The Crisis in Financial Reporting

2. The Crisis in Financial Reporting Rick Antle Senior Associate Dean and Professor of Accounting Yale School of Management

3. Criticized Parties • Government regulators • Standards’ setters (FASB & EITF) • Management • Boards of directors • Accounting profession

4. Debacle • A sudden, disastrous collapse, or defeat; a rout

5. Fiasco • A complete failure

6. Failure • Cessation of proper functioning or performance

7. “I am not an accountant.”

8. Basis of Financial Reporting • Economic concepts • Accounting conventions • Institutional context

9. Accounting Identity Assets = Liabilities + Equity Assets – Liabilities = Equity

10. How it Works • 0 – 0 = 0? • 5 – 3 = 2? • RECOGNITION CRITERIA!!

11. Building Example • Original cost: $6 million • Accumulated depreciation: $4 million • Sales price: $3 million • Does selling the building add to shareholders’ wealth?

12. I Am Not An Accountant • Professes confusion of the aspirations of accounting with the practical results of applying its conventions and techniques.

13. Standards’ Setters • FASB’s elaborate due process means: Details and loopholes are there becausesomeone wants them there. • Just look at the treatment of executive stock options.

14. Loan Big Bank Payments (Interest rate?) Special Purpose Entity - Problem Risky Corp Office Corp A special purpose entity. Will issue debt, construct the office building, and lease it to Risky Corp Wants to borrow $100 to build an office building, which it will occupy

15. Risky Corp & Subsidiary Risky Corp Lease Payments Office Corp Use of office building Payments Loan Special Purpose Entity - Consolidated Big Bank

16. Equity Dividends Risky Corp Lease Payments Office Corp Use of office building Payments Loan Big Bank Special Purpose Entity - Off Balance Sheet Outside investors Loan guarantee

17. Dialog One • How about $0.1 of equity for Office Corp? • Not enough? How about $0.02? • Still not enough? Ok, you tell me, how much equity is enough?

18. Two Choices • Don’t answer questions • Pick a cut-off number or a rule for determining a cut-off number • Pre-Enron, number was $3. Now I believe it is $10.

19. Not Feasible to Refuse to Answer • Another dialog: • How about $100 of equity? • That will do it? Then how about $99? • That’s OK, too? Then how about $98?

20. Categorizations • Use of categories as a basis of aggregation is too handy to abandon. • Requires methods for assigning things to categories. • Creates the possibility of playing games to manipulate the classification.

21. Principles-Based Standards • Some think less detailed rules are the answer. • I think not. • Rules for assigning things to categories fall somewhere in the following box:

22. Logical Possibilities for Classification Rules

23. Accounting Profession During the recent past, however, the profession has not always lived up to its duties and responsibilities. …Because of the growing list of substandard audits, the profession is slowly losing its credibility…. We have seen too many recent instances of flawed accounting reports that simply have been chalked up to the overworked explanation that a certain amount of poor financial reporting is inevitable. Judge Sporkin

24. Accounting Profession We are not confronted with a liability crisis. We are instead confronted with an identity crisis. We don’t know for what, to whom, and the when of our responsibility. Abraham Briloff

25. Profession’s Response • Tightened internal control of Big 4 • Emergency response teams • Pro-active – before the Public Company Accounting Oversight Board requires changes

26. You can’t regain credibility by only doing things you are required to do.