THERISEOF = “ECONOMIC CONSEQUENCES” The impact of accounting reports on decision making may be the most challenging accounting issue of the 1970s. by Stephen A. Zeff Since the 1960s, the American accounting profession has been aware of the increasing influence of “outside forces” in the standard- setting process. Two parallel developments have marked this trend, First, individuals and groups that had rarely shown any inter- est in the setting of accounting standards began to intervene actively and powerfully in the process. Second, these parties began to invoke arguments other than those which have traditionally been employed in account- 2 discussions. The term “economic conse- quences” has been used to describe these novel kinds of arguments. By “economic consequences” is meant the impact of accounting reports on the decision- making behavior of business, government, unions, investors and creditors. It is argued that the resulting behavior of these individu- als and groups could be detrimental to the interests of other affected parties. And, the argument goes, accounting standard setters must take into consideration these allegedly detrimental consequences when deciding on accounting questions.* The recent debates in- volving foreign currency translation and the accounting for unsuccessful exploration ac- tivity in the petroleum industry have relied heavily on economic consequences argu- Copyright © 1978 by Stephen A. Zef. EA. note: For the opinion of an accounting standard selter, see Oscar S. Gellein’s article in Statements in Quotes, p. 75: 56 The Journal of Accountancy, December 1978 Copyright @200T-All Rights ments, and the Financial Accounting Stan- dards Board and the Securities and Exchange Commission have become extremely sensitive to the issue." The economic consequences argument represents a veritable revolution in account- ing thought. Until recently, accounting policy making was either assumed to be neutral in its effects or, if not neutral, it was not held ‘out to the public as being responsible for those effects. Today, these assumptions are being severely questioned, and the subject of social and economic consequences “has become the central contemporary issue in accounting.” That the FASB has commis- sioned research papers on the economic con- sequences of selected standards and has held a conference devoted entirely to the subject® underscores the current importance of this issue. Accounting policy makers have been aware since at least the 1960s of the third- Several articles have been wrilfen on “economic con- sequences.” See, e.g, Alfred Rappaport, “Economic Impact of Accounting Standards—Implications for the FASB." JofA, May77, pp.89-98; Arthur R. Wyatt, “The Economic Impact of Financial Accounting Stan- dards” JOfA, Oct77, pp.92-94; and Robert J. Swie- ings, “Consequences of Financial Accounting Stan- dards,” Accounting Forum, May 1977, pp.25-39. Report of the Committee on the Social Consequences of Accounting Information (Sarasota, Fla.: American ‘Accounting Association, 1978), p4. 3 Conference on the Economic Consequences of Finan- cial Accounting Standards (Stamford, Conn.: FASB, 1978), STEPHEN A. ZEFF, Ph.D.. is professor of accounting at Rice University, Houston, Texas. The American ‘Accounting Association's 1977 distinguished interna- tional lecturer in Latin America, he is the editor of the Accounting Review. Professor Zeft js the author ‘of Forging Accounting Principles in Five Countries History and an Analysis of Trends (Champaign, Ti: Stipes Publishing Company, 1972) and a coeditor ‘of Essays in Honor of William A. Paton: Pioneer Ac- ‘counting Theorist (Aun Arbor, Mich.: Division of Research, Graduate School of Business Administ tion, University of Michigan, 1978). This article is an abridged version of a paper presented on June 9, 1978, ft the Stanford Lectures in Accounting, Graduate School of Business, Stanford University. Reservedparty intervention issue,* while the issue of economic consequences has surfaced only in the 1970s, Indeed, much of the history of the Accounting Principles Board during the 1960s was one of endeavoring to understand and cope with the third-party forces which were intervening in the standard-setting process. In the end, the inability of the APB to deal effectively with these forces led to its demise and the establishment in 1973 of the FASB. . ‘The true preoccupations of the intervening third parties have not always been made clear. When trying to understand the third- party arguments, one must remember that before the 1970s the accounting model em- ployed by the American Institute of CPAs committee on accounting procedure (CAP) its self-interest in the economic consequences of the contents of published reports, 3 The economic consequences in which management was self-interested. If one accepts Johnson's dictum that it re- quires a “lively imagination” to believe that ‘management is genuinely concerned with fair presentation when choosing between account- ing alternatives,* it could be concluded that the first argument has seldom been employed in third-party interventions. In recent years, particularly since the early 1970s, manage- ‘ment has become more candid in its dia- logues with the FASB, insistently advancing the third argument and thus bringing eco- nomic consequences to the fore. “\.. outside parties intervened in the standard-setting process by an appeal to criteria that transcended the traditional questions of accounting measurement and fair presentation. They were concerned in- stead with, the economic consequences...” and the APB was, formally at least, confined to technical accounting considerations (sometimes called “accounting principles” or “conceptual questions”) such as the measure- ment of assets, liabilities and income and the “fair presentation” of financial position and ‘operations. The policy makers’ sole concern was with the communication of financial in- formation to actual and potential investors, for, indeed, their charter had been “granted” by the SEC, which itself had been charged by Congress to assure “full and fair disclo- sure” in reports to investors. Third-party in- tervenors, therefore, would have had an ob- vious incentive to appeal to the accounting model used by policy makers rather than raise the specter of an economic consequen- ces model preferred by the third parties. ‘When corporate management began inter- vening in the standard-setting process to an increasing degree, therefore, its true position was probably disguised. An examination of management arguments suggests the follow- ing range of tactical rhetoric. Arguments were couched in terms of 1 The traditional accounting model, where management was genuinely concerned about unbiased and “theoretically sound” account- ing measurements. 2 The traditional accounting model, where management was really seeking to advance ‘in this article, Cam chiefly concerned with third: party intervention in the standard setting for unregu- lated industries. Accounting policy makers in this country have been alive for several decades to the ac- counting implications of the rales and regulations of rate-making in the energy, transportation and com- ‘munication industries. See, eg, George O. May, Fi- hnanciel Accounting: A Distillation of Experience (New York: The Macmillan Company, 1943), chs, 7-8, and William A. Paton, “Accounting Policies of the Federal Power Commission—A Critique,” JOfA, Junes4, pp. 432-60, ‘Two factors tend to explain why economic consequences did not become a substantive issue before the 1970s. First, management and other interested parties predominantly used the second argument cited above, en- couraging the standard-setting bodies to con- fine themselves to the traditional accounting model. Second, the CAP and APB, with few exceptions, were determined to resolve, or appear to resolve, standard-setting controver- sies in the context of traditional accounting. Early Uses of Economic ‘Consequences Arguments Perhaps the first evidence of economic conse~ quences reasoning in the pronouncements of American policy makers occurred as long ago as 1941. In Accounting Research Bulle- tin no. 11, Corporate Accounting for Ordi- nary Stock Dividends, the CAP, in accord- ance with “proper accounting and corporate policy,” required that fair market value be used to record the issuance of stock dividends where such market value was substantially in excess of book value Evidently, both the New York Stock Ex- janagement’s Role in External in Robert K. Jacdicke, Yoji Wiri and Oswald Nielsen. (editors), Research in Accounting Measurement ([n.p-l, AAA,” 1966), p91. “Accounting Research Bulletin no, 11, Corporate, Ac: ¢ for Ordinary Stock Dividends (New York ‘American Institute of Accountants, 1941), pp.t02-03 ‘The Journal of Accountancy, December 1978 57 Copyright © 2001 All Rights Reserved