the solution satisfies one’s personal definition of right, good and fair. It means that individuals should understand how their values influence decision making to ensure the decision reflects those values. For ethical decision-making to occur in an accounting situation those values should include independence, integrity, objectivity and due care, which are the principles of professional behavior.
Ethical decision making is a complicated process that relies on organizational variables to ensure the ultimate decision is supported by those who have to carry it out. The PLUS model incorporates those factors and should be used in accounting ethics education to make it more relevant given the increased focus on organizational ethics in the post Sarbanes-Oxley era.
The advantage of using the PLUS model to teach ethics to accounting students is it increases student awareness of organizational factors that influence ethical decision making. In reality, regardless of the ethical justification for one’s position it’s unlikely to be implemented unless individuals within the organization support resolution of the ethical problem. Knowing how the internal systems work can help to make that determination early on and influence ethical decision making in a positive way.
Sunday, August 25, 2019
Wednesday, July 31, 2019
Sustainability Reports and the Limitations of ‘Limited’ Assurance
Editorial Note: We are delighted to publish the following article by Professor Michael Kraten of Houston Baptist University. It was originally published in this month’s issue of The CPA Journal; we thank Journal Editor-In-Chief Rick Kravitz (who is himself a frequent contributor to our blog) for permitting us to transmit the article to our Section members. We encourage our members to peruse the contents of this month’s issue at CPAJournal.com.
How many standards can a sustainability accountant possibly follow? Three dozen comprehensive standards are published by the Global Reporting Initiative (GRI), and 77 industry-specific standards are issued by the Sustainability Accounting Standards Board (SASB). In addition, 17 sets of metrics are promulgated within the Sustainability Development Goals (SDG) of the United Nations, 15 components of integrated reporting are defined by the International Integrated Reporting Council (IIRC), and the AICPA, not to be outdone, chimed in earlier this year with its new guide, Attestation Engagements on Sustainability Information.
Sustainability standards are growing in length and complexity; as a result, the length and complexity of corporate sustainability reports are growing as well. The 2018 sustainability report of Volkswagen (VW), for instance, runs at 108 pages. The report of its European rival Fiat Chrysler Automobiles (FCA) is much lengthier, at 148 pages.
Some analysts complain that such reports are filled with “green-washed” public relations content. Others disagree, claiming that the European Union’s Directive on nonfinancial reporting ensures that the sustainability content is meaningful on an individual report basis and comparable across multiple reports.
To be fair, the latter group of analysts can cite examples of meaningful and comparable data. VW’s report, for instance, includes a section entitled “GRI Content Index”; it cross-references its published data to the standards of the Global Reporting Initiative. FCA’s equivalent section, the “GRI Standards Content Index,” serves the same purpose.
But are readers of sustainability reports missing out if they only pay attention to the sustainability report data and the underlying standards? Should they also pay attention to the assurance letters issued by public accounting firms and printed in the reports? After all, if the assurance letters are not sufficient, then all of the information in the reports, greenwashed or substantive, is of dubious value.
Consider, in comparison, the annual financial statements of business entities. They would obviously be less useful if public accounting firms were to use extremely limited assurance procedures during their annual audits. Their assurance procedures would be even less useful if auditing firms could offer different levels of assurance to different clients.
Indeed, spending a little less time worrying about the data in the sustainability reports and a bit more time considering the limited assurance letters may lead to the conclusion that confidence in the validity of any of the report data may not be warranted.
Volkswagen
Consider, for instance, Volkswagen’s 2018 report. The table of contents lists a two-page “Independent Assurance Report” on pages 104 and 105. That assurance letter, issued by PricewaterhouseCoopers, is called “Independent Practitioner’s Report On A Limited Assurance Engagement On Non-Financial Reporting.” How much assurance does it actually convey?
The letter notes that PricewaterhouseCoopers is required to “plan and perform the assurance engagement to allow us [i.e., the CPA] to conclude with limited assurance that nothing has come to our attention that causes us to believe that the Company’s Non-financial Report … has not been prepared, in all material aspects, in accordance with” the relevant standards.”
This double-negative structure raises some flags. In essence, the CPA is only required to conclude that nothing came to his attention to cause a belief that something is not right. Metaphorically speaking, an ostrich that buries its head in the sand during a desert storm could satisfy that level of assurance about the weather.
The letter continues by listing eight assurance procedures that were performed by the CPA. It notes that PricewaterhouseCoopers obtained an understanding of the structure of the organization, conducted inquiries regarding the preparation process, analytically evaluated selected disclosures, compared selected disclosures, and so on. There are, however, almost no detailed disclosures of the nature of the inquiries that were made, the disclosures that were selected for analytical evaluation or comparison, or anything else. Interestingly, PricewaterhouseCoopers does list a single specific procedure in its letter; it notes that it performed an “assessment of the aggregation of Scope-3-GHG-emissions (categories 1 and 11) on group level.” That procedure may have been necessitated by Volkswagen’s recent global emissions scandal. (For more on the Volkswagen case, see “The Volkswagen Diesel Emissions Scandal and Accountability” by Daniel Jacobs and Lawrence P. Kalbers, on p. 16 of this issue.). Nevertheless, no other detailed procedure is disclosed in the report.
Finally, the letter concludes with a disclaimer that it “is not intended for any third parties to base any (financial) decision thereon. Our responsibility lies only with the Company. We do not assume any responsibility towards third parties.” Thus, PricewaterhouseCoopers’s letter is not designed to serve the needs of the readers of Volkswagen’s sustainability report, despite being the sole assurance letter that is included in that very report.
Incidentally, although Volkswagen’s 2017 sustainability report is comparable to its 2018 report, one cannot compare these two documents to its 2016 report. Although a synopsis of the 2016 report is posted online, the full 2016 report has been deleted from the Internet. It is left to readers to wonder what was in the full report and why it is no longer available.
Fiat Chrysler Automobiles (FCA)
Fiat Chrysler Automobiles’ table of contents likewise lists a two-page “Independent Auditor’s Report” on pages 139 and 140. That letter, issued by Deloitte, is called “Independent Auditor’s Report on the Sustainability Report.” Deloitte does not explain why it refers to itself as an auditor and not as a practitioner (as PricewaterhouseCoopers does).
Furthermore, Deloitte’s letter contains the same double negative language as PwC’s, concluding that “nothing has come to our attention that causes us to believe that the Sustainability Report … is not prepared, in all material aspects, in accordance with” the relevant standards.
The Deloitte letter lists seven bullet points of assurance procedures. Certain details are excluded from the Deloitte report but are included in the PricewaterhouseCoopers report, and vice versa. For example, PwC’s explicit statement about its GHG emissions assessment procedure is missing from Deloitte’s letter. Conversely, Deloitte’s letter explicitly refers to analyses performed on “minutes of the meetings,” and the receipt of a “representation letter signed by the legal representative” of Fiat Chrysler. Such language is missing from the PricewaterhouseCoopers letter.
Finally, Deloitte’s letter does not contain a warning that it “is not intended for any third parties to base any decision thereon,” or that Deloitte does “not assume any responsibility towards third parties.” PricewaterhouseCoopers’s letter, as noted above, includes these disclaimers.
The Limitations of Limited Assurance
Should stakeholders worry about these facts? On the one hand, it is important to keep in mind that the sustainability movement has succeeded in compelling global corporations to issue more than 100 pages of data each year. Even if significant portions of the reports are filled with green-washed information, the remaining (and perhaps some significant) portions of the reports may contain useful data.
On the other hand, it is also important to keep in mind that the limited assurance of these public accountant’s sustainability letters provides, in certain respects, even less assurance than detailed agreed-upon procedure letters. After all, an agreed-upon procedure letter contains detailed descriptions of the procedures that are performed and the findings that are produced by the procedures. In contrast, the limited assurance letters in these sustainability reports contain very little detailed information and only reach vague, double-negative conclusions regarding the findings.
Furthermore, the descriptions of the procedures in the letters are inconsistent from company to company, and the disclaimers regarding the use of the letters by third parties vary remarkably from firm to firm. Such inconsistencies and variations greatly reduce the value of the assurance reports, and thus of the sustainability data that are included in them.
Clearly, there are significant limitations to the limited assurance letters in the sustainability reports. Perhaps, in addition to lobbying for improvements in sustainability reporting standards, public interest advocates should consider lobbying for the development of more stringent sustainability assurance standards.
How many standards can a sustainability accountant possibly follow? Three dozen comprehensive standards are published by the Global Reporting Initiative (GRI), and 77 industry-specific standards are issued by the Sustainability Accounting Standards Board (SASB). In addition, 17 sets of metrics are promulgated within the Sustainability Development Goals (SDG) of the United Nations, 15 components of integrated reporting are defined by the International Integrated Reporting Council (IIRC), and the AICPA, not to be outdone, chimed in earlier this year with its new guide, Attestation Engagements on Sustainability Information.
Sustainability standards are growing in length and complexity; as a result, the length and complexity of corporate sustainability reports are growing as well. The 2018 sustainability report of Volkswagen (VW), for instance, runs at 108 pages. The report of its European rival Fiat Chrysler Automobiles (FCA) is much lengthier, at 148 pages.
Some analysts complain that such reports are filled with “green-washed” public relations content. Others disagree, claiming that the European Union’s Directive on nonfinancial reporting ensures that the sustainability content is meaningful on an individual report basis and comparable across multiple reports.
To be fair, the latter group of analysts can cite examples of meaningful and comparable data. VW’s report, for instance, includes a section entitled “GRI Content Index”; it cross-references its published data to the standards of the Global Reporting Initiative. FCA’s equivalent section, the “GRI Standards Content Index,” serves the same purpose.
But are readers of sustainability reports missing out if they only pay attention to the sustainability report data and the underlying standards? Should they also pay attention to the assurance letters issued by public accounting firms and printed in the reports? After all, if the assurance letters are not sufficient, then all of the information in the reports, greenwashed or substantive, is of dubious value.
Consider, in comparison, the annual financial statements of business entities. They would obviously be less useful if public accounting firms were to use extremely limited assurance procedures during their annual audits. Their assurance procedures would be even less useful if auditing firms could offer different levels of assurance to different clients.
Indeed, spending a little less time worrying about the data in the sustainability reports and a bit more time considering the limited assurance letters may lead to the conclusion that confidence in the validity of any of the report data may not be warranted.
Volkswagen
Consider, for instance, Volkswagen’s 2018 report. The table of contents lists a two-page “Independent Assurance Report” on pages 104 and 105. That assurance letter, issued by PricewaterhouseCoopers, is called “Independent Practitioner’s Report On A Limited Assurance Engagement On Non-Financial Reporting.” How much assurance does it actually convey?
The letter notes that PricewaterhouseCoopers is required to “plan and perform the assurance engagement to allow us [i.e., the CPA] to conclude with limited assurance that nothing has come to our attention that causes us to believe that the Company’s Non-financial Report … has not been prepared, in all material aspects, in accordance with” the relevant standards.”
This double-negative structure raises some flags. In essence, the CPA is only required to conclude that nothing came to his attention to cause a belief that something is not right. Metaphorically speaking, an ostrich that buries its head in the sand during a desert storm could satisfy that level of assurance about the weather.
The letter continues by listing eight assurance procedures that were performed by the CPA. It notes that PricewaterhouseCoopers obtained an understanding of the structure of the organization, conducted inquiries regarding the preparation process, analytically evaluated selected disclosures, compared selected disclosures, and so on. There are, however, almost no detailed disclosures of the nature of the inquiries that were made, the disclosures that were selected for analytical evaluation or comparison, or anything else. Interestingly, PricewaterhouseCoopers does list a single specific procedure in its letter; it notes that it performed an “assessment of the aggregation of Scope-3-GHG-emissions (categories 1 and 11) on group level.” That procedure may have been necessitated by Volkswagen’s recent global emissions scandal. (For more on the Volkswagen case, see “The Volkswagen Diesel Emissions Scandal and Accountability” by Daniel Jacobs and Lawrence P. Kalbers, on p. 16 of this issue.). Nevertheless, no other detailed procedure is disclosed in the report.
Finally, the letter concludes with a disclaimer that it “is not intended for any third parties to base any (financial) decision thereon. Our responsibility lies only with the Company. We do not assume any responsibility towards third parties.” Thus, PricewaterhouseCoopers’s letter is not designed to serve the needs of the readers of Volkswagen’s sustainability report, despite being the sole assurance letter that is included in that very report.
Incidentally, although Volkswagen’s 2017 sustainability report is comparable to its 2018 report, one cannot compare these two documents to its 2016 report. Although a synopsis of the 2016 report is posted online, the full 2016 report has been deleted from the Internet. It is left to readers to wonder what was in the full report and why it is no longer available.
Fiat Chrysler Automobiles (FCA)
Fiat Chrysler Automobiles’ table of contents likewise lists a two-page “Independent Auditor’s Report” on pages 139 and 140. That letter, issued by Deloitte, is called “Independent Auditor’s Report on the Sustainability Report.” Deloitte does not explain why it refers to itself as an auditor and not as a practitioner (as PricewaterhouseCoopers does).
Furthermore, Deloitte’s letter contains the same double negative language as PwC’s, concluding that “nothing has come to our attention that causes us to believe that the Sustainability Report … is not prepared, in all material aspects, in accordance with” the relevant standards.
The Deloitte letter lists seven bullet points of assurance procedures. Certain details are excluded from the Deloitte report but are included in the PricewaterhouseCoopers report, and vice versa. For example, PwC’s explicit statement about its GHG emissions assessment procedure is missing from Deloitte’s letter. Conversely, Deloitte’s letter explicitly refers to analyses performed on “minutes of the meetings,” and the receipt of a “representation letter signed by the legal representative” of Fiat Chrysler. Such language is missing from the PricewaterhouseCoopers letter.
Finally, Deloitte’s letter does not contain a warning that it “is not intended for any third parties to base any decision thereon,” or that Deloitte does “not assume any responsibility towards third parties.” PricewaterhouseCoopers’s letter, as noted above, includes these disclaimers.
The Limitations of Limited Assurance
Should stakeholders worry about these facts? On the one hand, it is important to keep in mind that the sustainability movement has succeeded in compelling global corporations to issue more than 100 pages of data each year. Even if significant portions of the reports are filled with green-washed information, the remaining (and perhaps some significant) portions of the reports may contain useful data.
On the other hand, it is also important to keep in mind that the limited assurance of these public accountant’s sustainability letters provides, in certain respects, even less assurance than detailed agreed-upon procedure letters. After all, an agreed-upon procedure letter contains detailed descriptions of the procedures that are performed and the findings that are produced by the procedures. In contrast, the limited assurance letters in these sustainability reports contain very little detailed information and only reach vague, double-negative conclusions regarding the findings.
Furthermore, the descriptions of the procedures in the letters are inconsistent from company to company, and the disclaimers regarding the use of the letters by third parties vary remarkably from firm to firm. Such inconsistencies and variations greatly reduce the value of the assurance reports, and thus of the sustainability data that are included in them.
Clearly, there are significant limitations to the limited assurance letters in the sustainability reports. Perhaps, in addition to lobbying for improvements in sustainability reporting standards, public interest advocates should consider lobbying for the development of more stringent sustainability assurance standards.
Tuesday, July 16, 2019
Accounting In The Food And Drink Industry
Editorial Note: We are delighted to publish the following editorial by Professor Lisa Jack of the University of Portsmouth in the United Kingdom. The content is representative of the quality of the material that our colleagues will share at our 2019 Annual Meeting in San Francisco next month.
We hope to see you there! As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.
Is it in the public interest to know about accounting in the food and drink industry? As one of the very few researchers in the discipline who study this field in depth, and I’ve been looking at the industry for nearly 20 years now, what I usually encounter is a vague idea that accounting in the area ‘cannot be that complicated’, something that runs philosophically with a general unawareness of what really goes into producing food and drink in a developed, capitalist country.
It’s not that people are generally disinterested in food and drink, and where it comes from. Yes, some schoolchildren and some adults take supermarket food for granted and are bemused to find that what they eat involves animals and plants (and chemicals). But the TV schedules, in the UK and Canada at least, are filled with people cooking and baking, and investigating ‘how things are made’, food scandals, diets and advising on how to reduce the costs of the weekly shop for families. Gastronomy, artisan foods, organic, vegan – all are taking new footholds and as Julie Guthman of UC Santa Barbara says very quickly become part of a capitalism that embodies (literally) the faults in the system. The domination of capitalist multi-retailers and food processing companies is directly implicated in policy on both obesity and healthy eating.
In fact, most of us have a reasonable general knowledge of food and some perception of what it costs to produce, distribute and sell. But it is a complicated industry, with complicated social interactions at play. The accounting is also complicated – and often under the radar. So, I want to touch first on how others have articulated the underlying problems and then on bringing forward some of the things I’ve found going on under that radar. In particular, here, I’m interested with others on how city dwellers (around 55% of the world’s population according to the UN, and set to rise to 68% by 2050) see food.
Michael Pollen (The Omnivore’s Dilemma) and Michael Carolan (The Real Cost of Cheap Food) are the other must reads in this area, along with Julie Guthman (Weighing In).
One of the most quoted and respected writers in the US is Wendell Berry (b.1934), this is an extract from ‘The Pleasures of Eating’.
I begin with the proposition that eating is an agricultural act. Eating ends the annual drama of the food economy that begins with planting and birth. Most eaters, however, are no longer aware that this is true. They think of food as an agricultural product, perhaps, but they do not think of themselves as participants in agriculture. They think of themselves as "consumers." If they think beyond that, they recognize that they are passive consumers. They buy what they want — or what they have been persuaded to want — within the limits of what they can get. They pay, mostly without protest, what they are charged. And they mostly ignore certain critical questions about the quality and the cost of what they are sold: How fresh is it? How pure or clean is it, how free of dangerous chemicals? How far was it transported, and what did transportation add to the cost? How much did manufacturing or packaging or advertising add to the cost? When the food product has been manufactured or "processed" or "precooked," how has that affected its quality or price or nutritional value?
Georg Simmel wrote in 1903 in ‘The metropolis and mental life’: “…the money economy that dominates the metropolis in which the last remnants of domestic production and direct barter of goods have been eradicated and in which the amount of production on direct personal order is reduced daily. Furthermore, [a] psychological intellectualist attitude and the economy are in such close integration that no-one is able to say whether it is the former that has affected the latter or vice-versa”. One result might be that living in a city makes one unaware of the cost of food production, and the effects of a demand for cheap food on suppliers and producers. The English writer Adrian Bell (1931) says that when he was a struggling farmer (having been a city-bred boy who chose an apprenticeship on a farm over other professions): “I began to realise, also, how much of the money which the consumer says he gives so plentifully, and of which the producer says he receives so sparingly, fell through the hole in the middle-man’s pocket into the gulf of wastage and wear-and-tear. What Mrs. Sinks of Surbiton doesn’t realise is that for the privilege of going out at any moment and buying a chicken ready for the oven, she has to pay for all those other times when the chicken was waiting for her and she doesn’t want it”.
This last quote is so relevant to what I hear in conversations that I have today. Consumers (or “individual eaters” for a less pejorative term these days) tell me at length either about how wicked it is that the supermarkets charge so much and make such large profits, or at length about how they are prepared to pay more in order to get quality, or fairness, or whatever, and how wicked it is that supermarkets charge so little for (junk) food. Producers, suppliers and retailers tell me about the difficulties of maintaining incredibly tight NET margins averaging around 1-2% of turnover, but I also find that increasingly, I am looking at the money that vanishes in between. I am also taken with looking, as Bell does, at the problem from the other side, the non-consumer side. Here in the UK, for example, food manufacturing, processing, distribution and selling accounts for some 29.5% of GDP, employs 14% of the workforce and accounts for £22bn of exports (including quite a lot of scotch whiskey). Yet, of the 6,000 companies in the industry (excluding farmers, around 2% of national production), 5,800 are small or mid-sized entities and nearly 1500 are teetering on the edge of insolvency.
What is included then, in a conversation about accounting and the public interest? A surprising number of topics, in fact, which include: subsidies and support from government; the public cost of deleterious consequences of the food industry – public in terms of social and environmental damage; individual costs in terms of health and well-being; pay inequality (there are attested reports of workers in supermarkets having to use foodbanks, whilst executives can be very highly remunerated); the whole cheap food debate linked to the real costs of production; power and capitalism, evinced in the extreme concentration of production and selling in the hands of a few businesses. These debates are already out there but I promised to discuss what things go under the radar, which is what I research. Here are three of them: commercial income; discounting in negotiations and the growth of food service. There is also the nature of narrow margins, marginal costing, performance measurement and risk assessment and their effect on the fairness of the industry*. Enough for a book, let alone one blog post, so I am just going to focus in on commercial income.
In the UK, the largest supermarket (Tesco) was acquitted on charges of fraud related to an overstatement of £250million in its profits. What is not in dispute is that the overstatement related to recognising commercial income in advance.
Following disquiet on its commercial income, the supermarket Morrisons in the UK started to lead the industry on disclosures of this activity in the annual report but only from 2014/15. The Germany-based discounter, Aldi (recently spotted in an outpost in Ames, Iowa and a significant rising player in the UK), states clearly that it does not use commercial income in its purchases.
In the US, as one BBC article reports, “According to Fitch, the credit rating agency, the payments are the equivalent to 8% of the cost of goods sold for the retailers, equal to virtually all their profit.”
So, what is commercial income? Briefly, it is income from suppliers to retailers. This, of course, should elicit the response ‘What, hang on a minute, customers pay suppliers, right, not the other way around?’ This is to fundamentally misunderstand the nature of multiple retailers (supermarkets). In fact, the new terminology handily loses the term ‘market’ but that is what they are offering and managing. Like a marketplace, you pay the market owner for a place and their ability to bring people in to buy. You might reward them for doing the latter well and for selling large quantities of your product. Commercial income, then, includes a raft of payments extracted from the supplier for the privilege of supplying – space, bonuses, discounts offered and so on. However, supermarkets are also now driven by customer demand (created largely by the supermarkets themselves) for full shelves, full choice all year around. Suppliers tied into the system, already taking the slimmest of margins for their products because the margin needed by the retailer to run their system is substantial, are bound to deliver in full, to specification, on time. For some supermarkets, the slightest infringement of this incurs penalties, also accounted for under ‘commercial income’. The supplier might well lose the payment for the consignment as well. An article in the British weekly industry publication in 2015, ‘The Grocer’ lists around 30 different types of commercial income.
Essentially, supermarket profits do not come from consumers, they come from suppliers. Link that with extended payment terms and it becomes clear why small and mid-size food companies, and their employees, are at risk. It is not a case of ‘supermarkets bad, suppliers/consumers good’. There are retailers have records of working to build long-term beneficial relationships with some suppliers and many consumers themselves prefer to shop under the radar than visibly in a local shop, and to have the perceived convenience. The job for accounting researchers is to help devise possible alternatives to enhancing profits that do not involve commercial income, low wages and non-affordable food. That really is a research challenge.
We hope to see you there! As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.
Is it in the public interest to know about accounting in the food and drink industry? As one of the very few researchers in the discipline who study this field in depth, and I’ve been looking at the industry for nearly 20 years now, what I usually encounter is a vague idea that accounting in the area ‘cannot be that complicated’, something that runs philosophically with a general unawareness of what really goes into producing food and drink in a developed, capitalist country.
It’s not that people are generally disinterested in food and drink, and where it comes from. Yes, some schoolchildren and some adults take supermarket food for granted and are bemused to find that what they eat involves animals and plants (and chemicals). But the TV schedules, in the UK and Canada at least, are filled with people cooking and baking, and investigating ‘how things are made’, food scandals, diets and advising on how to reduce the costs of the weekly shop for families. Gastronomy, artisan foods, organic, vegan – all are taking new footholds and as Julie Guthman of UC Santa Barbara says very quickly become part of a capitalism that embodies (literally) the faults in the system. The domination of capitalist multi-retailers and food processing companies is directly implicated in policy on both obesity and healthy eating.
In fact, most of us have a reasonable general knowledge of food and some perception of what it costs to produce, distribute and sell. But it is a complicated industry, with complicated social interactions at play. The accounting is also complicated – and often under the radar. So, I want to touch first on how others have articulated the underlying problems and then on bringing forward some of the things I’ve found going on under that radar. In particular, here, I’m interested with others on how city dwellers (around 55% of the world’s population according to the UN, and set to rise to 68% by 2050) see food.
Michael Pollen (The Omnivore’s Dilemma) and Michael Carolan (The Real Cost of Cheap Food) are the other must reads in this area, along with Julie Guthman (Weighing In).
One of the most quoted and respected writers in the US is Wendell Berry (b.1934), this is an extract from ‘The Pleasures of Eating’.
I begin with the proposition that eating is an agricultural act. Eating ends the annual drama of the food economy that begins with planting and birth. Most eaters, however, are no longer aware that this is true. They think of food as an agricultural product, perhaps, but they do not think of themselves as participants in agriculture. They think of themselves as "consumers." If they think beyond that, they recognize that they are passive consumers. They buy what they want — or what they have been persuaded to want — within the limits of what they can get. They pay, mostly without protest, what they are charged. And they mostly ignore certain critical questions about the quality and the cost of what they are sold: How fresh is it? How pure or clean is it, how free of dangerous chemicals? How far was it transported, and what did transportation add to the cost? How much did manufacturing or packaging or advertising add to the cost? When the food product has been manufactured or "processed" or "precooked," how has that affected its quality or price or nutritional value?
Georg Simmel wrote in 1903 in ‘The metropolis and mental life’: “…the money economy that dominates the metropolis in which the last remnants of domestic production and direct barter of goods have been eradicated and in which the amount of production on direct personal order is reduced daily. Furthermore, [a] psychological intellectualist attitude and the economy are in such close integration that no-one is able to say whether it is the former that has affected the latter or vice-versa”. One result might be that living in a city makes one unaware of the cost of food production, and the effects of a demand for cheap food on suppliers and producers. The English writer Adrian Bell (1931) says that when he was a struggling farmer (having been a city-bred boy who chose an apprenticeship on a farm over other professions): “I began to realise, also, how much of the money which the consumer says he gives so plentifully, and of which the producer says he receives so sparingly, fell through the hole in the middle-man’s pocket into the gulf of wastage and wear-and-tear. What Mrs. Sinks of Surbiton doesn’t realise is that for the privilege of going out at any moment and buying a chicken ready for the oven, she has to pay for all those other times when the chicken was waiting for her and she doesn’t want it”.
This last quote is so relevant to what I hear in conversations that I have today. Consumers (or “individual eaters” for a less pejorative term these days) tell me at length either about how wicked it is that the supermarkets charge so much and make such large profits, or at length about how they are prepared to pay more in order to get quality, or fairness, or whatever, and how wicked it is that supermarkets charge so little for (junk) food. Producers, suppliers and retailers tell me about the difficulties of maintaining incredibly tight NET margins averaging around 1-2% of turnover, but I also find that increasingly, I am looking at the money that vanishes in between. I am also taken with looking, as Bell does, at the problem from the other side, the non-consumer side. Here in the UK, for example, food manufacturing, processing, distribution and selling accounts for some 29.5% of GDP, employs 14% of the workforce and accounts for £22bn of exports (including quite a lot of scotch whiskey). Yet, of the 6,000 companies in the industry (excluding farmers, around 2% of national production), 5,800 are small or mid-sized entities and nearly 1500 are teetering on the edge of insolvency.
What is included then, in a conversation about accounting and the public interest? A surprising number of topics, in fact, which include: subsidies and support from government; the public cost of deleterious consequences of the food industry – public in terms of social and environmental damage; individual costs in terms of health and well-being; pay inequality (there are attested reports of workers in supermarkets having to use foodbanks, whilst executives can be very highly remunerated); the whole cheap food debate linked to the real costs of production; power and capitalism, evinced in the extreme concentration of production and selling in the hands of a few businesses. These debates are already out there but I promised to discuss what things go under the radar, which is what I research. Here are three of them: commercial income; discounting in negotiations and the growth of food service. There is also the nature of narrow margins, marginal costing, performance measurement and risk assessment and their effect on the fairness of the industry*. Enough for a book, let alone one blog post, so I am just going to focus in on commercial income.
In the UK, the largest supermarket (Tesco) was acquitted on charges of fraud related to an overstatement of £250million in its profits. What is not in dispute is that the overstatement related to recognising commercial income in advance.
Following disquiet on its commercial income, the supermarket Morrisons in the UK started to lead the industry on disclosures of this activity in the annual report but only from 2014/15. The Germany-based discounter, Aldi (recently spotted in an outpost in Ames, Iowa and a significant rising player in the UK), states clearly that it does not use commercial income in its purchases.
In the US, as one BBC article reports, “According to Fitch, the credit rating agency, the payments are the equivalent to 8% of the cost of goods sold for the retailers, equal to virtually all their profit.”
So, what is commercial income? Briefly, it is income from suppliers to retailers. This, of course, should elicit the response ‘What, hang on a minute, customers pay suppliers, right, not the other way around?’ This is to fundamentally misunderstand the nature of multiple retailers (supermarkets). In fact, the new terminology handily loses the term ‘market’ but that is what they are offering and managing. Like a marketplace, you pay the market owner for a place and their ability to bring people in to buy. You might reward them for doing the latter well and for selling large quantities of your product. Commercial income, then, includes a raft of payments extracted from the supplier for the privilege of supplying – space, bonuses, discounts offered and so on. However, supermarkets are also now driven by customer demand (created largely by the supermarkets themselves) for full shelves, full choice all year around. Suppliers tied into the system, already taking the slimmest of margins for their products because the margin needed by the retailer to run their system is substantial, are bound to deliver in full, to specification, on time. For some supermarkets, the slightest infringement of this incurs penalties, also accounted for under ‘commercial income’. The supplier might well lose the payment for the consignment as well. An article in the British weekly industry publication in 2015, ‘The Grocer’ lists around 30 different types of commercial income.
Essentially, supermarket profits do not come from consumers, they come from suppliers. Link that with extended payment terms and it becomes clear why small and mid-size food companies, and their employees, are at risk. It is not a case of ‘supermarkets bad, suppliers/consumers good’. There are retailers have records of working to build long-term beneficial relationships with some suppliers and many consumers themselves prefer to shop under the radar than visibly in a local shop, and to have the perceived convenience. The job for accounting researchers is to help devise possible alternatives to enhancing profits that do not involve commercial income, low wages and non-affordable food. That really is a research challenge.
Saturday, March 23, 2019
Pay Your Dues and Get Abuse
Editorial Note: We are delighted to publish the following editorial by Paul F. Williams, the 2013 recipient of the Accounting Exemplar Award. The content is representative of the quality of the material that our colleagues will share at our 2019 Midyear Meeting in Orlando next week.
We hope to see you there! As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.
***
Paul F. Williams is a Professor of Accounting at the Poole College of Management at North Carolina State University. Paul earned a BSF from West Virginia University, and MBA and Ph.D. degrees from the University of North Carolina at Chapel Hill. He joined the N.C. State faculty in 1985 after spending 1977 to 1985 at Florida State University. His research interests include accounting ethics, theory, and critical perspectives in accounting. His publications have appeared in Critical Perspectives on Accounting, Accounting, Organizations and Society, The Accounting Review, Contemporary Accounting Research, Journal of Business Ethics, Accounting and the Public Interest, Accounting Horizons (for which he won the best paper award for 2014), among many other journals. He has served as chairperson of the Public Interest Section of the American Accounting Association and as editor of Accounting and the Public Interest. He received the Public Interest Section’s Accounting Exemplar Award in 2013.
An astonishing event occurred at the 2016 Centennial meeting of the American Accounting Association (AAA). Even more astonishing is that the event went largely unremarked – it passed into history without disrupting the normal life of the North American accounting academy. That it might not be obvious to many of you who happen to read this blog to what I am referring proves my point. It also says something about AAA leadership and even more about AAA members. What it says about us as members of AAA is not encouraging. The event to which I refer is the Plenary devoted to the proposition that accounting will be a learned profession by the year 2036. That obviously means, at least in the opinion of the AAA leadership, accounting is not as yet a learned profession. The astonishing part of the public admission that accounting is as yet not a learned profession is that a characteristic of professions is that they are, by definition, learned. There cannot be an un-learned profession. Would the legal profession or the medical profession ever publicly admit they were not yet learned? A lot more to learn, yes, but not as yet learned? We should be embarrassed by such an admission since we have already had over a century to become learned.
That law or medicine (or any other academic discipline) would admit to such a thing is not likely. This is so for at least two reasons: 1. Something is being learned by someone in order to be admitted to the discipline and that something is substantial and continuously tested with some process for ascertaining the value of that something, and 2. There is not a monolithic organization that controls the process by which something enters the canon of what is permissible learning and what is not. Unlike medicine and law where research and practice are intertwined, the accounting academy in the U.S. is unusual in that the something to be learned to be admitted to the practice of accounting is determined largely by the rules promulgated by regulatory bodies (e.g. FASB, IRS, SEC, PCAOB, etc.). Perhaps only second to the military is any field so dominated by acronyms as accounting – acronyms that stand for organized bodies writing rules. The academy produces very little that actually makes its way into the canon which must be learned to be admitted to the profession (it does however contribute a great deal to what must be believed). Given the academy’s lengthy disinterest in the actual practice of accounting or the actual function of accounting in society, a promise to make accounting a learned profession seems a bit disingenuous.*
Law, medicine, or almost any other scholarly discipline is dispersed. There are vast numbers of people engaged in those disciplines without extensive centralized bureaucratic control. The natural sciences which provide us lay people with the template for the so-called scientific method could not function as sciences under bureaucratic control (the Lysenko affair in the old USSR is a case in point). Freedom to explore is essential to “progress.” There are no single organizations that legislate the structures or contents of scientific disciplines. For example, according to Hossenfelder (2018, p. 153) there were 2,000 physics PhDs awarded in the U.S. in 2012. Membership in the American Physical Society is 51,000 and the membership in the German Physical Society is 60,000. The sheer number and dispersion of people doing physics provides at least a freedom from control by anything other than the constrictions of the discipline itself, i.e., there are certain things you are no longer permitted to believe since they have been ruled out as believable by the discipline, not by an organization that controls the discipline through bureaucratic fiat.
Accounting, at least in North America, is, perhaps uniquely, a discipline where discipline is imposed by a bureaucratic organization. Accounting as an academic discipline is extraordinarily small compared to virtually all other academic disciplines. As the physics example illustrates fields in the natural sciences are populated by thousands of people. Accounting academics are relatively few in number and emerged as such largely in the U.S. Prior to the movement to make business disciplines more scientific, which began in the 1950s, accounting was taught mostly by people from practice and research in the sense of applying the methods of social science was non-existent. What shape a scientific approach to accounting would take was contested territory. The first quantitative applications in accounting appeared in the area of management. The developments in operations research that came about because of WWII appeared in TAR written by people like W.W. Cooper. Edwin Caplin was an early pioneer in introducing psychology to the investigation of accounting – thus was born behavioral accounting research. But the battle for hegemony over the accounting research agenda has clearly been won by the group that claims ownership of the financial reporting revolution. This is a clearly identifiable group of cohorts who matriculated at the University of Chicago between the mid-1960s and the early 1970s. Their significance is evidenced by the fact that the first four Seminal Contributions to the Accounting Literature Awards were given to work produced by that cohort. Apparently nothing of any intellectual value was produced prior to this group of persons steeped in neoclassical economics Friedman style and neoliberal ideology (Friedman was a founding member of the Mt. Pelerin Society).
Because there is a monolithic organization (the AAA) that manages the U.S. professoriate control of the AAA gives control of the agenda. The Seminal Contribution Awards** is a case in point. Perhaps some of you know how the selection process for that award works, but I don’t. Magically it is announced that one has been bestowed, but who does it or how it is done is a mystery. The AAA has a history of self-appointed elites as the laughable case of ARIA (Edwards, et al., 2013) illustrates. The doctoral consortium and the new faculty consortium were created as mechanisms for controlling the agenda. I attended one of the early doctoral consortia in 1974 and the entire program was dedicated to EMH and the methods of financial economics. A most vivid memory of that experience was the panel on which Sandy Burton was invited to speak only to be assaulted for his naïve understanding of the world by rebel soldiers in the financial reporting revolution. Some years later Gary Previts made an effort to introduce doctoral students to broader perspectives and had Tim Fogarty organize a faculty that included a Foucaldian, a leading accounting historian, a past editor of Issues in Accounting Education, an eclectic scholar, and an ethicist. Needless to say the reaction by the AAA’s director of research was one of extreme displeasure and none of those people were ever invited back.
The proclivity of the AAA toward bureaucratic control of the discipline is perhaps understandable. It is, after all, an organization populated mostly by people who lived in the culture of the accounting profession, a culture that places highest value on conformity. To me the latest outrage is the change in procedure for the selection of the best paper awards for Issues and Horizons. In spite of the changes in bylaws made a few years ago, there is no visible effect of those changes on the intellectual agenda of the AAA becoming more diverse. Horizons and Issues were created to devalue certain scholarship. TAR used to contain an Education section, but it was removed because rewarding someone with a TAR citation for writing about education was just not on. Comments were eliminated from TAR as well because a TAR byline could not be provided to someone who just wanted to comment, particularly if the comment cast skepticism on the content of TAR. Horizons was to be where articles that could be comprehended by practitioners were to be published, but it quickly became a paler version of TAR. Since articles in Issues and Horizons were not deemed serious scholarship the best paper awards for those two journals were left to a plebiscite of the members. The winners of the Horizons awards reflected the eclectic interests of the members. Papers dealing with education, systems, audit, history, epistemology, sociology of knowledge, and, yes, financial reporting were winners. This past year, however, the idea of letting the members choose from among all papers published in Horizons, was apparently deemed too risky. The AAA decided that might lead to the “wrong” kind of literature being noted as award winning. So the list of acceptable papers was pared to only five, all of which dealt with financial reporting. What little power the members have to shape what the AAA acknowledges as intellectually worthy has been taken away and without a whimper.
The people who gave us the financial reporting revolution and their successors have for some years now been expressing angst over the stagnant, banal nature of accounting research. As far back as 1991 a group of pre-eminent revolutionaries remarked on the lack of creativity in accounting research (Demski, et al. 1991). Judy Rayburn’s AAA presidency made central the issue of the lack of diversity in accounting research; she invited Anthony Hopwood (noted for Accounting from the Outside) to be her Presidential Speaker. Shyam Sunder made the theme of his presidency Imagining New Accountings and Greg Waymire pushed for Seeds of Innovation while proclaiming, “I believe our discipline is evolving towards irrelevance within the academy and the broader society with the ultimate result being intellectual irrelevance and eventually extinction” (Waymire, 2011, p. 3). But like the monkey with its fist inside the coconut shell, the leadership is incapable of relinquishing their ideological control over the nature of accounting as an intellectual discipline. Accounting research isn’t evolving toward irrelevance; it’s been irrelevant for quite some time. In spite of lip service to Imagining and Innovation, the management style of the AAA is to stifle Imagination and Innovation because that threatens the ideology and the associated reward structure that the financial reporting revolutionaries established nearly 50 years ago and from which they have so richly rewarded themselves. Virtually every North American doctoral program produces the same standardized education designed primarily to enable students to meet the standards of the so-called premier journals, which the revolutionaries also created. The accounting proclivity to standardize everything, even things we don’t understand well enough to standardize, has given us GASS (Generally Accepted Scientific Standards). I admit to being guilty of subsidizing through the dues I have paid this incoherent circumstance of needing more creativity in the academic process but allowing that process to be managed by an organization that has repeatedly demonstrated its inability to cede its autocratic instincts. I have been waiting for decades for our “I’m as mad as hell and I’m not going to take in anymore,” moment. It appears it will never come.
* The history of accounting academia post WWII with its fixation on price level effects and income theories, the creation of JAR and its positivist ideology, and the information metaphor itself stem from intellectual contempt for the premises of accountants in the field. With the exception of Ijiri, the academy abandoned a long time ago the discourses that informed practice because they were intellectually inferior to those of neoclassical economics.
** “Seminal” is apropos since all of the winners so far have been men.
We hope to see you there! As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.
***
Paul F. Williams is a Professor of Accounting at the Poole College of Management at North Carolina State University. Paul earned a BSF from West Virginia University, and MBA and Ph.D. degrees from the University of North Carolina at Chapel Hill. He joined the N.C. State faculty in 1985 after spending 1977 to 1985 at Florida State University. His research interests include accounting ethics, theory, and critical perspectives in accounting. His publications have appeared in Critical Perspectives on Accounting, Accounting, Organizations and Society, The Accounting Review, Contemporary Accounting Research, Journal of Business Ethics, Accounting and the Public Interest, Accounting Horizons (for which he won the best paper award for 2014), among many other journals. He has served as chairperson of the Public Interest Section of the American Accounting Association and as editor of Accounting and the Public Interest. He received the Public Interest Section’s Accounting Exemplar Award in 2013.
An astonishing event occurred at the 2016 Centennial meeting of the American Accounting Association (AAA). Even more astonishing is that the event went largely unremarked – it passed into history without disrupting the normal life of the North American accounting academy. That it might not be obvious to many of you who happen to read this blog to what I am referring proves my point. It also says something about AAA leadership and even more about AAA members. What it says about us as members of AAA is not encouraging. The event to which I refer is the Plenary devoted to the proposition that accounting will be a learned profession by the year 2036. That obviously means, at least in the opinion of the AAA leadership, accounting is not as yet a learned profession. The astonishing part of the public admission that accounting is as yet not a learned profession is that a characteristic of professions is that they are, by definition, learned. There cannot be an un-learned profession. Would the legal profession or the medical profession ever publicly admit they were not yet learned? A lot more to learn, yes, but not as yet learned? We should be embarrassed by such an admission since we have already had over a century to become learned.
That law or medicine (or any other academic discipline) would admit to such a thing is not likely. This is so for at least two reasons: 1. Something is being learned by someone in order to be admitted to the discipline and that something is substantial and continuously tested with some process for ascertaining the value of that something, and 2. There is not a monolithic organization that controls the process by which something enters the canon of what is permissible learning and what is not. Unlike medicine and law where research and practice are intertwined, the accounting academy in the U.S. is unusual in that the something to be learned to be admitted to the practice of accounting is determined largely by the rules promulgated by regulatory bodies (e.g. FASB, IRS, SEC, PCAOB, etc.). Perhaps only second to the military is any field so dominated by acronyms as accounting – acronyms that stand for organized bodies writing rules. The academy produces very little that actually makes its way into the canon which must be learned to be admitted to the profession (it does however contribute a great deal to what must be believed). Given the academy’s lengthy disinterest in the actual practice of accounting or the actual function of accounting in society, a promise to make accounting a learned profession seems a bit disingenuous.*
Law, medicine, or almost any other scholarly discipline is dispersed. There are vast numbers of people engaged in those disciplines without extensive centralized bureaucratic control. The natural sciences which provide us lay people with the template for the so-called scientific method could not function as sciences under bureaucratic control (the Lysenko affair in the old USSR is a case in point). Freedom to explore is essential to “progress.” There are no single organizations that legislate the structures or contents of scientific disciplines. For example, according to Hossenfelder (2018, p. 153) there were 2,000 physics PhDs awarded in the U.S. in 2012. Membership in the American Physical Society is 51,000 and the membership in the German Physical Society is 60,000. The sheer number and dispersion of people doing physics provides at least a freedom from control by anything other than the constrictions of the discipline itself, i.e., there are certain things you are no longer permitted to believe since they have been ruled out as believable by the discipline, not by an organization that controls the discipline through bureaucratic fiat.
Accounting, at least in North America, is, perhaps uniquely, a discipline where discipline is imposed by a bureaucratic organization. Accounting as an academic discipline is extraordinarily small compared to virtually all other academic disciplines. As the physics example illustrates fields in the natural sciences are populated by thousands of people. Accounting academics are relatively few in number and emerged as such largely in the U.S. Prior to the movement to make business disciplines more scientific, which began in the 1950s, accounting was taught mostly by people from practice and research in the sense of applying the methods of social science was non-existent. What shape a scientific approach to accounting would take was contested territory. The first quantitative applications in accounting appeared in the area of management. The developments in operations research that came about because of WWII appeared in TAR written by people like W.W. Cooper. Edwin Caplin was an early pioneer in introducing psychology to the investigation of accounting – thus was born behavioral accounting research. But the battle for hegemony over the accounting research agenda has clearly been won by the group that claims ownership of the financial reporting revolution. This is a clearly identifiable group of cohorts who matriculated at the University of Chicago between the mid-1960s and the early 1970s. Their significance is evidenced by the fact that the first four Seminal Contributions to the Accounting Literature Awards were given to work produced by that cohort. Apparently nothing of any intellectual value was produced prior to this group of persons steeped in neoclassical economics Friedman style and neoliberal ideology (Friedman was a founding member of the Mt. Pelerin Society).
Because there is a monolithic organization (the AAA) that manages the U.S. professoriate control of the AAA gives control of the agenda. The Seminal Contribution Awards** is a case in point. Perhaps some of you know how the selection process for that award works, but I don’t. Magically it is announced that one has been bestowed, but who does it or how it is done is a mystery. The AAA has a history of self-appointed elites as the laughable case of ARIA (Edwards, et al., 2013) illustrates. The doctoral consortium and the new faculty consortium were created as mechanisms for controlling the agenda. I attended one of the early doctoral consortia in 1974 and the entire program was dedicated to EMH and the methods of financial economics. A most vivid memory of that experience was the panel on which Sandy Burton was invited to speak only to be assaulted for his naïve understanding of the world by rebel soldiers in the financial reporting revolution. Some years later Gary Previts made an effort to introduce doctoral students to broader perspectives and had Tim Fogarty organize a faculty that included a Foucaldian, a leading accounting historian, a past editor of Issues in Accounting Education, an eclectic scholar, and an ethicist. Needless to say the reaction by the AAA’s director of research was one of extreme displeasure and none of those people were ever invited back.
The proclivity of the AAA toward bureaucratic control of the discipline is perhaps understandable. It is, after all, an organization populated mostly by people who lived in the culture of the accounting profession, a culture that places highest value on conformity. To me the latest outrage is the change in procedure for the selection of the best paper awards for Issues and Horizons. In spite of the changes in bylaws made a few years ago, there is no visible effect of those changes on the intellectual agenda of the AAA becoming more diverse. Horizons and Issues were created to devalue certain scholarship. TAR used to contain an Education section, but it was removed because rewarding someone with a TAR citation for writing about education was just not on. Comments were eliminated from TAR as well because a TAR byline could not be provided to someone who just wanted to comment, particularly if the comment cast skepticism on the content of TAR. Horizons was to be where articles that could be comprehended by practitioners were to be published, but it quickly became a paler version of TAR. Since articles in Issues and Horizons were not deemed serious scholarship the best paper awards for those two journals were left to a plebiscite of the members. The winners of the Horizons awards reflected the eclectic interests of the members. Papers dealing with education, systems, audit, history, epistemology, sociology of knowledge, and, yes, financial reporting were winners. This past year, however, the idea of letting the members choose from among all papers published in Horizons, was apparently deemed too risky. The AAA decided that might lead to the “wrong” kind of literature being noted as award winning. So the list of acceptable papers was pared to only five, all of which dealt with financial reporting. What little power the members have to shape what the AAA acknowledges as intellectually worthy has been taken away and without a whimper.
The people who gave us the financial reporting revolution and their successors have for some years now been expressing angst over the stagnant, banal nature of accounting research. As far back as 1991 a group of pre-eminent revolutionaries remarked on the lack of creativity in accounting research (Demski, et al. 1991). Judy Rayburn’s AAA presidency made central the issue of the lack of diversity in accounting research; she invited Anthony Hopwood (noted for Accounting from the Outside) to be her Presidential Speaker. Shyam Sunder made the theme of his presidency Imagining New Accountings and Greg Waymire pushed for Seeds of Innovation while proclaiming, “I believe our discipline is evolving towards irrelevance within the academy and the broader society with the ultimate result being intellectual irrelevance and eventually extinction” (Waymire, 2011, p. 3). But like the monkey with its fist inside the coconut shell, the leadership is incapable of relinquishing their ideological control over the nature of accounting as an intellectual discipline. Accounting research isn’t evolving toward irrelevance; it’s been irrelevant for quite some time. In spite of lip service to Imagining and Innovation, the management style of the AAA is to stifle Imagination and Innovation because that threatens the ideology and the associated reward structure that the financial reporting revolutionaries established nearly 50 years ago and from which they have so richly rewarded themselves. Virtually every North American doctoral program produces the same standardized education designed primarily to enable students to meet the standards of the so-called premier journals, which the revolutionaries also created. The accounting proclivity to standardize everything, even things we don’t understand well enough to standardize, has given us GASS (Generally Accepted Scientific Standards). I admit to being guilty of subsidizing through the dues I have paid this incoherent circumstance of needing more creativity in the academic process but allowing that process to be managed by an organization that has repeatedly demonstrated its inability to cede its autocratic instincts. I have been waiting for decades for our “I’m as mad as hell and I’m not going to take in anymore,” moment. It appears it will never come.
* The history of accounting academia post WWII with its fixation on price level effects and income theories, the creation of JAR and its positivist ideology, and the information metaphor itself stem from intellectual contempt for the premises of accountants in the field. With the exception of Ijiri, the academy abandoned a long time ago the discourses that informed practice because they were intellectually inferior to those of neoclassical economics.
** “Seminal” is apropos since all of the winners so far have been men.
Sunday, March 17, 2019
Are Annual Audits still “Fit for Purpose?”
Editorial Note: We are delighted to present the following editorial column by Nick Shepherd, President of EduVision. Nick currently chairs the CPA Canada Committee for developing Statements in Management Accounting.
As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.
Annual reports together with various supplementary requirements and filings are important for boards, investors, rating agencies and others as a foundation to assess and determine the financial health of an organization. Historically this has worked reasonably well; up until the 1970’s most of the corporate value – an average of 80% – was reflected on the balance sheet. If the audit revealed the integrity of assets and liabilities, there was a reasonable expectation that the business was healthy.
Fast forward to today. Most corporate value for owners, investors and others is now intangible with only an average of 15% represented by financial assets. While certain intangibles can be capitalized and included on the balance sheet, the majority are nowhere to be seen, nor are they assessed or reported on through the audit. If an audit is designed to provide reasonable assurance of organizational health and integrity, doesn't basing this on the verification of only 15% of the value seem high risk?
There is continuing criticism of auditors and the profession for failing to alert investors and others to potential risk when organizations fail – yet how can the profession shoulder the blame when its scope and mandate are determined by compliance with standards that focus principally on tangible assets and liabilities? Apparent failures in oversight and governance approaches are not attributable to the profession alone, but the profession does have a responsibility to reflect on its own role and determine whether the principles that were initially established for audits are still meeting their goals. When significant “sea change” occurs, it requires re-invention rather than improvement. Is society changing the expectations and rules that make an audit relevant? Or are we “re-arranging the deck chairs on the Titanic?”
Customers of the audit profession are increasingly asking for additional information to enhance their risk assessments; this has resulted in regulatory changes as well as voluntary supplemental reporting. In certain jurisdictions, certain supplemental reporting – such as environmental and social issues – are now mandatory. A major thrust is being implemented by those adopting “integrated reporting,” but in most cases, this is not mandatory, audited or based on strongly established standards. A “sea change” it is not! The financial profession does not appear to be front and centre in driving fundamental change, apparently believing that its focus on financial capital remains adequate. Yes, changes are being made, but progress is much too slow; thus, the risk of “surprises” continues to increase.
The profession must start asking some fundamental questions in order to drive governance and accountability changes so that audits are fit for purpose. As a start, let’s consider the drivers of sustainable corporate value creation, and try to “peel back” corporate performance in the areas that might give investors an increased visibility into risk.
From a financial perspective, two sources of cash flow are critical to a sustainable business. First, for most organizations, more than 60% of expenditures are driven by employee costs; yet employee productivity and effectiveness are hard to measure, other than at the macro level. However, we do know that most employee costs are traditionally considered period expenses that convert inputs to outputs.
This is no longer the case, with large portions of employee expense related to building “capacity,” i.e. the contribution of intellectual capital that provides history and process capacity, as well as innovation in process improvement, new products and services, and relationship building with third parties. Only “motivated” employees will do this continually and effectively. To be a sustainable business in the future, the audit should reveal:
Overall, what users need to know is whether approaches to the workforce are protecting human capital sustainability through effective nurturing and development of people.
The second core cash flow is “cash flow in from customers.” Areas such as retention rates, repurchasing patterns, repeat customers and others are all important, but especially critical are relationships. One factor that could be more fully implemented into annual reporting is the stability of brand value.
The attached table shows 2018 data regarding the year end and most recent brand valuations by either Interbrand or Brand Finance (we used the higher valuation). This table demonstrates that, although the “pure audit” of financials provides insight into book values (i.e. balance sheet / shareholder equity), the shareholders value of their investment (i.e. the market value) is much greater.
Several key questions should be of interest to the investor. Using the traditional audit, is the integrity of the balance sheet acceptable? Is the brand value, as calculated by independent third parties, increasing or decreasing? If so, why? And what is the impact on this for the future? For instance, was a potential “auditable” cause the diversion of human capital resources away from customer support activities to enhance financial capital results? Finally, what makes up the ‘other intangible assets’ that contribute a key part of an investment valuation, but that are not being assessed or audited?”
One key failure of the accounting profession is to grasp and modernize the assessment of goodwill. On a sale or purchase of a business entity, it is the “market value-based intangibles” that end up on the acquirer’s balance sheet that must be assessed for “impairment.” How can an auditor do this effectively if the drivers of this value have not been clearly determined?
As can be seen from the table, book values range from 5.9% of value to 24.4%, and it is these underlying valuations of “financial capital” that a traditional audit discloses. If these are examples of the impact on financial capital of the growing knowledge economy, then one can only conclude that audits that remain focused on financial capital alone are not “fit for purpose.”
As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.
Annual reports together with various supplementary requirements and filings are important for boards, investors, rating agencies and others as a foundation to assess and determine the financial health of an organization. Historically this has worked reasonably well; up until the 1970’s most of the corporate value – an average of 80% – was reflected on the balance sheet. If the audit revealed the integrity of assets and liabilities, there was a reasonable expectation that the business was healthy.
Fast forward to today. Most corporate value for owners, investors and others is now intangible with only an average of 15% represented by financial assets. While certain intangibles can be capitalized and included on the balance sheet, the majority are nowhere to be seen, nor are they assessed or reported on through the audit. If an audit is designed to provide reasonable assurance of organizational health and integrity, doesn't basing this on the verification of only 15% of the value seem high risk?
There is continuing criticism of auditors and the profession for failing to alert investors and others to potential risk when organizations fail – yet how can the profession shoulder the blame when its scope and mandate are determined by compliance with standards that focus principally on tangible assets and liabilities? Apparent failures in oversight and governance approaches are not attributable to the profession alone, but the profession does have a responsibility to reflect on its own role and determine whether the principles that were initially established for audits are still meeting their goals. When significant “sea change” occurs, it requires re-invention rather than improvement. Is society changing the expectations and rules that make an audit relevant? Or are we “re-arranging the deck chairs on the Titanic?”
Customers of the audit profession are increasingly asking for additional information to enhance their risk assessments; this has resulted in regulatory changes as well as voluntary supplemental reporting. In certain jurisdictions, certain supplemental reporting – such as environmental and social issues – are now mandatory. A major thrust is being implemented by those adopting “integrated reporting,” but in most cases, this is not mandatory, audited or based on strongly established standards. A “sea change” it is not! The financial profession does not appear to be front and centre in driving fundamental change, apparently believing that its focus on financial capital remains adequate. Yes, changes are being made, but progress is much too slow; thus, the risk of “surprises” continues to increase.
The profession must start asking some fundamental questions in order to drive governance and accountability changes so that audits are fit for purpose. As a start, let’s consider the drivers of sustainable corporate value creation, and try to “peel back” corporate performance in the areas that might give investors an increased visibility into risk.
From a financial perspective, two sources of cash flow are critical to a sustainable business. First, for most organizations, more than 60% of expenditures are driven by employee costs; yet employee productivity and effectiveness are hard to measure, other than at the macro level. However, we do know that most employee costs are traditionally considered period expenses that convert inputs to outputs.
This is no longer the case, with large portions of employee expense related to building “capacity,” i.e. the contribution of intellectual capital that provides history and process capacity, as well as innovation in process improvement, new products and services, and relationship building with third parties. Only “motivated” employees will do this continually and effectively. To be a sustainable business in the future, the audit should reveal:
- The overall level of expense committed to employee costs, with a split showing (hopefully) a declining share going into repetitive conversion costs, and a growing share committed to building “intangibles for the future.” Key indicators might also include “strategic reassignments” that give perspectives on whether management is committed to redeploying staff as a result of change versus firing them (which does not create motivation).
- Levels of employee engagement at a depth of detail that is more than just a general percentage. What is needed is visibility into alignments of individuals, teams and departments with organizational purpose, both in “task” (the work of the business) and also critically in behavior (the stated conduct of the business that is driven by its culture and its understanding of ethical compliance).
- Leadership effectiveness. Disengagement comes from a gap between what organizations state they do, versus what employees see from leaders. The effective development of internal leadership, accompanied by the results of 360° assessments based on corporate values, would start to identify areas of concern if they exist. It might have been interesting to see what indicators of this type would have shown for some of the banks involved in recent scandals.
- Focus on “behavioral based” internal controls. Process controls are no longer adequate in an environment where high levels of delegation take place, leading to individual autonomy (this also applies to controls and relationships with third parties. such as outsourcing providers). Stronger reporting is needed on ethical hiring, leadership values and behavior, whistle blowing, levels of employee stress, illness (especially mentally related issues), and other behavioral aspects.
Overall, what users need to know is whether approaches to the workforce are protecting human capital sustainability through effective nurturing and development of people.
The second core cash flow is “cash flow in from customers.” Areas such as retention rates, repurchasing patterns, repeat customers and others are all important, but especially critical are relationships. One factor that could be more fully implemented into annual reporting is the stability of brand value.
The attached table shows 2018 data regarding the year end and most recent brand valuations by either Interbrand or Brand Finance (we used the higher valuation). This table demonstrates that, although the “pure audit” of financials provides insight into book values (i.e. balance sheet / shareholder equity), the shareholders value of their investment (i.e. the market value) is much greater.
Several key questions should be of interest to the investor. Using the traditional audit, is the integrity of the balance sheet acceptable? Is the brand value, as calculated by independent third parties, increasing or decreasing? If so, why? And what is the impact on this for the future? For instance, was a potential “auditable” cause the diversion of human capital resources away from customer support activities to enhance financial capital results? Finally, what makes up the ‘other intangible assets’ that contribute a key part of an investment valuation, but that are not being assessed or audited?”
One key failure of the accounting profession is to grasp and modernize the assessment of goodwill. On a sale or purchase of a business entity, it is the “market value-based intangibles” that end up on the acquirer’s balance sheet that must be assessed for “impairment.” How can an auditor do this effectively if the drivers of this value have not been clearly determined?
As can be seen from the table, book values range from 5.9% of value to 24.4%, and it is these underlying valuations of “financial capital” that a traditional audit discloses. If these are examples of the impact on financial capital of the growing knowledge economy, then one can only conclude that audits that remain focused on financial capital alone are not “fit for purpose.”
Wednesday, March 13, 2019
Reimagining a More Ethical and Sustainable Management AccountingCurriculum
Editorial Note: We are delighted to present the following editorial column by Richard Kravitz, the Editor In Chief of the CPA Journal. As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.
Furthermore, the opinions expressed below do not reflect the position of the CPA Journal, The New York State Society of CPAs, or the Board of Directors or Executives of the New York State Society of CPAs.
The accounting curriculum, while relevant 40 years ago, has lost much of its relevance today in our post-modern global economy. Accounting education fails to account for the real drivers of enterprise growth in the digital economy. This article focuses on the components of value creation within publicly traded multinational corporations. It also addresses how these valued components are all but ignored in the accounting classroom, in AACSB’s model curriculum for accounting education, and by the majority of our accounting professoriate.
Accounting is a practical discipline. It focuses on the application of skills and knowledge that enable practitioners to identify, measure, monitor, control and report on business activities. However, the real drivers of long term value creation within the modern global corporation are no longer measured by these traditional accounting tools. Financial accounting, cost accounting, and managerial accounting methodologies provide little guidance on how to accurately report on the condition and value of global business. Accounting information teaches us very little about great companies whose great products and services drive our postmodern global economy.
Similarly, accounting information ignores the dominant creators of long term sustainable value, i.e. the growth drivers of modern enterprise. Accounting rules even expense many of the value creators, such as reputational capital [brand marketing], intellectual capital [patents, trademarks, business method processes], human capital [talented workforce], social and relationship capital [infrastructure, health, education and safety], and others.
Accounting also does not account for the impact that global corporations have on society. For the past 20 years, organizations such as Ceres, the GRI, the IIRC, the UN Global Compact and others have been looking at this issue. Mervyn King, founder of the IIRC, for example, focuses on the evolution of the corporation from share value to shared values, and from a shareholder centric to a stakeholder centric perspective.
Nevertheless, the average time a shareholder in America owns a US public company, according to Prem Sika in the The Myth of Shareholder Ownership, is 22 seconds. Even Larry Fink, the consummate Milton Friedman capitalist who heads Black Rock, now suggests a new approach to corporate earnings: “Profits With Purpose.” But accounting does not measure purpose.
Finally, the lack of relevance of accounting information was amplified by luminary NYU professor Baruch Lev in his seminal work, The End of Accounting. According to Lev, “financial information contributes only 4-5% of decision relevant information for investors.” What a loss for accounting relevance.
The Critical Role of Accountants in our Post Modern Global Economy
While our training may be suspect, the role of accountants in society is not. Accountants are even more critically important in today’s global society; they are arguably more important than ever. Indeed, accounting remains a critically important gatekeeping profession.
The obligation of accountants, as its founders passionately argued, lies in their ethical responsibility to protect the public, and to insure public trust. Accountants are the historical stewards and fiduciaries of the public interest. Indeed, accountants protect the public from corporate mischief. They help insure honesty and trust in our institutions. And they report on companies that are too good to fail, too strong to fail, and yes, even too big to fail.
Accounting in a Global Environment – What has changed?
This is not our parent’s world from a global corporate perspective. It is not the world that existed even 40 years ago:
• 52 of the largest economies of the world today are multinational corporations, not sovereign nations.
• The top 2000 companies generate more than 50% of the global GDP.
• The market cap of Apple, at almost one trillion dollars, even after decline, is larger than the GDP of all of the European Union Countries except for two.
• The market cap to book value of the top 5 global corporations is between seventy five to a hundred to one. US Steel, the consummate brick and mortar corporation, on the other hand, still boasts a ratio of market cap to book value of about one to one.
• Walmart employs 2.7 million people, half the population of New Zealand.
• Google uses more electricity than the country of Sweden.
• 85% of the federal government expenditures of the United States are made to corporations, including transportation, defense, and nuclear power firms, as well as various other organizations that now perform tasks that government once performed.
• Today, corporations impact societies and stakeholders to a greater extent than at any time in history.
The Exponential Growth of Intangibles
So why is there such a huge divide between traditional accounting measurements, and between book value and market caps? What has happened during the past 40 years is revolutionary. According to the authors of Capitalism without Capital, the intangible revolution has impacted society far more than the industrial revolution of a few hundred years earlier.
87% of the value of today’s postmodern global corporation [per Ocean Tomo] lies hidden in its intangibles. These hidden assets or strategic resources do not appear on the balance sheet, income statement, cash flow statement or in retained earnings. They do not appear in inventory, goodwill, or tangible long term assets. They do not appear in the pages of accounting texts.
Strategic resources [such as intangible or hidden assets] power society today. Strategic capital drives long term value creation in our postmodern global corporation. Cost accounting texts ignore them, but they are familiar to all of us. These hidden intangibles include knowledge, data, information and ideas. They are the conceptual assets and creators of corporate value today. In fact, the investment in intangibles at 2-3 trillion dollars a year is now the dominant creator of corporate value. Intangibles include intellectual property, patents, trademarks, brands, brand identify, a skilled and talented workforce, business method patents, business processes, and supply chain sourcing.
Financial accountants and auditors hide conceptual assets from the public. They are expensed or hidden from the balance sheet. Conceptual assets are buried in SG&A or Cost of Sales, with the exception of those conceptual assets which are acquired or booked on the balance sheet for financial statement disclosure purposes. This is not deliberate; it occurs because accountants have not been trained to recognize intangibles.
Realigning Accounting Education
Accounting students invest 4 to 5 years of their lives in accounting schools. They hone their skills on traditional financial and managerial accounting techniques while ignoring 87% of the value of the global corporate enterprise. What a loss for accounting’s relevance. What a huge hole, then, that exists in the education curriculum. In future blog posts, I will suggest a realignment of accounting education.
Furthermore, the opinions expressed below do not reflect the position of the CPA Journal, The New York State Society of CPAs, or the Board of Directors or Executives of the New York State Society of CPAs.
The accounting curriculum, while relevant 40 years ago, has lost much of its relevance today in our post-modern global economy. Accounting education fails to account for the real drivers of enterprise growth in the digital economy. This article focuses on the components of value creation within publicly traded multinational corporations. It also addresses how these valued components are all but ignored in the accounting classroom, in AACSB’s model curriculum for accounting education, and by the majority of our accounting professoriate.
Accounting is a practical discipline. It focuses on the application of skills and knowledge that enable practitioners to identify, measure, monitor, control and report on business activities. However, the real drivers of long term value creation within the modern global corporation are no longer measured by these traditional accounting tools. Financial accounting, cost accounting, and managerial accounting methodologies provide little guidance on how to accurately report on the condition and value of global business. Accounting information teaches us very little about great companies whose great products and services drive our postmodern global economy.
Similarly, accounting information ignores the dominant creators of long term sustainable value, i.e. the growth drivers of modern enterprise. Accounting rules even expense many of the value creators, such as reputational capital [brand marketing], intellectual capital [patents, trademarks, business method processes], human capital [talented workforce], social and relationship capital [infrastructure, health, education and safety], and others.
Accounting also does not account for the impact that global corporations have on society. For the past 20 years, organizations such as Ceres, the GRI, the IIRC, the UN Global Compact and others have been looking at this issue. Mervyn King, founder of the IIRC, for example, focuses on the evolution of the corporation from share value to shared values, and from a shareholder centric to a stakeholder centric perspective.
Nevertheless, the average time a shareholder in America owns a US public company, according to Prem Sika in the The Myth of Shareholder Ownership, is 22 seconds. Even Larry Fink, the consummate Milton Friedman capitalist who heads Black Rock, now suggests a new approach to corporate earnings: “Profits With Purpose.” But accounting does not measure purpose.
Finally, the lack of relevance of accounting information was amplified by luminary NYU professor Baruch Lev in his seminal work, The End of Accounting. According to Lev, “financial information contributes only 4-5% of decision relevant information for investors.” What a loss for accounting relevance.
The Critical Role of Accountants in our Post Modern Global Economy
While our training may be suspect, the role of accountants in society is not. Accountants are even more critically important in today’s global society; they are arguably more important than ever. Indeed, accounting remains a critically important gatekeeping profession.
The obligation of accountants, as its founders passionately argued, lies in their ethical responsibility to protect the public, and to insure public trust. Accountants are the historical stewards and fiduciaries of the public interest. Indeed, accountants protect the public from corporate mischief. They help insure honesty and trust in our institutions. And they report on companies that are too good to fail, too strong to fail, and yes, even too big to fail.
Accounting in a Global Environment – What has changed?
This is not our parent’s world from a global corporate perspective. It is not the world that existed even 40 years ago:
• 52 of the largest economies of the world today are multinational corporations, not sovereign nations.
• The top 2000 companies generate more than 50% of the global GDP.
• The market cap of Apple, at almost one trillion dollars, even after decline, is larger than the GDP of all of the European Union Countries except for two.
• The market cap to book value of the top 5 global corporations is between seventy five to a hundred to one. US Steel, the consummate brick and mortar corporation, on the other hand, still boasts a ratio of market cap to book value of about one to one.
• Walmart employs 2.7 million people, half the population of New Zealand.
• Google uses more electricity than the country of Sweden.
• 85% of the federal government expenditures of the United States are made to corporations, including transportation, defense, and nuclear power firms, as well as various other organizations that now perform tasks that government once performed.
• Today, corporations impact societies and stakeholders to a greater extent than at any time in history.
The Exponential Growth of Intangibles
So why is there such a huge divide between traditional accounting measurements, and between book value and market caps? What has happened during the past 40 years is revolutionary. According to the authors of Capitalism without Capital, the intangible revolution has impacted society far more than the industrial revolution of a few hundred years earlier.
87% of the value of today’s postmodern global corporation [per Ocean Tomo] lies hidden in its intangibles. These hidden assets or strategic resources do not appear on the balance sheet, income statement, cash flow statement or in retained earnings. They do not appear in inventory, goodwill, or tangible long term assets. They do not appear in the pages of accounting texts.
Strategic resources [such as intangible or hidden assets] power society today. Strategic capital drives long term value creation in our postmodern global corporation. Cost accounting texts ignore them, but they are familiar to all of us. These hidden intangibles include knowledge, data, information and ideas. They are the conceptual assets and creators of corporate value today. In fact, the investment in intangibles at 2-3 trillion dollars a year is now the dominant creator of corporate value. Intangibles include intellectual property, patents, trademarks, brands, brand identify, a skilled and talented workforce, business method patents, business processes, and supply chain sourcing.
Financial accountants and auditors hide conceptual assets from the public. They are expensed or hidden from the balance sheet. Conceptual assets are buried in SG&A or Cost of Sales, with the exception of those conceptual assets which are acquired or booked on the balance sheet for financial statement disclosure purposes. This is not deliberate; it occurs because accountants have not been trained to recognize intangibles.
Realigning Accounting Education
Accounting students invest 4 to 5 years of their lives in accounting schools. They hone their skills on traditional financial and managerial accounting techniques while ignoring 87% of the value of the global corporate enterprise. What a loss for accounting’s relevance. What a huge hole, then, that exists in the education curriculum. In future blog posts, I will suggest a realignment of accounting education.
Saturday, February 9, 2019
Accounting and the Public Interest
We usually begin our blog posts with a customary disclaimer that our columnists only speak for themselves, and do not express the positions of the AAA or of any other party.
This post, however, is different. Our columnist Amy Hageman does speak for us! She is the incoming Senior Editor of our section's flagship journal Accounting and the Public Interest (API).
We are delighted to introduce her to our members with this blog post. Welcome, Amy, to your new role. And thank you for your contribution to our Section!
My name is Amy Hageman, and I have the honor and privilege of serving as the Senior Editor of Accounting and the Public Interest (API) for a three-year term, beginning in January 2019 through 2021. API has a rich history of excellent Editors, and currently has an outstanding group of Associate Editors and Editorial Board members. This journal serves an important role in our field – as it is an American Accounting Association (AAA) section journal focusing on socially responsible accounting research. The journal has a history of publishing work from leading accounting academics – and I believe this trend will continue as universities’ emphasis on showing how accounting research positively impacts society continues to grow. I am excited to take on the role of Senior Editor of API, as I want to positively influence the future of this journal by increasing its presence, quality, and efficiency, and in helping to establish API as one of the top specialty accounting journals in the field.
Currently, my primary objective is to build on and expand the tradition of excellent scholarship published by this journal, as well as enhancing the efficient administration of API. One of my aims is to provide guidance to submitting authors to enhance the quality and contribution of their work, as well as working across other AAA sections to identity potential submissions that could further our understanding of how accounting affects the public interest. In short, I am striving to continue the tradition at API of aiming to publish articles across a wide variety of functional areas of accounting using an equally-wide array of methodologies.
These are several opportunities to improve the impact of API. A long-term goal is to see an increase in citations of published articles in API, and for more universities to positively evaluate API in making promotion and tenure decisions. One strategy for potentially increasing the journal’s impact is to consider publishing special issues, which have the potential to increase both readership and citations. One possible idea would be a special issue dedicated to a specific theme. Potential themes could include professional and business ethics, governance of accounting organizations, social and environmental accounting trends, or responsible actions by governmental and non-profit accounting entities. Another possibility would be to devote a special issue to increasing the journal’s impact beyond the United States – such as a special issue on U.S.-Canadian issues, or on accounting issues that are emerging in Europe. Such a special issue may be a way of reaching contributors who may not have submitted to API in the past. Another is to potentially hold a special conference tied to the journal.
Overall, API is an outstanding journal with a rich history and an even brighter future. As I begin my three-year Editor term, my goal is to strive to act as an excellent steward of this journal and to work to further improve both the quality and overall impact of API. Thank you for entrusting me with this role, and I look forward to working together to disseminate public interest-related research in API.
This post, however, is different. Our columnist Amy Hageman does speak for us! She is the incoming Senior Editor of our section's flagship journal Accounting and the Public Interest (API).
We are delighted to introduce her to our members with this blog post. Welcome, Amy, to your new role. And thank you for your contribution to our Section!
My name is Amy Hageman, and I have the honor and privilege of serving as the Senior Editor of Accounting and the Public Interest (API) for a three-year term, beginning in January 2019 through 2021. API has a rich history of excellent Editors, and currently has an outstanding group of Associate Editors and Editorial Board members. This journal serves an important role in our field – as it is an American Accounting Association (AAA) section journal focusing on socially responsible accounting research. The journal has a history of publishing work from leading accounting academics – and I believe this trend will continue as universities’ emphasis on showing how accounting research positively impacts society continues to grow. I am excited to take on the role of Senior Editor of API, as I want to positively influence the future of this journal by increasing its presence, quality, and efficiency, and in helping to establish API as one of the top specialty accounting journals in the field.
Currently, my primary objective is to build on and expand the tradition of excellent scholarship published by this journal, as well as enhancing the efficient administration of API. One of my aims is to provide guidance to submitting authors to enhance the quality and contribution of their work, as well as working across other AAA sections to identity potential submissions that could further our understanding of how accounting affects the public interest. In short, I am striving to continue the tradition at API of aiming to publish articles across a wide variety of functional areas of accounting using an equally-wide array of methodologies.
These are several opportunities to improve the impact of API. A long-term goal is to see an increase in citations of published articles in API, and for more universities to positively evaluate API in making promotion and tenure decisions. One strategy for potentially increasing the journal’s impact is to consider publishing special issues, which have the potential to increase both readership and citations. One possible idea would be a special issue dedicated to a specific theme. Potential themes could include professional and business ethics, governance of accounting organizations, social and environmental accounting trends, or responsible actions by governmental and non-profit accounting entities. Another possibility would be to devote a special issue to increasing the journal’s impact beyond the United States – such as a special issue on U.S.-Canadian issues, or on accounting issues that are emerging in Europe. Such a special issue may be a way of reaching contributors who may not have submitted to API in the past. Another is to potentially hold a special conference tied to the journal.
Overall, API is an outstanding journal with a rich history and an even brighter future. As I begin my three-year Editor term, my goal is to strive to act as an excellent steward of this journal and to work to further improve both the quality and overall impact of API. Thank you for entrusting me with this role, and I look forward to working together to disseminate public interest-related research in API.
Saturday, January 12, 2019
Redefining Audit Quality
During the past two weeks, our contributing columnists Steven Mintz and Sri Ramamoorti shared their perspectives on the topic of Audit Quality. This week, Michael Kraten completes the trilogy of blog posts by asking whether the profusion of unaudited sustainability data should compel our profession to modify our definition of audit quality.
As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.
We are presenting this trio of articles to illustrate the rich editorial value of the conversations that you will join when you attend our Midyear Meeting. Please keep in mind that the manuscript submission deadline of our meeting is Monday, January 14, 2019.
Are you aware of the massive volume of disclosure data that is defined by the Global Reporting Initiative? A firm that fully complies with the GRI's directives must report on 3 sets of universal standards, 6 sets of economic standards, 8 sets of environmental standards, and 19 sets of social standards.
How about the Sustainability Accounting Standards Board? Its standards encompass a set of 77 industries.
And the United Nations? It has defined 17 Strategic Development Goals.
These data sets have become so massive that organizations now require guidance to determine how to organize it all! And thus another entity has developed a framework to meet that need; the International Integrated Reporting Council defines 5 governance, 4 business model, and 6 capital factors that can be employed to structure the reported data.
Because these data sets are gigantic in size, corporate sustainability reports are expanding into massive tomes as well. Let’s assume, for instance, that we are interested in researching Coca Cola’s sustainable agriculture policies and metrics. We would begin by reviewing all 21 pages of its Sustainability Report for 2017. We would then read its 13th page on Agriculture more intently.
What next? A link on that Agriculture page would take us to Coca Cola’s full 2017 Agriculture Update. On that web page, we would find additional links to information about the organization’s Sustainable Agriculture Guiding Principles (SAGPs), Seven Steps to Supplier Verification, 5bv20 Supply Chain program, fifteen research studies, a set of climate protection goals, Field to Market program, Farm Sustainability Assessments, Sustainable Agriculture Initiative Platform …
… and the list continues.
These disclosures are clearly voluminous in length and dense with content. But how much of it was subjected to independent assurance activities?
Hmm. It's a bit difficult to find the answer to that question. The very last page of the 2017 Sustainability Report sports a circle entitled “Assuring The Adequacy Of Our Disclosures.” A click on that icon carries us to a web page with a brief section entitled “Assurance 2017.”
That section contains a link to Ernst & Young LLP’s Review Report. How much of Coca Cola’s sustainability data was reviewed by the public accounting firm?
Four metrics.
Not much, eh? The Review Report only addressed Coca Cola’s Greenhouse Gas Emissions value of 5.54 millions of metric tonnes, Water Replenishment percentage of “More Than 100%,” Water Use Ratio of 1.92, and Lost Time Incident Rate of 0.57.
Furthermore, although the scope of E&Y's independent review work was limited to these four measurements, it still failed to address key concerns about the validity of Coca Cola’s water replenishment and use disclosures.
We usually define audit quality in terms of assessing the validity of the information that is presented in the Annual Report. And we often expand that definition to the supplemental disclosures in the 10-K and 10-Q reports.
But should we also consider the massive amounts of data disclosures that are presented to the public outside of these traditional reports? Would it be helpful to redefine our concept of “Audit Quality” to encompass the extent to which the auditors are, in essence, ignoring other critical public disclosures?
Michael Kraten, PhD, CPA is a Professor of Accounting at Houston Baptist University. He is also the President of AQPQ Management Consulting.
As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.
We are presenting this trio of articles to illustrate the rich editorial value of the conversations that you will join when you attend our Midyear Meeting. Please keep in mind that the manuscript submission deadline of our meeting is Monday, January 14, 2019.
Are you aware of the massive volume of disclosure data that is defined by the Global Reporting Initiative? A firm that fully complies with the GRI's directives must report on 3 sets of universal standards, 6 sets of economic standards, 8 sets of environmental standards, and 19 sets of social standards.
How about the Sustainability Accounting Standards Board? Its standards encompass a set of 77 industries.
And the United Nations? It has defined 17 Strategic Development Goals.
These data sets have become so massive that organizations now require guidance to determine how to organize it all! And thus another entity has developed a framework to meet that need; the International Integrated Reporting Council defines 5 governance, 4 business model, and 6 capital factors that can be employed to structure the reported data.
Because these data sets are gigantic in size, corporate sustainability reports are expanding into massive tomes as well. Let’s assume, for instance, that we are interested in researching Coca Cola’s sustainable agriculture policies and metrics. We would begin by reviewing all 21 pages of its Sustainability Report for 2017. We would then read its 13th page on Agriculture more intently.
What next? A link on that Agriculture page would take us to Coca Cola’s full 2017 Agriculture Update. On that web page, we would find additional links to information about the organization’s Sustainable Agriculture Guiding Principles (SAGPs), Seven Steps to Supplier Verification, 5bv20 Supply Chain program, fifteen research studies, a set of climate protection goals, Field to Market program, Farm Sustainability Assessments, Sustainable Agriculture Initiative Platform …
… and the list continues.
These disclosures are clearly voluminous in length and dense with content. But how much of it was subjected to independent assurance activities?
Hmm. It's a bit difficult to find the answer to that question. The very last page of the 2017 Sustainability Report sports a circle entitled “Assuring The Adequacy Of Our Disclosures.” A click on that icon carries us to a web page with a brief section entitled “Assurance 2017.”
That section contains a link to Ernst & Young LLP’s Review Report. How much of Coca Cola’s sustainability data was reviewed by the public accounting firm?
Four metrics.
Not much, eh? The Review Report only addressed Coca Cola’s Greenhouse Gas Emissions value of 5.54 millions of metric tonnes, Water Replenishment percentage of “More Than 100%,” Water Use Ratio of 1.92, and Lost Time Incident Rate of 0.57.
Furthermore, although the scope of E&Y's independent review work was limited to these four measurements, it still failed to address key concerns about the validity of Coca Cola’s water replenishment and use disclosures.
We usually define audit quality in terms of assessing the validity of the information that is presented in the Annual Report. And we often expand that definition to the supplemental disclosures in the 10-K and 10-Q reports.
But should we also consider the massive amounts of data disclosures that are presented to the public outside of these traditional reports? Would it be helpful to redefine our concept of “Audit Quality” to encompass the extent to which the auditors are, in essence, ignoring other critical public disclosures?
Michael Kraten, PhD, CPA is a Professor of Accounting at Houston Baptist University. He is also the President of AQPQ Management Consulting.
Saturday, January 5, 2019
The Future of Auditing
Last week, our contributing columnist Steven Mintz led off our three part series on audit quality by addressing the topic of mandatory audit rotation. This week, our columnist Sri Ramamoorti continues the conversation by discussing the Expectation Gap, the Information Gap, the need for non-GAAP measures, and the future of auditor education.
We acknowledge, and thank, The CPA Journal’s Editor In Chief Richard (Rick) Kravitz for permitting us to repurpose and reposition content that originally appeared in the February 2017 edition of his publication. The material appeared in an article entitled The Future of Auditing: A Roundtable Discussion; it is available online in its entirety.
Rick is a friend of the AAA Public Interest Section. He is a frequent presenter at our meetings and symposia, and is a contributing columnist to this blog as well.
Dr. Sridhar Ramamoorti, ACA, CPA/CITP/CFF/CGMA, CIA, CFE, CFSA, CGAP, CGFM, CRMA, CRP, MAFF, is an associate professor of accounting at the University of Dayton. Previously, he was an associate professor of accounting and director of the Corporate Governance Center at the Michael J. Coles College of Business at Kennesaw State University. Dr. Ramamoorti was also a principal in the Professional Standards Group of Andersen Worldwide, Sarbanes-Oxley Advisor for Ernst & Young’s National Advisory Practices, a Corporate Governance partner with Grant Thornton, and was a principal leading the governance, risk and compliance (GRC) practice of Infogix, Inc. In December 2016, Dr. Ramamoorti completed a three-year term on the prestigious Standing Advisory Group of the Public Company Accounting Oversight Board (PCAOB).
Why are we utilizing our blog in this manner? We are showcasing our perspectives in order to generate interest in our midyear meeting. If you would like to present your own work about accounting and the public interest, please keep in mind that the manuscript submission deadline is Monday, January 14, 2019.
***
Sri, in our previous blog post, our colleague Steven Mintz suggested that mandatory auditor rotation may help address certain challenges that confront the audit profession. He cites KPMG’s 109 consecutive year audit relationship with GE as one that is ripe for rotation, in light of GE’s recent travails. What do you think?
You know, the medical profession’s lament applies to us, too—that the operation was successful, but the patient died. All we are able to assure as auditors are the standards and the processes that are the inputs to the audit. But we are unable to guarantee the outcome. Yet, the first thing that happens when there is the collapse of a company, perhaps because of poor governance or a terrible business model, is that the business failure is almost immediately equated with an audit failure. And we have to live out the consequences as a profession. I think this is also going to be part of the education of the public, that we can’t be held responsible for a mistake that is being really committed by company management and their governance.
Having said that, any century-old relationship between an audit firm and its client certainly raises questions about the lack of independence in appearance. The optics aren’t good, even if the client is growing and profitable.
But don’t users of financial statements expect auditors to be held responsible for such mistakes? And if there is an expectation gap, is there also an information gap?
On this issue of the expectations gap, as far back as 1988, the MacDonald Commission in Canada very systematically broke it down into three separate gaps. One was the standards gap, another was the performance gap, and the third was the communications gap. That’s one framework.
More recently, in 2012, the International Auditing and Assurance Standards Board [IAASB] talked about the information gap. There is a lot more information than what appears in the financial statements, and hence, the recent pressure on the profession to look in some way or the other at these non-GAAP measures. They’re just proliferating, and it’s clear that there is much more that investors and other stakeholders are demanding to know. In a world that is awash with information, I think these demands have gotten only worse. Herbert Simon, a Nobel Prize winner and a polymath, said, “a wealth of information creates a poverty of attention.” Simon perceptively noted that many designers of information systems incorrectly represented the design problem as information scarcity rather than attention scarcity. We don’t have information scarcity; we have information abundance. Attention scarcity is the real issue.
He went on to say what was really needed were systems that excelled at filtering out unimportant or irrelevant information. This is going to be one of the future jobs of the auditing profession, to serve as that filter in such a way that we define relevance to our stakeholders. That really allows us to become trusted as a profession, because people don’t know what’s relevant and what’s not. We are really becoming the curators of information in terms of its underlying quality, its relevance, and providing that decision context in which stakeholders can maximally use that information. The recent proliferation of non-GAAP measures, potentially more relevant but perhaps less reliable, is highlighting this perspective. In a way, I am merely expanding on what the AICPA’s Elliott Committee concluded in its 1996 Report.
It sounds like you’re calling for the development of Integrated Reports that include both GAAP and non-GAAP measures. Are we adequately educating auditors to perform assurance activities on such reports? Or do we need to modify our education practices in creative ways?
I’ve always wondered why ours is probably the only discipline—I won’t say profession—in which the word “creative” is a bad word. Creative accounting is not a bad thing. After all, as Albert Einstein famously remarked, “Imagination is more important than knowledge.”
H. G. Wells maintained that it is nature’s inexorable imperative that you either adapt or perish. One may choose not to change, however, because survival is not mandatory. Given all the change that we’re seeing, if we remain in the status quo, we’re finished. We have to be grabbing at these opportunities to become more relevant in a fast-changing world.
In my opinion, we are facing a human capital crisis in the accounting profession. However, the problem is not with the young people who are entering the profession. They are actually very smart. There are these very advanced and sophisticated technologies that are really putting the lie to what used to be big problems. They can be solved, but you’ve got to be creative. And you need to master some of these new technologies.
For instance, let’s think about the classic problem of finding a needle in a haystack. Pretty difficult, isn’t it? And yet, some of our young professionals might suggest that we wave an industrial grade magnet over the stack, and the needle will simply jump up.
To me, the need for being creative is fulfilled by having a diversity of experience, curiosity, and the ability to learn continuously. These are the kind of people we’re looking for, and the profession should be able to attract them. The worst type of auditor we could have in today’s world is the gullible auditor. We want the skeptical auditors who will not accept answers at face value. They’re always going to dig deeper. We want to attract these kinds of insatiably curious kids into our profession.
I think it’s going to require a different skill set, a different kind of ability among young people. I’m not sure we want the types of students who did really well only in accounting, as in the olden days.
Are we, as a profession, up to this challenge?
We started by talking about the past, the present, and the future. And that progression, to me, gives us the opportunity to use hindsight to get insight, which hopefully will allow us to get foresight.
Sigmund Koch, a very famous and distinguished professor of psychology at New York University, in 1985 observed that the mark of maturity of a profession is its ability to do soul-searching. And so the fact that we are doing this kind of [discussion] is itself evidence that this is a profession that has that capacity, that is willing to look at itself critically. The profession is a prestigious one with a glorious history. You cannot have true accountability without proper accounting, so I have tremendous hope for the future.
We acknowledge, and thank, The CPA Journal’s Editor In Chief Richard (Rick) Kravitz for permitting us to repurpose and reposition content that originally appeared in the February 2017 edition of his publication. The material appeared in an article entitled The Future of Auditing: A Roundtable Discussion; it is available online in its entirety.
Rick is a friend of the AAA Public Interest Section. He is a frequent presenter at our meetings and symposia, and is a contributing columnist to this blog as well.
Dr. Sridhar Ramamoorti, ACA, CPA/CITP/CFF/CGMA, CIA, CFE, CFSA, CGAP, CGFM, CRMA, CRP, MAFF, is an associate professor of accounting at the University of Dayton. Previously, he was an associate professor of accounting and director of the Corporate Governance Center at the Michael J. Coles College of Business at Kennesaw State University. Dr. Ramamoorti was also a principal in the Professional Standards Group of Andersen Worldwide, Sarbanes-Oxley Advisor for Ernst & Young’s National Advisory Practices, a Corporate Governance partner with Grant Thornton, and was a principal leading the governance, risk and compliance (GRC) practice of Infogix, Inc. In December 2016, Dr. Ramamoorti completed a three-year term on the prestigious Standing Advisory Group of the Public Company Accounting Oversight Board (PCAOB).
Why are we utilizing our blog in this manner? We are showcasing our perspectives in order to generate interest in our midyear meeting. If you would like to present your own work about accounting and the public interest, please keep in mind that the manuscript submission deadline is Monday, January 14, 2019.
***
Sri, in our previous blog post, our colleague Steven Mintz suggested that mandatory auditor rotation may help address certain challenges that confront the audit profession. He cites KPMG’s 109 consecutive year audit relationship with GE as one that is ripe for rotation, in light of GE’s recent travails. What do you think?
You know, the medical profession’s lament applies to us, too—that the operation was successful, but the patient died. All we are able to assure as auditors are the standards and the processes that are the inputs to the audit. But we are unable to guarantee the outcome. Yet, the first thing that happens when there is the collapse of a company, perhaps because of poor governance or a terrible business model, is that the business failure is almost immediately equated with an audit failure. And we have to live out the consequences as a profession. I think this is also going to be part of the education of the public, that we can’t be held responsible for a mistake that is being really committed by company management and their governance.
Having said that, any century-old relationship between an audit firm and its client certainly raises questions about the lack of independence in appearance. The optics aren’t good, even if the client is growing and profitable.
But don’t users of financial statements expect auditors to be held responsible for such mistakes? And if there is an expectation gap, is there also an information gap?
On this issue of the expectations gap, as far back as 1988, the MacDonald Commission in Canada very systematically broke it down into three separate gaps. One was the standards gap, another was the performance gap, and the third was the communications gap. That’s one framework.
More recently, in 2012, the International Auditing and Assurance Standards Board [IAASB] talked about the information gap. There is a lot more information than what appears in the financial statements, and hence, the recent pressure on the profession to look in some way or the other at these non-GAAP measures. They’re just proliferating, and it’s clear that there is much more that investors and other stakeholders are demanding to know. In a world that is awash with information, I think these demands have gotten only worse. Herbert Simon, a Nobel Prize winner and a polymath, said, “a wealth of information creates a poverty of attention.” Simon perceptively noted that many designers of information systems incorrectly represented the design problem as information scarcity rather than attention scarcity. We don’t have information scarcity; we have information abundance. Attention scarcity is the real issue.
He went on to say what was really needed were systems that excelled at filtering out unimportant or irrelevant information. This is going to be one of the future jobs of the auditing profession, to serve as that filter in such a way that we define relevance to our stakeholders. That really allows us to become trusted as a profession, because people don’t know what’s relevant and what’s not. We are really becoming the curators of information in terms of its underlying quality, its relevance, and providing that decision context in which stakeholders can maximally use that information. The recent proliferation of non-GAAP measures, potentially more relevant but perhaps less reliable, is highlighting this perspective. In a way, I am merely expanding on what the AICPA’s Elliott Committee concluded in its 1996 Report.
It sounds like you’re calling for the development of Integrated Reports that include both GAAP and non-GAAP measures. Are we adequately educating auditors to perform assurance activities on such reports? Or do we need to modify our education practices in creative ways?
I’ve always wondered why ours is probably the only discipline—I won’t say profession—in which the word “creative” is a bad word. Creative accounting is not a bad thing. After all, as Albert Einstein famously remarked, “Imagination is more important than knowledge.”
H. G. Wells maintained that it is nature’s inexorable imperative that you either adapt or perish. One may choose not to change, however, because survival is not mandatory. Given all the change that we’re seeing, if we remain in the status quo, we’re finished. We have to be grabbing at these opportunities to become more relevant in a fast-changing world.
In my opinion, we are facing a human capital crisis in the accounting profession. However, the problem is not with the young people who are entering the profession. They are actually very smart. There are these very advanced and sophisticated technologies that are really putting the lie to what used to be big problems. They can be solved, but you’ve got to be creative. And you need to master some of these new technologies.
For instance, let’s think about the classic problem of finding a needle in a haystack. Pretty difficult, isn’t it? And yet, some of our young professionals might suggest that we wave an industrial grade magnet over the stack, and the needle will simply jump up.
To me, the need for being creative is fulfilled by having a diversity of experience, curiosity, and the ability to learn continuously. These are the kind of people we’re looking for, and the profession should be able to attract them. The worst type of auditor we could have in today’s world is the gullible auditor. We want the skeptical auditors who will not accept answers at face value. They’re always going to dig deeper. We want to attract these kinds of insatiably curious kids into our profession.
I think it’s going to require a different skill set, a different kind of ability among young people. I’m not sure we want the types of students who did really well only in accounting, as in the olden days.
Are we, as a profession, up to this challenge?
We started by talking about the past, the present, and the future. And that progression, to me, gives us the opportunity to use hindsight to get insight, which hopefully will allow us to get foresight.
Sigmund Koch, a very famous and distinguished professor of psychology at New York University, in 1985 observed that the mark of maturity of a profession is its ability to do soul-searching. And so the fact that we are doing this kind of [discussion] is itself evidence that this is a profession that has that capacity, that is willing to look at itself critically. The profession is a prestigious one with a glorious history. You cannot have true accountability without proper accounting, so I have tremendous hope for the future.
Monday, December 24, 2018
Should Auditors Rotate Every 109 Years?
Independence. Integrity. Objectivity. Professional skepticism. These concepts are bedrock principles of audit quality.
As audit failures continue to plague the accounting profession, the Contributing Columnists of the AAA Public Interest Section offer different perspectives about preserving these principles.
During the next few weeks, a number of our Columnists will present an online conversation about this critical issue. Steven Mintz will kick off our series (below) by addressing GE’s recent travails while raising the suggestion of auditor rotation. Sri Ramamoorti, Michael Kraten, and others will then approach the issue from different directions.
Why are we utilizing our blog in this manner? We are showcasing our perspectives in order to generate interest in our midyear meeting. If you would like to present your own work about accounting and the public interest, please keep in mind that the manuscript submission deadline is Monday, January 14, 2019.
***
We are delighted to publish this “opinion piece” by Dr. Steven Mintz, a frequent contributor to our social media blog. As always, when you read his contribution, we ask that you keep in mind that the opinions expressed therein are those of the author. They do not represent the position of the AAA or of any other party.
A new rule adopted by the U.S. Securities and Exchange Commission requires disclosure of the tenure of a public company’s external auditor in the annual report. KPMG recently reported that it has audited GE since 1909. This raises the question whether there should be mandatory audit firm rotation after some period of service. Right now, other than the tenure disclosure, there are no requirements for mandatory audit firm rotation.
The fact that KPMG has audited GE for 109 years is coming under greater scrutiny, given that the SEC disclosed on January 24, 2018 that it was beginning an investigation of the company’s accounting practices. The regulators are investigating a $6.2 billion insurance loss from GE Capital, the troubled financial service business that the company is trying to wind down.
The SEC is also looking into “revenue recognition and controls” for the company’s long-term service agreements including insurance reserves. GE restated its 2016 and 2017 quarterly numbers to reflect new accounting standards. The company lost $9.8 billion in a single recent quarter. With the company’s stock down more than 40 percent during a recent twelve month period, the uncertainty of the accounting investigation raises troubling questions.
The obvious question is: Where were the auditors during the accounting scandals? The answer is: Nowhere To Be Found. In fact, two shareholder watchdog groups – Glass-Lewis and Institutional Shareholder Services -- urged shareholders not to ratify KPMG as GE’s auditor at the company’s annual shareholders meeting last April. GE shareholders approved KPMG for another year, but only after overcoming substantial opposition in the wake of GE’s accounting issues. Only 65 percent of shareholders supported GE, an historically low percentage of support. Last year 94 percent of shareholders supported GE.
Let’s examine the potential costs and benefits of auditor rotation. The costs should be obvious. There is a learning curve during which time the audit may not be as efficient and increase the costs to the client. Moreover, a relationship of trust between the audit firm and client builds up over several years and any forced rotation may make it more difficult to build trust simply because of the lesser passage of time. In that regard, GE defended its decision to stick with KPMG, noting that the benefits of a “long-tenured auditor” include “deep expertise” and “familiarity” with the company’s vast business empire. GE also highlighted “independence controls” on KPMG, including “thorough” oversight from the board’s audit committee and requirements that the lead partner be rotated every five years.*
The benefits of forced rotation are subtler. After a period of service (say, 20 years), the auditors may become too complacent and close to the client, creating a familiarity threat to independence. Audit independence and objectivity may fall by the way side. And conflicts of interest may develop over time, making it more difficult for auditors to exercise professional skepticism in gathering and evaluating financial data to ensure that the financial statements do not contain any material misstatements.
The benefits of auditor rotation may also include getting a fresh look at the company’s accounting methods and financial reporting techniques. The new firm may not be biased by past audits, and may critically challenge accounting techniques that smooth net income or create earnings to meet or exceed financial analysts’ earnings consensus estimates. Glass-Lewis chimed in when it wrote to GE shareholders, saying that GE shareholders must beware that “a long-tenured auditor can become too close with a client,” while a new auditor can “uncover problems previously unidentified.”*
The accounting profession contends that the mandatory rotation of principal audit partners sufficiently protects the public interest and builds in the “fresh look” critics are looking for. The Sarbanes-Oxley Act created a five-year auditor requirement. The SEC enforces it through the Public Company Accounting Oversight Board (PCAOB). Critics contend that this is not enough, and that mandatory audit firm rotation is necessary to compensate for years of influence by audit clients over their auditors.
The key factor in evaluating the net benefits of mandatory audit firm rotation is the public interest. The problem is there hasn’t been sufficient research on this issue because the mandatory partner rotation requirement under Sarbanes-Oxley is relatively recent, and less time has gone by since the European Union first required a 10 to 20 year firm rotation.
I have a different perspective. The PCAOB conducts inspections of public company audits every year or so. Why can’t the PCAOB look at the retention issue based on noted deficiencies in audits examined? It’s true that the Board may not look at the same client each year. Still, some kind of overall evaluation of the ethics of the firms, based on audit inspections, might add value to the process of determining when audit firms should be rotated. Noted deficiencies such as a lack of independence, integrity, objectivity, and professional skepticism, the bedrocks of audit quality, should raise questions in the minds of shareholders about whether a firm should be rotated.
The presence of these factors suggests ethical failures in the audits. By making the evaluations public so that shareholders can consider them in their annual retention votes, the firms may take the noted failures more seriously. This may not be the perfect solution, but it does begin the process of holding audit firms accountable for their audits by having meaningful consequences for repeated failures in ethics, and it protects the public interest.
* Source: Matt Egan, GE pressured to fire auditor after 109 years. April 24, 2018.
As audit failures continue to plague the accounting profession, the Contributing Columnists of the AAA Public Interest Section offer different perspectives about preserving these principles.
During the next few weeks, a number of our Columnists will present an online conversation about this critical issue. Steven Mintz will kick off our series (below) by addressing GE’s recent travails while raising the suggestion of auditor rotation. Sri Ramamoorti, Michael Kraten, and others will then approach the issue from different directions.
Why are we utilizing our blog in this manner? We are showcasing our perspectives in order to generate interest in our midyear meeting. If you would like to present your own work about accounting and the public interest, please keep in mind that the manuscript submission deadline is Monday, January 14, 2019.
***
We are delighted to publish this “opinion piece” by Dr. Steven Mintz, a frequent contributor to our social media blog. As always, when you read his contribution, we ask that you keep in mind that the opinions expressed therein are those of the author. They do not represent the position of the AAA or of any other party.
A new rule adopted by the U.S. Securities and Exchange Commission requires disclosure of the tenure of a public company’s external auditor in the annual report. KPMG recently reported that it has audited GE since 1909. This raises the question whether there should be mandatory audit firm rotation after some period of service. Right now, other than the tenure disclosure, there are no requirements for mandatory audit firm rotation.
The fact that KPMG has audited GE for 109 years is coming under greater scrutiny, given that the SEC disclosed on January 24, 2018 that it was beginning an investigation of the company’s accounting practices. The regulators are investigating a $6.2 billion insurance loss from GE Capital, the troubled financial service business that the company is trying to wind down.
The SEC is also looking into “revenue recognition and controls” for the company’s long-term service agreements including insurance reserves. GE restated its 2016 and 2017 quarterly numbers to reflect new accounting standards. The company lost $9.8 billion in a single recent quarter. With the company’s stock down more than 40 percent during a recent twelve month period, the uncertainty of the accounting investigation raises troubling questions.
The obvious question is: Where were the auditors during the accounting scandals? The answer is: Nowhere To Be Found. In fact, two shareholder watchdog groups – Glass-Lewis and Institutional Shareholder Services -- urged shareholders not to ratify KPMG as GE’s auditor at the company’s annual shareholders meeting last April. GE shareholders approved KPMG for another year, but only after overcoming substantial opposition in the wake of GE’s accounting issues. Only 65 percent of shareholders supported GE, an historically low percentage of support. Last year 94 percent of shareholders supported GE.
Let’s examine the potential costs and benefits of auditor rotation. The costs should be obvious. There is a learning curve during which time the audit may not be as efficient and increase the costs to the client. Moreover, a relationship of trust between the audit firm and client builds up over several years and any forced rotation may make it more difficult to build trust simply because of the lesser passage of time. In that regard, GE defended its decision to stick with KPMG, noting that the benefits of a “long-tenured auditor” include “deep expertise” and “familiarity” with the company’s vast business empire. GE also highlighted “independence controls” on KPMG, including “thorough” oversight from the board’s audit committee and requirements that the lead partner be rotated every five years.*
The benefits of forced rotation are subtler. After a period of service (say, 20 years), the auditors may become too complacent and close to the client, creating a familiarity threat to independence. Audit independence and objectivity may fall by the way side. And conflicts of interest may develop over time, making it more difficult for auditors to exercise professional skepticism in gathering and evaluating financial data to ensure that the financial statements do not contain any material misstatements.
The benefits of auditor rotation may also include getting a fresh look at the company’s accounting methods and financial reporting techniques. The new firm may not be biased by past audits, and may critically challenge accounting techniques that smooth net income or create earnings to meet or exceed financial analysts’ earnings consensus estimates. Glass-Lewis chimed in when it wrote to GE shareholders, saying that GE shareholders must beware that “a long-tenured auditor can become too close with a client,” while a new auditor can “uncover problems previously unidentified.”*
The accounting profession contends that the mandatory rotation of principal audit partners sufficiently protects the public interest and builds in the “fresh look” critics are looking for. The Sarbanes-Oxley Act created a five-year auditor requirement. The SEC enforces it through the Public Company Accounting Oversight Board (PCAOB). Critics contend that this is not enough, and that mandatory audit firm rotation is necessary to compensate for years of influence by audit clients over their auditors.
The key factor in evaluating the net benefits of mandatory audit firm rotation is the public interest. The problem is there hasn’t been sufficient research on this issue because the mandatory partner rotation requirement under Sarbanes-Oxley is relatively recent, and less time has gone by since the European Union first required a 10 to 20 year firm rotation.
I have a different perspective. The PCAOB conducts inspections of public company audits every year or so. Why can’t the PCAOB look at the retention issue based on noted deficiencies in audits examined? It’s true that the Board may not look at the same client each year. Still, some kind of overall evaluation of the ethics of the firms, based on audit inspections, might add value to the process of determining when audit firms should be rotated. Noted deficiencies such as a lack of independence, integrity, objectivity, and professional skepticism, the bedrocks of audit quality, should raise questions in the minds of shareholders about whether a firm should be rotated.
The presence of these factors suggests ethical failures in the audits. By making the evaluations public so that shareholders can consider them in their annual retention votes, the firms may take the noted failures more seriously. This may not be the perfect solution, but it does begin the process of holding audit firms accountable for their audits by having meaningful consequences for repeated failures in ethics, and it protects the public interest.
* Source: Matt Egan, GE pressured to fire auditor after 109 years. April 24, 2018.
Tuesday, November 27, 2018
Robin W. Roberts, Accounting Exemplar
Editorial Note: We are delighted to publish this interview of Professor Robin W. Roberts, our Accounting Exemplar. As always, when you read his comments, we ask that you keep in mind that the opinions expressed therein are those of Professor Roberts. They do not represent the position of the AAA or of any other party.
On Sunday, August 5th, Professor Robin W. Roberts of the University of Central Florida received the 2018 Accounting Exemplar Award during the Accounting Exemplar Luncheon held during the American Accounting Association Annual Meeting in Washington, DC.
The Public Interest Section’s Accounting Exemplar Award is given to an educator or a practitioner who has made notable contributions to the professional and ethical health of the accounting profession. The Exemplar represents a role model who has contributed to our profession in a manner that serves the public interest. Previous winners of this prestigious award have included Abe Briloff, Stuart Chase, Cynthia Cooper, Ralph Estes, Harold Langenderfer, Arthur Levitt, Eli Mason, Tony Menendez, Albert Meyer, Carl Devine, Tony Puxty, Bob Sack, Prem Sikka, and Art Wyatt.
Dr. Robin W. Roberts serves as the Al and Nancy Burnett Eminent Scholar Chair in Accounting and Pegasus Professor at the University of Central Florida (UCF). His research interests focus on accounting and business ethics, regulation, and social responsibility. Dr. Roberts serves on the Executive Council of the Center for Social and Environmental Accounting Research, which is housed at the University of St. Andrews, and is past editor of Accounting and the Public Interest. He has been instrumental in the development of the AAA Public Interest Section Emerging Scholars Colloquium and in promoting public interest scholarship in accounting.
We are delighted to publish this interview with Robin.
When you learned you were receiving the Accounting Exemplar Award, how did you react?
Pat Kelly emailed me and asked if we could talk by phone. I said of course, thinking, however, that I was about to commit to doing Pat a favor. I was so pleasantly surprised when Pat told me I was receiving the award. After finishing my talk with Pat, I called my spouse Sherron. During my call with her I got surprisingly emotional (and continue to be). The Public Interest Section has provided such a supportive and nurturing environment throughout my career. Receiving this honor is a very personal, significant career achievement for me.
I want to thank the Accounting Exemplar Award Selection Committee and my colleagues who conspired behind my back to nominate me, particularly Lisa Baudot, Charles Cho, Joseph Johnson, Pamela Roush, and Dana Wallace. And I have to give tremendous credit to my favorite colleague and life partner, Sherron. Sherron is an education professor and has been my personal teaching coach, professional advisor, and my editor for over 35 years. My career successes are due in large part to her counsel and encouragement.
How did you become interested in public interest accounting scholarship?
Like most public interest accounting scholars, my interest grew as I became more familiar with the AAA Public Interest Section and with public interest research. My original research interests were in governmental accounting and auditing, spurred in part by Dr. Michael Granof assigning our undergraduate class to read Aaron Wildavsky’s book, The Politics of the Budgetary Process. It was the very first time I found accounting really interesting.
Over time this evolved into a stronger interest in political science and in studying the politics embedded in the profession and practice of accounting. Researching and teaching accounting ethics, professionalism, and the public interest rescued me from a much more mundane and less satisfying academic career and I am grateful.
Why do you think you were chosen to receive the Accounting Exemplar award?
First, I will repeat how honored and grateful I am to receive the award. I know there are many others who have devoted significant time and effort to advancing ethics, professionalism, and the public interest in accounting. So, for one thing, I was lucky.
I view the award as a career achievement award. I don’t have a defining life episode when I faced tremendous pressure to stand up against unethical practices. I so admire our award recipients who took such personal risk to blow the whistle. Although I have published public interest accounting research, I think the award primarily reflects my interests and efforts in developing new public interest accounting scholars.
I served for 10 years as Director of the University of Central Florida’s Accounting PhD Program. Our program valued and supported doctoral students interested in public interest research. Also, I helped start the PIS Emerging Scholars Colloquium that is held in conjunction with our section’s mid-year meeting. The success of these two endeavors means the world to me.
What advice would you give to emerging public interest accounting scholars?
I believe that choosing to focus on ethics and public interest accounting research and teaching is a vocational calling. Dedicated ethics and public interest scholars are passionate, caring, and intellectually interesting people. We are the moral conscience of the accounting discipline and the accounting profession. Ethics, professionalism, and the public interest should be key aspects of our collective work as an accounting academy—in our teaching, in our research, and in our service to practice—and it is not. So, work to help these topics find their rightful place.
I will offer three pieces of advice. First, research without regret. Let your curiosity and passion drive your research program. If I had continued to study aspects of accounting that don’t resonate with me as a person, I would have failed miserably. Stand proud as an accounting researcher who cares about solving social problems such as discrimination, income inequality, access to health care, and environmental degradation.
Second, be bold in pushing the ethical envelope in your classes. Accounting is much more than a technical practice. It is a social practice that affects the lives of employees, customers, suppliers, citizens, and all living things. Bring the ethical aspects of decision-making and reporting into all of your classes. I have found students very receptive. Collectively, we can make difference, and it starts with you.
Third, become involved in the AAA Public Interest Section or another group of like-minded scholars. It is very difficult to go it alone as a public interest accounting scholar. If you become involved, you will find encouragement, support, and potential collaborators. Reach out if I can do anything to help!
On Sunday, August 5th, Professor Robin W. Roberts of the University of Central Florida received the 2018 Accounting Exemplar Award during the Accounting Exemplar Luncheon held during the American Accounting Association Annual Meeting in Washington, DC.
The Public Interest Section’s Accounting Exemplar Award is given to an educator or a practitioner who has made notable contributions to the professional and ethical health of the accounting profession. The Exemplar represents a role model who has contributed to our profession in a manner that serves the public interest. Previous winners of this prestigious award have included Abe Briloff, Stuart Chase, Cynthia Cooper, Ralph Estes, Harold Langenderfer, Arthur Levitt, Eli Mason, Tony Menendez, Albert Meyer, Carl Devine, Tony Puxty, Bob Sack, Prem Sikka, and Art Wyatt.
Dr. Robin W. Roberts serves as the Al and Nancy Burnett Eminent Scholar Chair in Accounting and Pegasus Professor at the University of Central Florida (UCF). His research interests focus on accounting and business ethics, regulation, and social responsibility. Dr. Roberts serves on the Executive Council of the Center for Social and Environmental Accounting Research, which is housed at the University of St. Andrews, and is past editor of Accounting and the Public Interest. He has been instrumental in the development of the AAA Public Interest Section Emerging Scholars Colloquium and in promoting public interest scholarship in accounting.
We are delighted to publish this interview with Robin.
When you learned you were receiving the Accounting Exemplar Award, how did you react?
Pat Kelly emailed me and asked if we could talk by phone. I said of course, thinking, however, that I was about to commit to doing Pat a favor. I was so pleasantly surprised when Pat told me I was receiving the award. After finishing my talk with Pat, I called my spouse Sherron. During my call with her I got surprisingly emotional (and continue to be). The Public Interest Section has provided such a supportive and nurturing environment throughout my career. Receiving this honor is a very personal, significant career achievement for me.
I want to thank the Accounting Exemplar Award Selection Committee and my colleagues who conspired behind my back to nominate me, particularly Lisa Baudot, Charles Cho, Joseph Johnson, Pamela Roush, and Dana Wallace. And I have to give tremendous credit to my favorite colleague and life partner, Sherron. Sherron is an education professor and has been my personal teaching coach, professional advisor, and my editor for over 35 years. My career successes are due in large part to her counsel and encouragement.
How did you become interested in public interest accounting scholarship?
Like most public interest accounting scholars, my interest grew as I became more familiar with the AAA Public Interest Section and with public interest research. My original research interests were in governmental accounting and auditing, spurred in part by Dr. Michael Granof assigning our undergraduate class to read Aaron Wildavsky’s book, The Politics of the Budgetary Process. It was the very first time I found accounting really interesting.
Over time this evolved into a stronger interest in political science and in studying the politics embedded in the profession and practice of accounting. Researching and teaching accounting ethics, professionalism, and the public interest rescued me from a much more mundane and less satisfying academic career and I am grateful.
Why do you think you were chosen to receive the Accounting Exemplar award?
First, I will repeat how honored and grateful I am to receive the award. I know there are many others who have devoted significant time and effort to advancing ethics, professionalism, and the public interest in accounting. So, for one thing, I was lucky.
I view the award as a career achievement award. I don’t have a defining life episode when I faced tremendous pressure to stand up against unethical practices. I so admire our award recipients who took such personal risk to blow the whistle. Although I have published public interest accounting research, I think the award primarily reflects my interests and efforts in developing new public interest accounting scholars.
I served for 10 years as Director of the University of Central Florida’s Accounting PhD Program. Our program valued and supported doctoral students interested in public interest research. Also, I helped start the PIS Emerging Scholars Colloquium that is held in conjunction with our section’s mid-year meeting. The success of these two endeavors means the world to me.
What advice would you give to emerging public interest accounting scholars?
I believe that choosing to focus on ethics and public interest accounting research and teaching is a vocational calling. Dedicated ethics and public interest scholars are passionate, caring, and intellectually interesting people. We are the moral conscience of the accounting discipline and the accounting profession. Ethics, professionalism, and the public interest should be key aspects of our collective work as an accounting academy—in our teaching, in our research, and in our service to practice—and it is not. So, work to help these topics find their rightful place.
I will offer three pieces of advice. First, research without regret. Let your curiosity and passion drive your research program. If I had continued to study aspects of accounting that don’t resonate with me as a person, I would have failed miserably. Stand proud as an accounting researcher who cares about solving social problems such as discrimination, income inequality, access to health care, and environmental degradation.
Second, be bold in pushing the ethical envelope in your classes. Accounting is much more than a technical practice. It is a social practice that affects the lives of employees, customers, suppliers, citizens, and all living things. Bring the ethical aspects of decision-making and reporting into all of your classes. I have found students very receptive. Collectively, we can make difference, and it starts with you.
Third, become involved in the AAA Public Interest Section or another group of like-minded scholars. It is very difficult to go it alone as a public interest accounting scholar. If you become involved, you will find encouragement, support, and potential collaborators. Reach out if I can do anything to help!
Tuesday, July 31, 2018
KPMG Knowledge of PCAOB Inspections: A Good Business Decision orViolation of Ethics?
Editorial Note: We are delighted to publish this “opinion piece” by Dr. Steven Mintz, a frequent contributor to our social media blog. As always, when you read his contribution, we ask that you keep in mind that the opinions expressed therein are those of the author. They do not represent the position of the AAA or of any other party.
With this piece, we are launching our “Contributing Columnist” series at AAAPublicInterest.org. It is adapted from a 2018 article that appears in the CPA Journal.
We thank the New York State Society of CPAs, the publisher of The CPA Journal, for permission to publish this essay. Richard Kravitz, the Editor-In-Chief of the Journal, will join Dr. Mintz as session panelists during the AAA’s upcoming 2018 Ethics Symposium.
Recent revelations that KPMG had help in its quest to prepare for audits from the PCAOB
raises the question whether it was a good business decision to hire a former PCAOB staffer to help it determine the target of audit inspections by the PCAOB or an unethical act. I would say while it may have seemed to be a good business decision at the time, KPMG’s actions to gain access to possible PCAOB inspections was unethical because it violates the public trust. The key ethical issue is intent. The intent of KPMG was to “cheat the system” by gaining an unfair advantage. In this regard it reminds me of the Volkswagen defeat device case.
Why did KPMG do it? It is because their audit deficiency rate was the highest of all the Big Four firms. The average audit deficiency rate for the Big Four since the inception of the inspection process has ranged between 30-to-40 percent. The rate for Big-4 firms has gotten as low as 21 percent (Deloitte) and gone as high as 54 percent (KPMG). In the case of KPMG, it was determined that the firm too often failed to gather enough supporting evidence before signing off on a company's financial statements and internal controls.
Let’s look at the indictment against KPMG’s partners. After being hired by KPMG, Brian Sweet, the former PCAOB staffer, was asked by three KPMG partners, knowing his background with the PCAOB, whether there were any plans to inspect a client of theirs. Reluctant at first to respond, David Middendorf, KPMG's former national managing partner for audit quality and professional practice, is said to have later told Sweet to "remember where [his] paycheck came from" and "to be loyal to KPMG." Sweet was asked about the plans again a few days later, this time by Thomas Whittle, former national partner-in-charge of inspections, who implied that his position within the firm was not secure. Sweet showed Whittle the inspection list later that day. The audit partners used this information to analyze and review audit workpapers relevant to the inspection and suggested revisions to avoid possible findings of deficiencies by the PCAOB.
A CPA’s loyalty should be to the public, not the firm. Otherwise, the public cannot trust that CPAs and their firms will act in the public interest, not those of the client or the firm.
There is an issue to consider with respect to quality controls. Quality controls relate not only to audit engagements but ethics as well. One such example is independence. Firms have quality controls to ensure their staff are independent of clients. I also believe quality controls should extend to integrity issues. KPMG’s actions lack integrity because they were unprincipled and violate the public trust. I believe KPMG’s actions border on being an act discreditable to the profession. Just imagine if all firms acted this way. The audit inspections would be relatively useless because the ethical rule that the audits selected by the PCAOB should not be known in advance by the inspected firm would be compromised.
I’m also troubled by the contingent fee issue. KPMG hired Palantir, the data analytics firm, to help it predict which of its engagements would be inspected and agreed to pay it $250,000, contingent on a certain rate of success. While contingent fees are acceptable in non-audit engagements, with certain exceptions related to tax practice, it is not unreasonable to evaluate the arrangement from a broader lens. Again, it smacks of being an act discreditable to the profession. It has elements of insider trading, in my view.
Another ethical issue is fairness. If we consider that all the other firms, including the non-Big-Four, may not have access to former PCAOB-staffers, or may have a higher ethical standard than KPMG, those firms are not being given the same opportunity to know in advance which audits might be inspected by the PCAOB. Simply stated, they are not playing on a level playing field because KPMG had a competitive advantage, albeit one based on improper actions. The result could have been that other firms wound up with a higher deficiency rate than KPMG because of its advantage and the steps it took to capitalize on it.
At the end of the day, KPMG’s actions should lead to a state board of accountancy investigation whether the firm violated its ethical commitment to standards of professional behavior and protecting the public interest.
Dr. Steven Mintz is a Professor Emeritus at Cal Poly San Luis Obispo. You are welcome to visit him at StevenMintzEthics.com.
With this piece, we are launching our “Contributing Columnist” series at AAAPublicInterest.org. It is adapted from a 2018 article that appears in the CPA Journal.
We thank the New York State Society of CPAs, the publisher of The CPA Journal, for permission to publish this essay. Richard Kravitz, the Editor-In-Chief of the Journal, will join Dr. Mintz as session panelists during the AAA’s upcoming 2018 Ethics Symposium.
Recent revelations that KPMG had help in its quest to prepare for audits from the PCAOB
raises the question whether it was a good business decision to hire a former PCAOB staffer to help it determine the target of audit inspections by the PCAOB or an unethical act. I would say while it may have seemed to be a good business decision at the time, KPMG’s actions to gain access to possible PCAOB inspections was unethical because it violates the public trust. The key ethical issue is intent. The intent of KPMG was to “cheat the system” by gaining an unfair advantage. In this regard it reminds me of the Volkswagen defeat device case.
Why did KPMG do it? It is because their audit deficiency rate was the highest of all the Big Four firms. The average audit deficiency rate for the Big Four since the inception of the inspection process has ranged between 30-to-40 percent. The rate for Big-4 firms has gotten as low as 21 percent (Deloitte) and gone as high as 54 percent (KPMG). In the case of KPMG, it was determined that the firm too often failed to gather enough supporting evidence before signing off on a company's financial statements and internal controls.
Let’s look at the indictment against KPMG’s partners. After being hired by KPMG, Brian Sweet, the former PCAOB staffer, was asked by three KPMG partners, knowing his background with the PCAOB, whether there were any plans to inspect a client of theirs. Reluctant at first to respond, David Middendorf, KPMG's former national managing partner for audit quality and professional practice, is said to have later told Sweet to "remember where [his] paycheck came from" and "to be loyal to KPMG." Sweet was asked about the plans again a few days later, this time by Thomas Whittle, former national partner-in-charge of inspections, who implied that his position within the firm was not secure. Sweet showed Whittle the inspection list later that day. The audit partners used this information to analyze and review audit workpapers relevant to the inspection and suggested revisions to avoid possible findings of deficiencies by the PCAOB.
A CPA’s loyalty should be to the public, not the firm. Otherwise, the public cannot trust that CPAs and their firms will act in the public interest, not those of the client or the firm.
There is an issue to consider with respect to quality controls. Quality controls relate not only to audit engagements but ethics as well. One such example is independence. Firms have quality controls to ensure their staff are independent of clients. I also believe quality controls should extend to integrity issues. KPMG’s actions lack integrity because they were unprincipled and violate the public trust. I believe KPMG’s actions border on being an act discreditable to the profession. Just imagine if all firms acted this way. The audit inspections would be relatively useless because the ethical rule that the audits selected by the PCAOB should not be known in advance by the inspected firm would be compromised.
I’m also troubled by the contingent fee issue. KPMG hired Palantir, the data analytics firm, to help it predict which of its engagements would be inspected and agreed to pay it $250,000, contingent on a certain rate of success. While contingent fees are acceptable in non-audit engagements, with certain exceptions related to tax practice, it is not unreasonable to evaluate the arrangement from a broader lens. Again, it smacks of being an act discreditable to the profession. It has elements of insider trading, in my view.
Another ethical issue is fairness. If we consider that all the other firms, including the non-Big-Four, may not have access to former PCAOB-staffers, or may have a higher ethical standard than KPMG, those firms are not being given the same opportunity to know in advance which audits might be inspected by the PCAOB. Simply stated, they are not playing on a level playing field because KPMG had a competitive advantage, albeit one based on improper actions. The result could have been that other firms wound up with a higher deficiency rate than KPMG because of its advantage and the steps it took to capitalize on it.
At the end of the day, KPMG’s actions should lead to a state board of accountancy investigation whether the firm violated its ethical commitment to standards of professional behavior and protecting the public interest.
Dr. Steven Mintz is a Professor Emeritus at Cal Poly San Luis Obispo. You are welcome to visit him at StevenMintzEthics.com.
Tuesday, July 10, 2018
Lise Valentine, Deputy Inspector General
Editorial Note: Dr. Lise Valentine is the Deputy Inspector General for Audit and Program Review for the City of Chicago. As a follow-up to her plenary appearance at the 2018 AAA Public Interest Section Midyear Meeting in Chicago, we asked Lise to respond to four questions.
With our Annual Meeting less than four weeks away, we hope that the quality of Dr. Valentine’s responses will remind our Section members of the value of our intellectual content. You are welcome to join us at our Section Business Meeting, at the Ethics Symposium, and at our research presentation sessions during the Annual Meeting in order to enjoy more such content.
(1) How much control do you maintain over defining your own audit and investigatory priorities? Are they strictly defined by statute and regulation? Or do you enjoy some latitude in applying resources where you believe they would do the most good?
Our jurisdiction, which is established by the Chicago Municipal Code, extends to all employees and elected officers of City of Chicago government performing their official duties, as well as contractors providing goods or services to the City. Interestingly, although City Council voted in 2016 to place itself under our jurisdiction, it limited our oversight authority—we have the power to investigate allegations of wrongdoing by aldermen and their staffs, but we may not audit their activities.
With respect to City entities under our jurisdiction, we have complete control over our audit and investigatory priorities. Our investigative staff receives and triages tips from the public, and we often open cases on the Inspector General’s own initiative. Each year we publish an audit plan identifying potential projects selected using our prioritization criteria. We thus have great freedom, but also great responsibility to apply our resources where we believe they will best promote economy, effectiveness, efficiency, and transparency in City operations.
(2) To what extent has budget pressures changed the nature of your procedures? Do you ever feel pressure to “find money,” as taxation authorities in certain jurisdictions are sometimes asked to do?
As a watchdog for the taxpayers, we take very seriously our responsibility to be good stewards of public funds. We apply the same critical eye to our own spending that we do to other departments; the sort of pressure you describe is primarily self-imposed. While we’re not a revenue-generating function, our audits and investigations often identify savings opportunities or result in restitution of City funds.
Pursuant to the Municipal Code, our annual budget is no less than 0.14% of the total City budget. This funding floor largely insulates us from budget cuts. However, we don’t have complete freedom. Our line-item budget is subject to City Council approval, and we cannot fill vacant positions without approval from the Mayor’s budget office.
(3) What kind of student should consider a career in the public sector? How can professors identify such students, and how should we encourage them to consider exploring such opportunities?
Students who are more motivated by mission than by money are the best candidates for the public sector. While a public sector career won’t make you rich, you will generally have a reliable middle-class income and you’ll be serving the greater good. We all need and use government services—from ambulances to expressways to economic policy—and we all pay taxes. So, proper accounting for these expenditures and revenues, and their accurate reporting, is in everyone’s interest.
All levels of government need accounting and finance experts who will safeguard our shared public assets and promote economy and efficiency in governmental operations. Of course, no job is perfect; everyone has some bad days at work. But in a public sector career you can get through those days by remembering the positive contribution you are making to society.
Governments don’t spend money on advertising and recruiting the way accounting firms do. Professors play the critical role of helping to bring these public service career options to their students’ attention, since they may not even know the jobs exist. Professors can invite public sector accounting professionals to speak to their classes. They can reach out to professional organizations like the Government Finance Officers Association, the National Association of State Auditors, Comptrollers, and Treasurers, or the Association of Local Government Auditors to solicit speakers and collect information on internships or jobs.
For example, the U.S. Government Accountability Office and the Government Accounting Standards Board have excellent intern and fellowship programs. Students should also consider following @ChicagoOIG on Twitter or connecting with the Office of Inspector General on LinkedIn, where our office regularly posts job vacancies. We also publish reports and promote our work, which helps students better understand what we do and discover that they may want to be a part of it. Our office regularly recruits interns, for both legal and IT roles, so be sure to visit our website for those details.
(4) Why did you leave the academic world for your current position? Was it more of a personal decision, or a professional one? And do you ever miss the opportunity to teach and to engage in research?
It was more of a professional decision. During my five-year Ph.D. program I had the good fortune to publish a single-authored article in a major journal, to design and teach 10 stand-alone courses, and to serve on several committees. I appreciated having these experiences while still a student because they made me realize I didn’t want an academic career. To be frank, I burned out on undergraduate teaching and I wasn’t motivated by the publishing race.
But my love for learning, teaching, and service persisted. Happily, my current role provides me with ample opportunities to teach and train others, to research ways to improve government, and to serve on committees working to advance OIG and the profession. What I miss most about academia is roving the real and virtual library stacks, marveling at all there is to know.
***
Dr. Lise Valentine is Deputy Inspector General for Audit and Program Review for the City of Chicago. To support the Inspector General's mission, her office conducts independent evaluations of municipal programs and operations, and makes recommendations to strengthen and improve public services. She has taught Public Finance for the Master’s in Public Administration Program at the University of Illinois at Chicago, and is an instructor for the Inspector General Institute®.
Prior to joining OIG, Valentine served as Vice President and Director of Research at the Civic Federation, a non-partisan governmental research organization, where she led research on government efficiency, transparency, and tax policy. She was elected to the post of Commissioner and Treasurer of the Park District of Oak Park, IL and served on advisory task forces for the Governmental Accounting Standards Board.
Dr. Valentine is a Certified Public Accountant, a Certified Internal Auditor, and a Certified Inspector General Auditor®.