The War of The Sidewardly Mobile Corporate Financial Report 2006 Critical Perspectives On Accounting

Critical Perspectives on Accounting 17 (2006) 419455
The war of the sidewardly mobile corporate

financial report
T.A. Lee
University of Newcastle Upon Tyne, Accounting and Finance Division, Business School,
Newcastle Upon Tyne NE1 7RU, UK
Received 15 November 2003; received in revised form 22 April 2004; accepted 30 September 2004
Abstract
A war exists in corporate financial reporting and the purpose of this paper is to identify and analyse why it persists despite continuous efforts to provide a resolution. The study uses the organic
intellectual approach to criticism recommended by Tinker [Beyond the Brilovian critique: traditional vs. organic intellectuals in critical accounting research. Acc Public Interest 2002;2:6887]
and focuses on the related commodity forms of public accountancy professionals and historical
cost accounting as key features of the war. The methodology of the study is broadly historical
and the analysis reveals battlegrounds of reporting deception, audit criticism, governmental and
professional responses and academic challenge. The paper argues that the war has caused reporting quality to remain poor throughout its historyi.e. to be sidewardly rather than upwardly mobile in terms of quality aspirations and achievement. It recommends fundamental debates on two
commodity forms in corporate financial reporting. The first debate concerns the type of public accountancy professional wanted and needed by society in relation to corporate financial reporting.
The second debate relates to the problem of social reality construction and its representation by
accounting numbers. The responsibility of academic accountants in these debates is particularly
emphasised.
2004 Elsevier Ltd. All rights reserved.
Keywords: Academics; Corporate financial reporting; Fraud; Historical cost accounting; Professionalism; Public
interest; Social reality construction
E-mail address: leeatom@aol.com.

1045-2354/$ see front matter 2004 Elsevier Ltd. All rights reserved.
doi:10.1016/j.cpa.2004.09.001
420
T.A. Lee / Critical Perspectives on Accounting 17 (2006) 419455
1. Preface and caveat

This paper presents observations and opinions on the state of corporate financial reporting from more than three decades of involvement by the writer in its practice, teaching and
research. It incorporates the work of many researchers and provides a commentary to encourage further thought and debate. The paper describes historical events and periods but is
not a history of these events and periods and does not offer new historical evidence. Instead,
the papers historical descriptions suggest that corporate financial reporting is in a state of
crisis and has been for many decades. Using a social analogy of mobility related to aspirations and achievement of improvement, the paper particularly argues that, far from being
upwardly mobile, corporate financial reporting has been, at best, sidewardly mobilei.e.
lacking substantial improvement in relevance and reliability.
The paper offers two recommendations as a first step to remedy the situation. These
are debates on the type of professional needed in corporate financial reporting, and the
problems associated with social reality construction and its accounting representation. The
recommendations are not what Tinker (2002, p. 77) describes as sentimental and traditional
intellectual yearnings to return to a golden age of the past. The point about this study is that
there never was such an agewhich is arguably the most damning criticism to make about
the current state of corporate financial reporting.
2. Introduction
This study rests on a primary assumption that there is a private war over a public good in
corporate activity. On one side of the divide are protectorsindividuals and organisations
who implicitly and explicitly covenant to protect the public interest in capital markets.1 On
the other side are deceiverscorporate managers who attempt to deceive actors in these
markets. The public good is the corporate financial report by managers to shareholders
that forms an important information source for normal market activity. The main content
of the report is a related set of accounting numbers derived from a rule-based system of
calculation, disclosed according to legislative or regulatory mandate, and verified by expert
public accountants. The war usually takes place far from the public eye in corporate and
professional offices but becomes visible when protectors catch deceivers in the act of major
reporting deception.
There are various protectors in capital markets including auditors, legislators, government regulators and academics. Each group has a significant role to play in protecting the
public from any harm caused by accounting deceit in corporate financial reports. However,
when fulfilling their public interest mission, protectors also necessarily pay attention to
their economic self-interests and this can result in compromising behaviour. This duality of
focus does not affect deceivers. They are corporate executives and directors who, with few
exceptions, manage by economic self-interest in a capitalist society. It is easy to exaggerate
1 Protection in the accounting literature typically appears in association with the needs of investors and lenders
operating within capital markets. However, for purposes of this paper, protection includes the needs of corporate
stakeholders and includes customers, employees, government agencies, and suppliers.
421
the problem from infamous cases such as Enron and WorldCom. However, numerous other
examples of misleading and fraudulent reporting over many decades suggest they regard
accounting and disclosure as matters of managerial discretion, typically use flexible accounting rules to manipulate numbers, and only disclose what they want to reveal (Clarke
et al., 2003).2 The conventional system of accounting calculation that combines allocated
historical costs with occasional market valuations assists them in this respect. At its heart are
subjective, flexible, and inconsistent rules that permit the reporting of accounting numbers
with ambiguous economic meaning.3 These rules appear tailor-made for manipulation and
possible deception because they depend on subjective judgments by management that are
difficult to challenge. In addition, deceivers are not usually concerned with the public interest in corporate reporting although some may believe their accounting manipulations are in
the best interests of their companies, markets, and stakeholders. The problem is that either
capital market participants use historical cost-based accounting numbers because they are
ignorant of the degree to which they have been or can be manipulated or they have no choice
as these data represent the only authoritative statements of corporate financial performance
and position available.
Given this context, the broad history of corporate financial reporting appears as a confused
story about a long-lived war over the quality of financial information reported to capital
markets. The purpose of this paper is to attempt to unravel the confusion and identify
significant characteristics that hold promise as a basis for discussion of its resolution. The
history of the war is more than one hundred and fifty years old in the English-speaking world
and enduring solutions are self-evidently thin on the ground. The historical sequence of the
paper evolves from a laissez faire state of no reporting protection to one with voluntary
measures and then to the current state of detailed legislative and regulatory prescriptions
involving numerous accounting rules. These changes have undoubtedly made accounting
numbers more transparent. However, there is also a paradoxical lack of change in the basics
of the system and pertinent questions require informed and credible answers. For example:
When there has been so much time and effort put into measures to improve its quality
internationally, why is corporate financial reporting in such a questionable state at the
beginning of the twenty-first century?
Why is it possible for major companies internationally to fool their auditors so persistently
despite sophisticated auditing practices?
2 There is a need for detailed historical research of this phenomenon. Nevertheless, for purposes of this paper,
there are sources that provide sufficient empirical evidence of the extensive nature of the problem. In addition
to Clarke et al. (2003), for example, there is the research of Abraham Briloff in the US that details numerous
American cases of dubious accounting and auditing over the last forty years (see Tinker, 2002 for a review of
Briloffs contributions) and the UK analysis of Hughes et al. (1998) to encourage the use of reporting scandals as
teaching sources. There are also various websites providing updated information on a selection of international
cases (e.g. http:/www.ex.ac.uk/rdavies/arian.scandals/classic.html).
3 Conventional accounting numbers frequently appear in legal contracts and capital market activities. This
obviously suggests their users infer some form of economic meaning from them. However, this does not mean
that the numbers necessarily represent economic activity faithfully or that there is homogeneity in the inferred
meanings. Empirical studies of the information content of accounting numbers provide evidence of use but not
necessarily of usefulness.
422
What problems endemic to corporate financial reporting permeate its questionable condition internationally?
Recent events in the US are the initial focus of the broad historical analysis in the
paper as they include the most serious financial reporting deceptions of modern times.
The commentary, however, also contains cases of UK deception and readers may wish to
consider comparable events in other countries and at other times. The study is therefore not
a detailed history of corporate financial reporting. Instead, its modest objective is to use
historical facts to inform arguments and recommendations, and encourage debate about a
serious problem. The analysis identifies problematic responses by various protector groups
to reporting deceit and castes serious doubts about the use of the conventions of historical
cost accounting to faithfully represent relevant corporate economic activity.
The study proposes that there is a debate on the type of public accountancy professional
required in corporate financial reporting (Macintosh and Shearer, 2000; see also Macintosh,
2004). It also recommends that the social reality subject matter of accounting requires debate
to consider its construction and accounting (Macintosh et al., 2000; Mattessich, 2003). As
such, the study is consistent with recent professional critics such as Zeff (2003) and Wyatt
(2003), and historical cost accounting critics such as West (2003). However, as previously
stated, it is not a traditional intellectual call to return to a golden age of public accountancy
professionalism or accounting theorising (Tinker, 2002; see also Macintosh and Shearer,
2000). Instead, it is a response to Tinker (2002, p. 80) appeal to examine the commodity
forms associated with financial reporting in a capitalist systemi.e. commodities that act
as bearers of the alienated social relations of capitalism. It also relates to Williams (2004)
charge that academic accountants develop and change accounting separate from the influence of the public accountancy profession. If the recommended debates are to take place,
the contributions of academics are essential.
3. Initial thoughts on war

There was no formal declaration of war between protectors and deceivers in corporate
financial reporting, nor is it usual to characterise their activities as warfare. However, a
continuous and long-lived history of specific conflicts over reporting quality suggests a
war does exist. An obvious starting point in this historical analysis is the principalagent
relationship in corporate activity.
Companies publish financial reports because shareholders frequently delegate their management to agents who account periodically for their performance. These agents have incentives to produce deceitful performance reports, particularly if accounting numbers determine
their compensation. Shareholders, however, have auditors in place to attest report quality.
More specifically, shareholders seek comfort from auditors that reported accounting numbers and related disclosures given to them are not deceitful and are therefore safe to use in
decisions. Crises in shareholders confidence arise if auditors fail to detect reporting deceit.
The public nature of corporate financial reports also means that reporting deceit affects all
stakeholders and the efficient operation of capital markets.
423
Reporting deceit takes many forms and covers all accounting and disclosure practices
designed to mislead report users. It therefore includes practices designed to cover up theft
of corporate assets and ineffective management, as well as numerous earnings management strategies (Nelson et al., 2003). This study assumes that reporting deceit refers to
any accounting or disclosure practice that deliberately misrepresents economic activity
by enlarging or diminishing corporate assets, liabilities, equity, profits and cash flows reported in financial statements.4 Motivations for reporting deceit vary but, in the case of
earnings management, the need to meet capital market expectations of earnings appears to
be a typical trigger for manipulation of accounting numbers. According to Nelson et al.
(2003), expenses and losses are the most manipulated aspects of financial reports in this
respect, followed by accounting data connected to revenues and gains. Whatever the reason or method of deception, however, the result is a corporate financial report with accounting numbers and disclosures that do not faithfully represent underlying economic
activity.
Reasonable assumptions that this study make are that the protectors of corporate financial
reporting are rational, regard reporting deceit as undesirable, and act to detect, prevent, or
minimise it. In addition, although some commentators describe deceptive reporting as a
form of game in which, particularly, managed earnings are hocus-pocus (e.g. Levitt,
1998), this analysis assumes the approach of Dechow et al. (1996) that deliberate deception
in financial reporting is a form of fraud. In other words, the distortion of accounting numbers
is a cynical exercise by corporate management to mislead shareholders, other stakeholders
and protectors. Capital markets depend on credible information sources and expect corporate
financial reports to faithfully represent economic activity even though there are accounting
researchers who believe that misleading information is useful because it permits report users
to identify ineffective management within the information content of manipulated accruals
(Arya et al., 2003).
It is also clear that reporting quality issues create internal divisions between protectors
because of an uneasy relationship between the public accountancy profession and government. In recent times in the US, for example, McNamee et al. (2000) report conflict
between the Securities & Exchange Commission (SEC) and the largest public accountancy
firms with audit clients caught reporting deceitful accounting numbers. The SEC accused
these auditors of accommodating reporting deceit in order to secure non-audit services. Irrespective of the truth of the matter, this episode reveals the war against reporting deceit is not
just about conflict between protectors and deceivers. Instead, it also involves paradoxical
battles between different groups of protector.
4 The term economic activity is used at this point in the paper to simplify the discussion, although more specific terms such as economic substance appear later at appropriate points in the narrative. Economic substance
frequently appears in conceptual explanations of accounting practices and is typically undefined and unexplained.
Its conventional appearance is in recommendations by accounting standard-setters to account for the economic
substance of transactions rather than their legal form (e.g. FASB, 1980; IASB, 1989). Its generic form is encapsulated by the term economic reality. Adapting the arguments of the American philosopher John R. Searle (1995),
economic reality is a form of social reality collectively constructed by humans with agreed rules and functions. In
other words, economic reality is a mental construct that may not be easily associated with empirical referents that
provide it with so-called economic substance and meaning (see Macintosh et al., 2000 and Mattessich, 2003).
424
3.1. Recent events

The 1990s witnessed considerable reporting deceit by major American companies and
the 1998 disclosure of accounting fraud by the Cendant Corporation illustrates this point
(Barrett, 1998). Cendant restated previously reported earnings by approximately 300 million
dollars because of revenue and other accounting misstatements, and dismissed its auditor,
Ernst & Young. It paid its shareholders nearly three billion dollars in damages settled out
of court in 2002 and Ernst & Young settled with it for more than 300 million dollars.
Also in 1998, Sunbeam Corporation secretly transferred more than 20 million dollars of
reserves to reported income in order to appear profitable (Byrne, 1999). Sunbeams auditors,
Arthur Andersen, paid an out-of-court settlement to its shareholders of one hundred and 10
million dollars. Unsurprisingly, major reporting incidents such as these provoked the SEC
to action. However, before it could put effective counter measures into place, a much larger
reporting scandal emerged. The Enron Corporation disclosed its reporting fraud in 2001
and sought Chapter 11 bankruptcy with accounting manipulations of more than one billion
dollars despite audits by Arthur Andersen (Sridharan et al., 2002). Senior executives of the
company created false profits and hid massive amounts of debt in more than three thousand
off-balance sheet partnerships. The scandal traumatised the stock market and worsened
when Arthur Andersen admitted shredding Enron audit papers shortly after disclosure of
the fraud. With the rapid loss of other clients, Arthur Andersen dissolved in 2002.
Cendant, Sunbeam and Enron are not isolated incidents and regulatory responses are
unsurprising. Accounting Today, for example, reported four hundred and sixty-four earnings restatements by major American corporations in 1999, 2000 and 2001 (Carlino, 2002).
The SEC issued restrictive rules of independence for auditors in 2000 and 2003, and the
SarbanesOxley Act entered the statute book in 2002 (AICPA, 2002). The Act created
the Public Company Accounting Oversight Board (PCAOB) of the SEC. The PCAOB
is intended to be independent of the public accountancy profession, registers public accountancy firms, has overall responsibility for audit-related standards, and inspects and
disciplines public accountancy firms for audit transgressions. The Act effectively identifies
the state in the US as the overall manager of the profession and inevitably this diminishes
the professional status of American public accountants. However, it came too late to prevent
a further shockwave in 2002 when one of the worlds largest corporations, WorldCom, announced the discovery of accounting fraud in excess of nine billion dollars. The accounting
manipulation was a simple one in which the costs of telecommunication lines appeared as
capital rather than revenue expenditure. Stock market prices fell worldwide, senior WorldCom executives faced criminal charges, investors sought compensation for damages, and
the company remains in Chapter 11 bankruptcy. The deeply disturbing circumstances of
companies such as Cendant, Enron, and WorldCom suggest a broader context is necessary
to understand the current state of corporate financial reporting.
3.2. Broader context
The scandals of the late 1990s were recent events in a long-running war and there were
many other incidents without the intense international public exposure given to Cendant,
Enron and WorldCom. Equity Funding Corporation, for example, was a 1970s fraud in-
425
volving false life assurance contracts and poor auditing (AICPA, 1975). It was the basis for
a television movie and a professional inquiry by the American Institute of Certified Public
Accountants (AICPA), but had little long-term impact on public accountancy or corporate financial reporting. It preceded a wider crisis in American banking in the late 1970s and 1980s
in which savings and loan banks and the largest public accountancy firms were involved
(Merino and Kenny, 1994). The accounting practices of these banks failed to represent
the economic substance of banking transactions, their auditors focused on rule compliance
rather than economic substance, and bank regulations sanctioned these practices.5 When the
American economy declined, numerous banks declared bankruptcy and public accountancy
firms paid in excess of one billion dollars in fines and out-of-court settlements. At the same
time, there were numerous examples reported in The Wall Street Journal and elsewhere of
US companies reporting dubious or fraudulent accounting numbers (e.g. MiniScribe, W
R Grace, Bausch & Lomb, Waste Management and Crazy Eddie) (see e.g. Byrne, 1999).
Although their existence was well known in the US, their international exposure was limited.
In the UK, accounting and auditing scandals were also prevalent and some impacted
internationally. For example, the Bank of Credit & Commerce International (BCCI) collapsed in 1991 with assets overstated by thirteen billion dollars to conceal poor lending
within an organisational structure in 73 countries. The fraud involved numerous criminal devices including money laundering, resulted in a US senate investigation, auditors Price Waterhouse under investigation for negligent auditing, and the Bank of England defending a substantial civil law suit for failure to intervene. The Barings banking group, on the other hand, collapsed in early 1995 following 850 million pounds of
losses due to fraudulent currency trading by an individual employee (Rawnsley, 1995).
Following a Bank of England investigation, UK public accountancy regulators in 2000
(confirmed in 2002) fined Baring auditors, PricewaterhouseCoopers (formerly Coopers
& Lybrand) for a negligent audit relating to the assessment of market risk. In 2003, the
High Court in England found fellow auditors, Deloitte & Touche, guilty of negligent
auditing.
Each of these reporting deceits can be characterised as a single battle in the war of corporate financial reporting. It typically involves fraudulent reports by senior management, and
auditors who fail to report the fraud, and therefore, fail to protect the public interest (Cullinan
and Sutton, 2002). Auditors in these situations appear intent on ensuring representational
faithfulness through compliance with specified accounting rules, and are seemingly willing
to accept managerial explanations without much questioning or challenge. Regulators get
involved and investigate typically after exposure of reporting deceit. In an increasingly litigious environment, legal actions by shareholders and liquidators frequently arise but rarely
get to court because of out-of-court settlements. Accounting fraud details are therefore rarely
exposed. Deceivers can then retreat before re-emerging to practice further deceit when the
regulatory spotlight disappears from them. Proposed and actual counter measures appear
and the cycle of warfare continues. Unsurprisingly, problems of a century ago re-appear as
issues of today (Chandler and Edwards, 1996).
5 There appears to be a more widespread condition in contemporary accounting, particularly in the US, in which
compliance with legal form rather than economic substance is associated with compliance with generally accepted
accounting principles (GAAP). See Alexander and Archer (2003) for an analysis of this issue.
426
To emphasise the persistence of reporting deceit, it is salutary to examine briefly a

nineteenth century case that mirrors those of the twenty-first century. Indeed, the reporting
by directors of the City of Glasgow Bank (CGB) in 1879 is relatively unsurprising in the
context of 2003. CGB pursued aggressive expansion in the 1860s and 1870s based on
dubious lending to a small number of individuals and speculative overseas investments.
Assets were deliberately overstated and the fraud amounted to an asset deficiency of more
than 6 million pounds by 1878.6 The following statement describes the public reaction to
the trial of the directors (Anonymous, 1879, p.i.):
The Trial which has now terminated, and of which, in the following pages, we present
a full and authentic report, will in all probability rank as the most important which
has ever taken place in Scotland. Whether regard be had to the magnitude of the
distress occasioned by the collapse of the City of Glasgow Bank, the social position
of the directors who managed, or rather so grossly mismanaged the concern, the
disclosures that followed the preliminary investigation of its affairs, or the startling
character of the evidence disclosed by the witnesses for the Crown, no other great
trial at all approaches it in permanent interest. The facts presented in these pages
will long be regarded as a standing memorial of unparalleled commercial disaster
disaster brought about not by innocent misfortune, but by the culpable recklessness of
gentlemen moving in the highest social and commercial, not to say religious circles,
in whose honour and integrity many thousands of their countrymen had for years
placed the most unbounded confidence.
The quotation illustrates the shock felt in Scotland in 1879 because prominent citizens
mismanaged a major bank and covered up with false accounting numbers. The UK government in 1879 passed national legislation requiring all banks to publish an annual balance
sheet. BCCI is a recent UK banking example of similar dysfunctional behaviour and only
its twenty-first century size distinguishes it from CGB in nineteenth century Scotland. Both
cases illustrate consistent problems with managerial agencyin particular, that without
credible accounting numbers and auditing procedures, there is inadequate accountability
of managerial agents to their shareholder principals. In addition, both cases reveal how
managers used financial reports to create false messages about economic performance and
position, caused corporate failure, and damaged all stakeholders. Protectors reacted in both
cases to counter the scandals. However, an examination of a longer history of reporting
failure suggests these individual measures were unsuccessful.
3.3. Longer history
A more detailed historical review of corporate financial reporting in the UK and US
reveals the endemic nature of deception and the difficulties associated with countering it.
In 1720, for example, the South Sea Company imploded due to speculation that pushed its
stock price many times beyond its underlying economic value (Watzlaff, 1971). This was not
a case of reporting deceit because the company did not publish financial information and had
6
This represents an approximate equivalent of more than 700 million pounds in 2003.
427
no auditor. However, it marked the first corporate financial scandal to trigger governmental
intervention to protect investors. The Bubble Act 1720 attempted to control the formation
of companies such as the South Sea Company, as well as the activities of stockjobbers
who fed speculative comment to investors. Nevertheless, it failed to consider the option to
require companies to publish and audit financial information at a time when participants
in capital markets lacked such protection. Regulating these matters only returned to the
governments agenda in the early 1800s and, although audited balance sheets appeared
voluntarily in certain companies prior to its introduction, the Companies Act 1844 was
the first legislation that required audits for all companies (Hein, 1978).7 However, it did
not specify auditor qualifications and, in any case, the Companies Act 1856 removed the
general audit requirement as capital markets reverted to a more liberal and less protected
regime. Individual industries with specific problems, however, adopted reporting practices.
For example, railway scandals led to the Railway Companies Act 1867, as previously
mentioned the City of Glasgow Bank case resulted in the Companies Act 1879, and these
specific measures widened to all UK companies in the Companies Act 1900. The Companies
Act 1948 was the next significant change and required all companies to disclose audited
statements of profitability and financial position, with auditors being qualified accountants
in the case of public companies. Each of these enactments resulted from a prior review of
corporate governance concerns by a parliamentary select committee.
Government was therefore the first major protector against reporting deceit in the UK
and governmental measures resulted in ever-increasing disclosure and prescription, forcing
deceivers to look for ways around regulations. UK courts also offered protection to shareholders against reporting deceit, but particularly in the nineteenth century, gave little comfort
because judges did not regard auditors as guarantors of the accuracy of accounting numbers
(Wardhaugh, 1984). Protection for deceived third-party users of reports remains unclear
to the present day (Pacini et al., 2002). Prior to the 1880s, British public accountants and
their institutions were pre-occupied with establishing their professionalism and monopoly
in the area of court-related services rather than expanding into new areas such as corporate
financial reporting (Moore and Cooper, 1994; Walker, 1991; Walker and Shackleton, 1995).
However, during the 1880s and 1890s, accountants began to make a public case that they
had bodies of knowledge to cope with emerging services such as auditing (Chandler and
Edwards, 1994). This was the beginning of a period lasting to the present day in which the
public accountancy profession used image management techniques to engage the trust of
report users, particularly those ill informed about its bodies of knowledge (Neu, 1991).
The case of the Royal Mail Steam Packet Company in 1932 stimulated the British
public accountancy profession to specific protectionist action (Ashton, 1986). The case
centred on the then accepted practice of secret reserve accounting and led inevitably to
the explicit involvement of professional bodies in the war against reporting deceit and a
stream of measures to protect report users over several decades. The Institute of Chartered
Accountants in England and Wales (ICAEW) started its Recommendations on Accounting
Principles in the late 1940s and subsequent Statements on Auditing in the early 1960s.
These were the forerunners of todays standards in the UK and prior reporting problems
7 Nobes and Parker (1979) provide a full chronology of UK corporate financial reporting developments from
1844 to 1977.
428
and criticisms initiated each step in their evolution. In particular, reporting problems over
major acquisitions and mergers in the late 1960s led to a series of mandatory accounting
standards in 1970 from the ICAEWs Accounting Standards Steering Committee (ASSC).
The ASSC evolved into the multi-body Accounting Standards Committee and, in 1990, the
independent Accounting Standards Board (ASB). In 1992, the ASB became the standards
arm of the financial communitys Financial Reporting Council. In contrast, the auditing
recommendations of the ICAEW became mandatory in 1976 when its Auditing Practices
Committee (APC) joined the Consultative Committee of Accountancy Bodies because of
fraudulent reporting by the secondary bank London & County Securities. This case also
led to the formation of the Joint Disciplinary Scheme of the main UK public accountancy
bodies in 1979. The APC evolved into the Auditing Practices Board (APB) in 1991 and the
APB joined the independent Accountancy Foundation in 2002. In most recent times, these
self-regulatory changes took place in a wider context of continuous governmental inquiry
into the state of corporate governance in the UK (e.g. Dearing in 1988, Cadbury in 1992,
and both Higgs and Smith in 2003).
The UK reporting protection process therefore changed over a relatively few decades
from voluntary procedures to mandatory standards and from committees of public accountancy bodies to apparently independent regulatory authorities representing a wider financial
community. It also resulted in a proliferation of accounting rules for the conventional system
of historical cost accounting that, according to its critics has no basis in an authoritative
theory or body of knowledge (e.g. Sterling, 1979; see also West, 2003). In the US, a similar
history is evident (Previts and Merino, 1998; Zeff, 2003).8 The preference of protectors
prior to the Securities Acts 1933 and 1934 was for supervision rather than regulation of
companies in industries with financial reporting problems. Public accountants were slow
to develop a political relationship with the state.9 Despite pressures, the American Institute
of Accountants (AIA) and its predecessor body had no desire to provide accounting and
auditing standards, preferring to control and police these areas on behalf of the SEC (Sriram
and Vollmers, 1997).
The quest of US public accountants in the early part of the twentieth century was for
standardised accounting practice and the AIA published its Uniform Accounting in 1917.
This was disastrous for the AIAs professionalism project as it implied rulemaking and lack
of professional judgment in financial reporting. Consequently, several later generations of
American public accountants advocated accounting flexibility in reporting practice. This
precipitated a debate on the issue by leaders of the profession that, inter alia, ignored
the fundamental point of whether historical cost accounting was credible in its role of
representing the financial results of corporate economic activity (e.g. see Zeff, 1982a; see
also Storey, 1964). There was also a governmental aversion at the time to interference in
corporate affairs and it was not until 1926 that protection against reporting deceit became a
serious issue. The credibility of accounting numbers was the major problem and the inability
of public accountants to enforce acceptable accounting practices on corporate clients the
main concern. Secrecy by companies was not only the norm but also acceptable to many
8
Zeff (1979) provides a US chronology of corporate financial reporting events from 1926 to 1978.
Macdonald (1995) explains the importance of this relationship to professions generally and Cooper et al.
(1994) discuss its importance to the public accountancy profession.
9
429
in the financial community (e.g. bankers). Nevertheless, the New York Stock Exchange in
1926 recognised the need to monitor corporate financial reporting and started discussions
with the AIA to lobby for mandatory audits. The crisis of the stock market crash in 1929
coincided with this concern, and the Securities Acts 1933 and 1934 introduced the SEC and
mandatory accounting and auditing provisions for public companies. The AIA, however,
realised the danger of losing its control of reporting standards and, following several years of
discussion, persuaded the SEC to delegate responsibility for these matters to it in 1938. The
AIAs Accounting Terminology and Examination of Financial Statements in 1931 predated
Accounting Research Bulletins that started in 1939. The latter evolved into Accounting
Principles Board Opinions in 1962 while the SEC prosecuted the reporting fraud case of
McKesson-Robbins in 1939 that led to a significant reform of audit practices in the 1940s
and 1950s (Baxter, 1999). Thus, by 1940, public accountants in the US appear to have
developed into an authoritative profession, with an influential leadership and control over
its accounting and auditing standards (Zeff, 2003).
A mixed system of voluntary and mandatory provisions to protect against reporting
deceit in the US, however, did not reduce criticism of report quality. Indeed, following the Second World War, and building on prior ad hoc studies, there emerged a significant and growing literature by academic accountants concerned with the frailties of
historical cost accounting and the lack of a theory to justify it (Gaffikin and Aitken,
1982).10 In addition, the public accountancy profession was inundated with criticisms
and lawsuits. Leading practitioners began to initiate responsive action and eventually set
up the Wheat and Trueblood Committees and the Cohen Commission of the AICPA in
the 1970s. Wheat and Trueblood resulted in the independent Financial Accounting Standards Board (FASB) in 1973. Zeff (2003) argues that this was the point at which the
profession lost its control over accounting standards, the largest firms began to disengage from the standard-setting process, and a more difficult relationship with the state
emerged.
The Cohen Commission criticised the standard-setting processes of public accountants
and questioned the education and training of auditors. More generally, these reports precipitated continuous governmental monitoring of the public accountancy profession to the
present day. For example, the Treadway Congressional Commission in the mid 1980s investigated ways of improving financial management and reducing fraud. It emphasised the
need for ethical management by corporate executives and influenced several audit standards
dealing with expectations gap problems (Guy and Sullivan, 1988). The Dingall Congressional Committee held a number of enquiries into public accountancy in the early 1980s.
The financial reporting abuses of the 1990s then led to, first, the Private Securities Reform Act 1995 to reduce apparently discriminatory litigation against public accountants by
recognising proportional liability, and second, the SarbanesOxley Act 2002 that signalled
the direct involvement of national government in public accountancy. Also in 2002, the
Financial Accounting Standards Advisory Council that regulates the FASB added a User
Advisory Council to its structure in order to provide report users with a formal part to play
in the accounting standard-setting process.
10 Nelson (1973) describes this period as the golden age of a priori accounting research, and Gaffikin and Aitken
(1982) provide a selection of research by the most influential accounting writers of the time.
430
Parallel with these institutional changes in recent decades, the US government pressured
public accountants to remove restrictions of trade and this led to changes in the focus and
structure of the profession (Zeff, 2003). More specifically, the larger firms decided as a matter
of growth policy to enlarge their non-audit services. Management consultancy became the
lead activity and audit effectively was the loss leader. A consequence of these changes was
the removal of senior partners in the leading US firms from the standard-setting process
generally and the leadership of the AICPA particularly. A similar, although less pronounced
trend was noticeable in the UK.
3.4. Current state
The above broad analyses reveal parallel histories in the UK and US. The British experience is much longer, however, with government and legislative prescriptions from an
early stage. These initially related to specific industries with known corporate governance
problems (e.g. in banking), but extended in the twentieth century to all companies and predominantly provided report protection by increased financial disclosure. However, by the
1940s, the main public accountancy bodies were publicly involved in prescribing accounting and auditing practicesfirst as voluntary pronouncements, then as mandated standards.
The US evolution, on the other hand, has depended on an unspecified partnership between
the AICPA and the SEC. Nevertheless, it followed the same sequence from voluntary pronouncement to formal prescription as noted in the UK. In both countries, therefore, there
was a progression in standard-setting from committees of accountancy bodies to separate
and apparently independent bodies. However, most recently in the US, as a result of prominent scandals, there has been direct intervention by government in the form of legislation
to control the public accountancy profession.
Despite this history of measures to resolve the war on corporate financial reporting deceit,
there is no evidence that the latter has disappeared or reduced. Indeed, the most recent public
scandals in the UK and the US suggest the contrary. Increased prescription of accounting
and auditing standards parallels deceptions of increasing amounts such as in Cendant, Enron
and WorldCom in the US and BCCI and Maxwell Communications Corporation in the UK.
This conclusion should be of concern to all involved with protection in corporate financial
reporting. A war that persists for more than fifteen decades with no sign of a conclusion is
a war of failure. In addition, it is reasonable to argue based on the historical evidence that
deceivers appear to believe that the economic benefits of reporting deceit exceed any costs
of punishment due to discovery. In other words, they seem unwilling to forgo the economic
rewards of deceit and embrace proper disclosure in the public interest.
Equally obvious is protectors failure to introduce accounting and auditing changes of
sufficient power to discourage deceitful managers. The most recent initiative in the US
is that of the FASB to introduce principles-based accounting standards because of the
SarbanesOxley Act 2002 (FASB, 2002a). These standards are to be based on qualitative
reporting characteristics such as relevance and reliability as defined in the FASBs conceptual frameworks (FASB, 1980). The initiative will also affect many other countries due to the
recent pact between the FASB and the IASB to produce compatible and consistent standards
globally (FASB, 2002b). Thus, once implemented, principles-based accounting standards
will presumably have to produce accounting numbers that faithfully represent relevant eco-
431
nomic reality or substancei.e. if they are to adhere to the relevance and reliability qualities
defined by the FASB and the IASB. Yet nowhere in the conceptual pronouncements of the
FASB and the IASB is there evidence that standard-setters appreciate the problems of using
accounting numbers to represent social reality constructed by humans.11 In these circumstances, it is reasonable to predict that the SarbanesOxley Act 2002 and related responses
will not prevent major reporting deceits in the future. Indeed, the existence of false reporting throughout so many decades suggests inherent problems beyond the intention of any
such legislation or response. SarbanesOxley implies deceitful financial reports result from
pressures placed by corporate mangers on auditors to agree to dubious accounting practices
or else lose non-audit services. However, this appears to be a symptom of the disease rather
than the disease itself. There appear to be more substantive factors at work and these need
to be identified. This study suggests there are two primary candidates within the system
of protection. The first is public accountancy professionals, many of whom appear to have
forgotten or ignored their public interest mission in favour of economic self-interests. The
second is an enduring system of historic cost accounting calculation that produces arbitrary
numbers used to compensate corporate managers, hold them accountable, and inform capital markets. Before these matters are considered, however, the existing protection system
requires evaluation to determine these underlying problems.
4. Responses of protectors
As previously stated, corporate financial reporting is a system that involves several groups
of protector. Each has featured in the foregoing analyses and it is reasonable to argue that
the system works when there is inherent stability, with each protector group managing its
self-interest without compromising its public interest mission. Nelson (2003) describes this
stability as a situation in which accounting and auditing standards are precise enough to
determine reporting issues, dissuade reporting deceit, and remove incentives to avoid standards; yet imprecise enough to prevent auditors seeking safe harbours and allow regulators
to regulate. In other words, standards need to be strong enough to permit the public interest
to over-ride self-interests. Instability, on the other hand, arises when self-interests dominate the public interest. If this state persists, as it appears to have done for many decades,
then trust for protectors evaporates and it is unsurprising to find respected contemporary
commentators such as Wyatt (2003) and Zeff (2003) describe the demise of the public
accountancy profession and its professional values.
The argument of this paper is that there has been instability in corporate financial reporting throughout its history as particular protectors respond to specific crises. No major
protector group appears to have been able to place its public interest mission clearly beyond an intuitive need to address its self-interest. This is a conclusion that reflects the
survival instincts of human beings and is therefore more than a point of criticism. It describes a condition endemic to corporate financial reporting and is a substantial explanation
of the longevity of the war. The remainder of this section examines these points in more
detail.
11
See footnote 3.
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4.1. Public accountancy responses

Professions are socially closed communities permitted first, to control markets for their
services based on expert bodies of knowledge and second, to self-regulate (Larson, 1977).
Within this framework, membership entry hurdles are the primary method of providing
social closure for professions. Public accountants belong to a profession with these characteristics and specifically covenanted to protect the public interest when forming their
organisational institutions (e.g. Brown, 1905). Lee (1995) presents their history in the
Anglo-American world. He observes it as a continuous balancing of public interest mission
with economic self-interests.12 In addition, his analysis reveals matters pertaining to the
war of corporate financial reporting and the following commentary uses this as a basis to
demonstrate the public accountancy professions responses to reporting problems.
The formation and early maturation of public accountancy in the UK and US took
place in a period that started with general corporate legislation in the UK in the 1840s
and 1850s and ended with corresponding federal legislation in the US in the early 1930s.
Throughout this period, it is clear that matters affecting their economic self-interests tended
to distract public accountants and their institutions in both countries.13 They attempted to
legitimise their professional claim by demonstrating explicit entry hurdles, self-regulatory
systems, control over standards, and an expert body of knowledge. They also defended
their professional territory from rivals and critics and expanded their firms nationally and
internationally with a growing menu of financial and other services. At this critical time,
the institutions of public accountancy were relatively small, managed by practitioners on
a part-time basis, and only slowly recognised the importance of their political role with
the state. It is therefore unsurprising to find that, beyond offering audit services as part of
their economic expansion, public accountants were relatively late into the area of corporate
financial report protection.
Because British and American public accountants focused for so many decades on their
self-interests rather than the public interest, it is probable that their earlier behaviour conditioned the responses to reporting problems of more recent generations. In short, public
accountants attempted to protect the public interest in a self-interested way. However, with
government already in the driving seat, public accountants inevitably had to assume a role of
catch up. Their eventual realisation of the need to control their standards and body of knowledge led to an uneasy relationship with the state that persists to the present day. Particularly
in the period after the Second World War, they also observed a gradual public exposure of
their body of knowledge. Criticism of accounting and auditing practices created pressures
to respond and these responses led to prescribed standards and practice implementation
details and exceptions. The more the body of knowledge was exposed, the more deceivers
were able to determine ways of either adapting or circumventing standards, and the more
subjective the body of knowledge appeared to be. West (2003) provides a detailed review
of this history and concludes that accounting is rule-based and does not have the cognitive
authority required of expert knowledge. He further argues that practitioner judgements are
12
Mitchell and Sikka (1993), for example, provide a recent commentary on the politics of this situation.
The early problems of institutionalised public accountancy in the UK are reported in studies such as Walker
(1991) and Shackleton (1995). Miranti (1990) provides comparable evidence about the US.
13
433
consequently restricted to rule compliance rather than intellectual interpretation. In other

words, financial reporting qualities such as relevance and reliability have come to be interpreted by public accountants in terms of rule compliance instead of faithful representation
of a relevant social reality of economic activity (Alexander and Archer, 2003; Clarke et
al., 2003). Responding to the public interest in circumstances of criticism and response
is therefore a two-edged sword for public accountants. Response to criticism is what they
need to do to fulfil their public interest mission. However, it also has the potential to diminish their claim to professionalism by revealing their body of knowledge as rules and rules
compliance.
In this uneasy and unstable world of self-interest and public interest, it is unsurprising
that the public accountancy profession has been observed as adopting an implicit strategy
to address the problem of making visible its body of knowledge. The strategy described
by Fogarty et al. (1991) suggests that public accountants and their institutions do nothing in relation to pressures on their professional claim. More specifically, they de-couple
their explicit pronouncements of ideal states of accounting and auditing practice from any
corrective actions they put in place because of reporting crises. Thus, when a reporting
problem arises, public accountants typically respond with a search for a solution that claims
to have the potential to remove concerns and criticisms. The solution, however, is rarely
implemented. Responses typically take the form of institutional inquiries, commissioned
research projects, and tentative recommendations for discussion. In these circumstances, the
primary objective is to address the reporting issue with the intention of providing comfort to
report users that it is being attended to rather than that substantive changes to practice take
place. The strategy therefore maintains the status quo so long as this remains an economically viable option for public accountants. Examples observed by Fogarty and his colleagues
include fraud detection by auditors, competition for audit services, improvements to audit
practices, non-audit services, liability reform, and disciplining of auditors. The tactic in
these matters is to appear to respond when, in reality, there has been no response, and the
outcome is to control the debate over the body of knowledge of accounting and auditing.
Paradoxically, however, exposing the body of knowledge in this way makes it available to
others not within the control of accountants (e.g. corporate managers who wish to deceive).
Other researchers report evidence of the effect. For example, Humphrey et al. (1992)
and Humphrey et al. (1993), respectively, examine means by which UK public accountants
control debates on the issues of the expectations gap and fraud detection in auditing in order
to maintain the status quo. Cullinan and Sutton (2002) reveal improvements by American
auditors in their audit of corporate information system controls when the critical issue is not
this matter but the ability of senior managers to perpetrate reporting deceit by over-riding
system controls. Citron (2003) demonstrates the UK professions recent attempt to control
the area of practitioner independence by switching to a principles rather than rules-based
standard covering audit and non-audit services.
As if the doing nothing strategy was not sufficiently problematic, Byington and
Sutton (2001) reveal problems associated with the public accountancy professions political monopoly tendencies. They argue that public accountants respond to reporting issues
only when there is sufficient pressure placed on them. Their evidential support for this
condition is the correlation of reporting issues and subsequent responses, with the latter
appearing typically after prolonged criticism. Byington and Sutton also highlight the prob-
434
lem of judging the effectiveness of responses to crises when practitioners who are sued
continually settle out of court. There is also the issue of auditors seeking a safe harbour
of following the rules of GAAP instead of the more risky audit strategy of examining
the underlying economic substance of transactions (Martens and McEnroe, 1992; see also
Alexander and Archer, 2003).
The search for a conceptual framework to support the financial accounting used in corporate reports is a further area that, until recently, illustrates the strategy of doing nothing.
Hines (1989, 1991), for example, argues that public accountants have no body of knowledge of their own and, instead, rely on ideas imported from other disciplines. Yet it is
politically important for public accountants to demonstrate the existence of an expert body
of knowledge that supports their professional claim. For this reason, according to Hines,
the purpose of conceptual framework studies by public accountants has more to do with
emphasising professionalism than with changing practice. Hines further argues that these
studies have not changed financial accounting. Instead, they appear to make its standards
theoretically based and therefore authoritative and legitimate. They provide perceptions of
an objective world to represent in accounting terms. Dean and Clarke (2003) come to a similar conclusion when suggesting conceptual frameworks are more concerned with providing
a rationale and explanation for current practices than searching for the economic, legal,
and social concepts underpinning accounting. In addition, there are frequent discrepancies
between concept statements and standards of practice (Loftus, 2003; see also Booth, 2003).
In support of these conclusions on the role of conceptual frameworks, there are specific
instances of professionally-commissioned conceptual studies being rejected or ignored by
practitioners as too radical when they advocate practices different from the conventional
system of calculation. These include the US projects of Moonitz (1961) and Sprouse and
Moonitz (1962) on the postulates and principles of financial accounting14 and the two UK
studies of the corporate financial report (ASSC, 1975; McMonnies, 1988). The US studies,
in particular, were rejected despite publication because they were perceived by the AICPA
as too radically different from GAAP to be implemented. Other commissioned studies have
resulted in short-term experiments in practice that quickly end due to claims of lack of use,
relevance, or popularity. A relatively recent example is current cost accounting in the UK
and US that existed in practice for a few years in the early 1980s (Tweedie and Whittington,
1984). Mumford (1979) relates this specific cycle of interest to disinterest in accounting reform to prevailing rates of inflation and their effect on the economy. In light of this history and
as previously mentioned, it is of relevance to note the previously mentioned announcement
by the FASB (2002a) in the US that it proposes to introduce principles-based accounting
standards in response to recent crises such as Enron and WorldCom. These standards will
effectively be global because of FASBs (2002b) pact with the IASB to produce compatible
standards. Of relevance to this paper is the question of whether the FASB and the IASB will
be able to produce standards that are capable of faithfully representing a social reality of
economic activity relevant to a wide range of capital market decisions. Leading academics
such as Shipper (2003) appear to believe it is not only possible but is already happening
with existing standards, and that the problem is that stated exceptions and guidance notes
give standards the appearance of rules. An American Accounting Association committee
14
These studies, and the ensuing debate about their publication and approval, are contained in Zeff (1982b).
435
(AAA, 2003), however, is more cautious and warns of difficulties when determining the
economic substance of transactions and attempting to represent them faithfully in the form
of accounting numbers.
In summary, the existence of numerous conceptual accounting studies in recent decades
suggests that public accountants know their professional claim is flimsy unless they demonstrate a credible body of knowledge. A fruitful way of making this demonstration convincing
is to imply in conceptual frameworks that practice has a basis in theory. In other words,
that it is predictable and justifiable rather than random and arbitrary, and has what West
(2003) describes as cognitive authority. However, accountants also know from experience
that conceptual studies produce recommendations for accounting change that challenge an
economically-rewarding conventional practice based on historical cost accounting, and this
runs contrary to the strategy of maintaining the status quo. Thus, from time to time, and
at least until the 2002 initiative of the FASB, conceptual studies of accounting have appeared to support the professional claim without any explicit or prior commitment to follow
through and change practice. This has left public accountants with apparent authority over
corporate financial reporting but with no responsibility to revert to an alternative form of
accounting.15 Thus, professional institutions have concentrated on rule-based standards of
historical cost accounting as their preferred way of complying with their public interest
mission. However, a practitioner focus on rule compliance tends to diminish professional
judgement and intellectual reasoning, and erodes the professionalism claim. For this reason,
history suggests that the FASB (2002) initiative has potential to be yet another example of
the strategy of doing nothing.
4.2. Governmental responses
The responses of government to corporate financial reporting issues in the UK and
US appear to reflect favourably on legislators and regulators, at least in the sense of a
historical sequence of provisions that offers protection to report users. Due to the late
arrival of public accountants to the task, government was the main protector for many
decades. This was particularly the case in the UK during the period from approximately
1850 to 1950. Governmental legislation and regulations in this time focused predominantly
on audit and disclosure provisions. They did not address accounting and auditing standards
and therefore government protection was limited because it avoided the area in which
corporate management could best practice reporting deceit by means of manipulation of
accounting numbers.
In more recent times, however, reporting protection evolved in the UK and the US as an
unwritten partnership between the state and the public accountancy profession. Until very
recently, the former provided an overall framework of corporate governance and the latter
was left to police and control accounting and auditing standards within it. However, in the
US, the SEC recently assumed control of auditing standards via the PCAOB. The history of
the state-profession partnership reveals a difficult situation in which neither partner wishes
to divest control of its particular domain and where there is constant danger that reporting
15 This is not to deny that some changes have taken place within the principal structure of historical cost accounting
(e.g. market valuations for financial securities, and cash flow statements using the indirect method of calculation).
436
issues fall between the cracks as each group waits for the other to respond. The enormity
of this problem is clear in the historical evidence of Merino and Mayper (2001). Both
protector groups have been content to maintain the status quo in corporate reporting as
neither has any incentive to constrain or challenge the capital market system. Regulation
therefore appears to exist to provide comfort to investors that protection is there symbolically
rather than to provide effective protection. It also provides monopolistic opportunities for
public accountants to account and audit, and offer non-attest services as substantial byproducts. It is also the case that government agents are professionals and, like any other
professional community, need to demonstrate their professional claim to be acting in the
public interest. All parties in the partnership therefore have strong social and economic
reasons to maintain the systems complexities and ambiguities. It is effectively their reason
for being. Thus, corporate financial reporting issues such as earnings management are not
just matters affecting the public interest. They also have the potential to serve the selfinterests of protectors. The more complex and ambiguous accounting is, the greater the
need for professionals to audit and regulate it.
Evidence of a status quo similar to that of public accountants is not difficult to find as
far as the state is concerned. In the US, for example, Briloff (1993) examined corporate
financial reporting since the early 1970s and found little change over twenty years other than
larger monetary amounts in reporting deceit. Garner (1979) came to a similar conclusion
when reviewing financial reports from the 1920s to the 1970s. There is also evidence that
the SEC targets small rather than large companies and audit firms when prosecuting deviant
behaviour (Bremser et al., 1991). More recently, Briloff (2001) identified this bias in cases of
corporate fraud in which the SEC had acted, and particularly revealed numerous high profile
cases not investigated by the SEC. In the UK too there is evidence that national government
regards issues of corporate financial reporting as largely matters affecting shareholders and
the public accountancy profession (Cousins and Sikka, 1993). It seems curiously reluctant
to interfere in capital market affairs that clearly affect many other stakeholders in society.16
Thus, the state in the UK and the US does not seem to appreciate fully the complexity and
longevity of the war of corporate financial reporting.
4.3. Academic responses
Academic accountants are the intellectual conscience of the public accountancy profession and, as such, implicitly covenant to protect the public interest by observing, criticising,
and recommending on practice issues (Sikka et al., 1995). As accounting and auditing experts, academic accountants are in a position to challenge other protectors to achieve higher
levels of protection in corporate financial reporting, and to expose reporting deceit. They
also have a responsibility to protect the bodies of knowledge of accounting and auditing,
particularly when an ill-defined partnership between the state and the public accountancy
profession controls it ineffectively.
16 At the time of writing, for example, the Secretary of State for Trade and Industry in the UK seems reluctant
to introduce proportional liability for auditors, apparently preferring to retain the current situation of unlimited
liability (Warner, 2004).
437
Writers such as Briloff (1993) and Sikka et al. (1995) argue that in recent times academic
accountants have poorly protected the public interest in this area. They particularly condemn the silence of academic accountants and the lack of critical comment on issues in their
writing and teaching. Wilmott et al. (1993), however, are mindful that there are problems for
todays academics when responding to issues such as corporate financial reporting. They
argue that responses by academics are political in nature, reflect personal values, and may
lack coherence due to compromise. West (2003), on the other hand, argues that public accountants preoccupation with accounting rules and rule compliance diminishes intellectual
activity within the profession. He believes rules have silenced scholarly discourse and left
academics to justify and excuse conventional practice through their research. In addition,
West criticises the teaching of students within the framework of conventional accounting
and auditing where practice is separate from theory in the curriculum. Williams (2004), on
the other hand, believes that public accountants commitment to serving the public interest
and not their self-interests is so shallow that it is necessary for academic accountants to
develop accounting and auditing separately from the profession. Tinker (2002) goes further and condemns academics recently critical of the public accountancy profession (see
also Tinker and Carter, 2002). He describes them as traditional intellectuals who focus
narrowly on the activities of the largest public accountancy firms in the area of corporate
auditing, and who seek a return to a golden age of professionalismi.e. of guild control
and monopoly. He further argues for organic intellectuals embedded in accounting and auditing who observe and challenge the commodity forms of these practices. Macintosh and
Shearer (2000) also condemn academic researchers for their pursuit of a chimerathe sacred covenant of the public interest. Through historical analysis of a genealogical form,
they conclude that recommendations for a return to the covenant are outmoded and a
waste of time as the covenant no longer exists due to specific client relationships held by
accountants.
What these comments suggest is that the academic community in public accountancy has
changed over several decades. Accounting researchers of the past were often practitioners
(or had prior practice experience) and their research reflected a practical focus (Fleming et
al., 1990, 1991). In addition, their work had potential to influence practice directly through
responses to corporate financial reporting issues. In the period from the early 1900s to the
late 1960s, leading accounting academics were at the forefront of criticism of reporting
practice and many individuals developed careers and reputations as leading critics. Indeed,
criticism, deductive reasoning, and normative prescriptions dominated accounting research
at that time and continue to influence the research of standard-setters to the present day.
However, since the early 1970s, and with few exceptions, academics withdrew from this
area of intellectual activity and concentrated instead on two connected matters (Fleming et
al., 2000).
The first matter concerns what is claimed to be scientific research aimed at observing
accounting and auditing practice objectively without offering solutions (e.g. Watts and
Zimmerman, 1986). Its intellectual basis is a branch of political economy that favours
laissez faire and deregulation (Mouck, 1992), but there is no evidence that it influences
the body of knowledge that informs economic thinking and practice (Bricker et al., 2003).
Instead, to its critics, it seems to be a form of anthropology in which the subject matter is the
behaviour of accountants rather than accounting (or auditing) processes (Sterling, 1993).
438
As such, its critics argue that it has no prospect of and nor does it intend to influence change
in corporate financial reporting practice.17
The second related matter is that, for many researchers, contemporary accounting research appears to be an activity designed to impress fellow academics rather than influence
practitioners and other corporate financial report protectors. Indeed, the stated audience of
the leading journal in the US, The Accounting Review, is academics, graduate students,
and others interested in research. Originally launched in 1927 to meet the needs of both
academics and practitioners, it is reasonable to suggest that todays research in the Review
is unlikely to impact practice. The objective of the research appears to be one of conforming rigidly to apparently scientific standards of design, methodology, and presentation
rather than satisfying the criterion of practical usefulness. Research in journals of greatest prestige typically describes projects that are mundane and commonsense (e.g. capital
markets react to new information, practitioner judgments depend on expertise and experience, and managerial agents deceive investor principals if they have incentives to do so).
In addition, when leading researchers get involved in practice issues, they merely offer
advice supporting the status quo of the conventional system of accounting calculation.
Schipper (2003), for example, argues for historical cost accounting standards explicitly
based on principles rather than rules in the form of exceptions guidance and implementation detail. Her argument is intended to support public accountancys professional claim,
but it does not and was not intended to challenge the fundamental structure of conventional
accounting.
The result of this inward-looking behaviour by academics is that their community is no
longer an effective protector in the war of corporate financial reporting. With the exception
of a few individuals and journals, there is no consistent and coherent voice of criticism about
reporting deceit. Most recently, as indicated above, even critical researchers have begun to
look inward and dispute about the relative worth of their work (Tinker, 2002). At least
in the US, this scenario exists within a social hierarchy of academic accounting research
and researchers. For example, American accounting and auditing research consists mainly
of projects using research designs acceptable to the editors and reviewers of the leading
journals. These individuals are doctoral graduates from a relatively few universities and have
a very narrow perception of what is legitimate research (Lee, 1997). In addition, individuals
with similar backgrounds manage the academys largest professional body, the AAA (Lee,
1999). This means that the research function in the US is effectively determined by research
preferences learned in a relatively few elite doctoral programs. Academic compensation,
promotion, reputation, and awards correlate with these preferences and biases. The result
is that leading American researchers benefit considerably from research that aims to satisfy
academic quality standards rather than challenge practice.
17 Much of this research concerns the information content of reported accounting numbers and its relationship
to capital market activity measured in terms of price and volume movements. The general claim is that, if there
are such movements in the presence of reported accounting numbers then assuming control over other possible
variables, these numbers have information content and are therefore useful. It is the contention of this paper that
this conclusion exceeds the limitations of these studies and that all that may be concluded from them is that
accounting numbers are used by market participants. Whether these numbers are useful is a different and much
more difficult question to answer. See Sterling (1990) for a more extensively argued study of this issue.
439
Evidence of a social hierarchy in UK research is not available although there is no reason

to suggest that traits similar to the US do not exist there. In any case, it is reasonable to
argue that, as a result of various research quality assessment exercises, research in the UK
adheres more to the star rating system than to practical utility. In these exercises, judgment
about research performance depends on research publication numbers, perceived journal
quality, and research funding amounts (Brinn et al., 2001). There are no criteria used that
relate to the impact of research on practice. As in the US, publication in a top research
journal determines what is perceived to be quality research. In these circumstances, the
academic accounting community does not seriously challenge corporate financial reporting
deceivers, although there is one known exception to this situation. The researched criticism
of the financial reporting of specific American corporations by Abraham Briloff has had an
adverse affect on the stock market prices (Foster, 1979) and caused corporate executives to
sue him unsuccessfully (Tinker, 2002).
5. Explanations of current state

The foregoing analyses of the responses of protectors in the war of corporate financial
reporting suggest various explanations regarding its longevity and lack of resolution. They
provide a basis for discussion and appear in no particular order of importance.
5.1. Market failure
West (2003) identifies market failure in the demand and supply of corporate financial
reports as a reason often advocated for their regulation. Perceived instances of such market failure appear to be an impetus for the proliferation of accounting rules in response
to reporting problems. Failure in this context includes the powerful position of corporate
management to deceive, the lack of comprehension of accounting by report users, and
the ambiguity and flexibility inherent in conventional accounting practice. Placed within
the context of the analyses in this essay, however, continuous regulation and persistent
rule making do not appear to remove or diminish market failure. Indeed, the experience
of reporting deceit in the 1990s suggests that regulations and rules fuel the situation
rather than resolve it. Deceivers find ways around the rules through permitted or possible
exceptions.
5.2. Confused regulation
Regulation of corporate financial reporting is the responsibility of a complex partnership
of legislators, government agencies, professional institutions, and quasi-independent boards
with strong links to public accountancy. Each has its jurisdiction and sphere of influence
to maintain and protect and there is no guarantee that it has the same focus, understanding,
and commitment to reporting deceit and protection as its counterparts. In addition, there
is the possibility that reporting issues fall between the cracks as each regulator waits for
others to respond and act. In the context of this essay, such a situation is a recipe for too
little and too late.
440
5.3. Public exposure

One of the main lessons from this study of the war of corporate financial reporting is
the continuous exposure of what purports to be the bodies of knowledge of accounting
and auditing. Corporate financial reporting crises provoke public accountants to codify
their knowledge in a growing number of standards that contain practice rules, exceptions,
and guidance. This is a very different strategy from other professions where the apparent
convention is to reflect expert knowledge in abstract and general form (e.g. justice or health)
rather than in specific codes of practice. As studies of the histories of professional groups
reveal, it is exceedingly difficult for outsiders to observe the expert knowledge that converts
to practice skills and economic reward (Perkin, 1989).18 Keeping the existence of a body of
knowledge at the level of general abstraction is an effective means of preventing successful
criticism of a profession. It is also much easier for a profession to ignore or deflect criticism
than it is if its body of knowledge is in the public domain. Public accountancys knowledge
is no longer a private matter and comprehension of its foundation as a complex set of
rules without coherent theoretical justification has percolated beyond the accounting office
or classroom. For example, it is available to corporate managers who wish to practice
manipulation and deceit. For this reason, it is reasonable to suggest that the making public
of accounting and auditing knowledge is an important contributory factor in the war of
corporate financial reporting. Deceivers cannot effectively circumvent principles, standards,
and even rules that are not in the public domain.
5.4. Professional claims
The public accountancy profession is a relative newcomer to the world of professionalism
(Corfield, 1995). Its institutional history in the English-speaking world is approximately
one hundred and fifty years old (Brown, 1905). During this period, public accountants have
spent considerable time and resources making and defending their professional claim, and
radically changing accounting and auditing practices was apparently not an economically
viable option. It is therefore unsurprising that, when accountants balance their public interest
mission with their self-interests, the latter dominate within the implicit strategy of doing
nothing. In other words, specific responses to reporting crises are defences of public
accountancy professionalism rather than protection of the public interest. Seen in this light,
theoretical studies such as conceptual frameworks become the image management of a body
of knowledge rather than steps to radical change practice, and the war of corporate financial
reporting feeds off this status quo.
5.5. Lack of challenge
Market forces drive the capitalist system and it is unsurprising that its participants over the
centuries tend to regard interference in these mechanisms as unproductive. It is apparent that,
for various reasons, protectors of corporate financial reporting agree with this philosophy
of laissez faire. The previous analyses suggest that all the main protector groups have self18
See also Corfield (1995) for a study of professions prior to 1850.
441
interests that cause them to attempt to protect without unduly challenging companies and
their managers. It is understandable that protectors are aware of the danger of protection
measures stifling corporate activity and management in a market economy. On the other, a
hands-off approach provides incentives to deceive and there needs to be a balance in which
potential deceivers are discouraged without significantly interfering with healthy market
forces. This balance is not evident in the war of corporate financial reporting because
protectors do not challenge deceivers sufficiently to deter.
5.6. Academic bankruptcy
A specific lack of challenge that deserves separate identification in the war of corporate
financial reporting is the relative silence of the academic accounting community in recent
years and the irrelevance of most of the research produced by it in relation to reporting deceit.
The previous analysis reveals an academic community living the good life with research
produced for self-interested reasons and without regard to the public interest obligations
of academic accountants. The focus of teaching on procedural matters in accounting and
auditing is a further condemnation of the role of educators in the war against reporting
deceit. There is an obvious danger that future public accountancy practitioners are typically
unaware of the flawed nature of the accounting numbers in the corporate financial report. As
Sterling (1973) argues in an AICPA gold medal-winning article, most accounting research
does not inform the teaching of practice and the latter does not promote good practice.
6. Flawed public good

The above explanations of protector responses are curiously consistent. No protector
group has been successful in significantly reducing or eliminating reporting deceit and each
group appears to have self-interests that conflict with its public interest mission. The overall
consequence of this unhappy situation is that deceivers have sufficient freedom to practice
their manipulations. Only if deception gets out of hand do they risk exposure and punishment
as in the recent cases of Enron and WorldCom. The overwhelming conclusion from this
scenario is that, if reporting deceit is endemic to the system despite decades of protective
measures, something is rotten in the system. For this reason, it is instructive to return to the
history of corporate financial reporting and examine the most persistent features that appear
to encourage managerial deceit. The first feature appears throughout the previous analyses
and that is the domination of self-interests over public interest with respect to the various
professional groupings active in the system. There is no need to explore this feature further,
although it returns in later suggestions for resolution of the war. The second feature has
also been touched on at several points in this essay and deserves additional comment. This
is the conventional system of calculating accounting numbers, historical cost accounting.
6.1. Age of normative research
The period from the early 1950s to the early 1980s is relatively short in historical terms
but represents a time of continuous, expert, and global challenge to corporate financial
442
reporting. Critics of accounting practice during these decades produced a vast literature
and writers now refer to the period as the golden age of normative accounting research
(e.g. Nelson, 1973). The main focus of the criticism was the quality of historical cost
accounting and particularly its inability to provide relevant and reliable information for
stewardship and decision making purposes.19 Academics and practitioners often combined
to identify the strengths and weaknesses of historical cost accounting and offer amendments
and radical alternatives. As the debate intensified, the competence, complexity, and range
of the contributions expanded.
The initial concern of critics was the inherent flexibility of historical cost accounting that
permitted the calculation of a wide range of accounting numbers based on the same set of
economic circumstances. Sterling (1966), for example, estimated there were approximately
ten thousand possible variants of the last-in-first-out calculation of inventory cost in the US
alone. The response of accounting standard-setters to this flexibility issue was to produce
standards containing specific rules of calculation to reduce the number of variants. However,
responses were ad hoc, with individual standards debated and issued on the emergence of
each flexibility problem (Lee, 1971). For example, the following sequence of topics appeared
in the UK in the 1970sassociated companies, acquisitions and mergers, extraordinary
items, inventories, deferred taxation, government grants, research and development, and
foreign currency. Each identified practice problem became the subject of a standard that
contained rules of calculation, exceptions, and interpretations within an overall framework
of historical cost accounting.
Ad hoc problem-solving by standard-setters increased the probability of inconsistency
in accounting number calculations and led to more sophisticated criticisms of other undesirable features of historical cost accounting, including its inability to cope with changing
prices and price levels. Sterling (1975), for example, identified this problem as the failure
of historical cost accounting to reflect a relevant and interpretable attribute in its monetary
unit of measure, with the result that financial statements contained aggregations and subtractions of measurement units of different times and therefore had no economic meaning.
Measurement units failed to represent a common attribute such as command over resources.
The institutionalised protection response to this type of criticism was a short-term experiment in the late 1980s with general price-level accounting and current cost accounting.
However, both systems of accounting retained many of the undesirable features of historical cost accounting. General price-level accounting, for example, used the latter as its
basis and translated a mix of past monetary units to contemporary purchasing power terms.
Current cost accounting, in contrast, was a confusing mixture of historical costs, replacement costs, net realisable values, and present values. The lack of use in capital markets
of current cost accounting was the official reason given for its abandonment after a few
years in practice and historical cost accounting regained its status as the preferred system of
calculation.
19 It is impossible to provide even a limited review of this literature in the space available. However, West (2003)
contains a recent and succinct overview of the main issues affecting historical cost accounting. This section uses
the work of Robert R Sterling, a leading critic of the period, to illustrate the arguments presented. His portfolio of
work appears in Lee and Wolnizer (1997).
443
Other specific criticisms of historical cost accounting included its propensity to hide
underlying cash flows that were relevant to decision making and this led to cash flow
statements to replace accrual-based funds statements at the beginning of the 1990s. In
the meantime, mass criticism of historical cost accounting almost disappeared although
individuals continued to identify its considerable weaknesses. Sterling (1985), for example,
produced an extended essay on the problem of recognition in accounting, and it is interesting
that this issue was the reason for many of the reporting deceits of the 1990s. He later
summarised the critical case against historical cost accounting as follows (Sterling, 1993,
139):
My summary in regard to accounting practice is that it is numerology. Although
putatively a measurement of wealth and profit, accounting practice is in fact a calculational activity and the results of those calculations have no empirical referents. My
conclusion is that such a state is a problem in need of correction. The most serious
problem is that accounting practice numerals are meaningless in the logical positivist
sense of not being either analytical or verifiable, in the pragmatist sense of not being
decision-useful, and in the operationalist sense of not being operationally defined.
Accounting practice numerals need to be made meaningful by making them empirically verifiable, demonstrating that they are decision-useful (not merely used), and
defining them operationally.
6.2. Object of challenge
West (2003) synthesises the arguments of Sterling and other major contributors to the socalled golden age of normative research into a detailed case that historical cost accounting
is the fundamental problem of corporate financial reporting. He describes it as a system of
subjective and arbitrary calculation based on past transactions and future speculations that
purport to describe current financial performance and position. He further regards the rules
of historical cost accounting as not providing either serviceable financial information or
cognitive authority to support public accountants professional claim. Several conclusions
are possible from this argument. First, despite numerous conceptual frameworks, there is
cognitive discord in the public accountancy profession as the result of the lack of a coherent
and consistent body of knowledge of accounting. Second, prescribing detailed accounting
rules cannot remedy information failures in the capital markets because they reinforce
current practice by perpetuating fundamental quality deficiencies in reporting. Third, there
is no evidence of mandated accounting rules providing adequate protection for report users
against reporting deceit.
Barlev and Haddad (2003), however, present an alternative perspective on these matters.
They agree that the utility of historical cost accounting is limited, but argue that fair value
accounting is replacing it because standard-setters recognise user needs and the declining
relevance of conventional information.20 They claim the advantages of fair value accounting are improved disclosure, increased managerial accountability, and decreased potential
20 Various accounting standards worldwide interpret fair values as market prices and estimated market prices
based on present values as in the IASB (2004) standard for financial instruments.
444
for management to manipulate accounting numbers. None of these arguments, however,

stands up to robust scrutiny. Fair value accounting practices are of limited applicability and
currently relate almost exclusively to financial assets. They also depend on the availability
of fair markets with arms length transactions, and involve a wide range of market prices in
practice because of the multiplicity of markets. Most significantly, they increase the meaninglessness of accounting aggregations in corporate financial reports when combined with
historical cost data (e.g. to produce asset, liability, and equity totals). In any case, as previously mentioned, historical cost accounting numbers lack theoretical justification, depend
on arbitrary conventions, and imply rule compliance rather than professional expertise and
judgment. And, because of its rule dependence, historical cost accounting has the propensity
to permit self-interests to dominate public interest in the protection of corporate financial
reporting. In other words, the name of the game for auditors becomes GAAP compliance,
with legal form predominating over economic substance (Alexander and Archer, 2003).
It is a primary argument of this paper that historical cost accounting numbers make
no sense because of their lack of relevance and reliability, and that both deceivers and
protectors prefer them because they confer considerable benefits. Managers favour historical
cost accounting as a basis for accountability because, inter alia, its numbers depend on
substantial, speculative, and virtually unverifiable inputs from them regarding the future of
the business and its economic activities and circumstances. Thus, irrespective of specific
mandated rules, managers have relative freedom to disclose what they want to disclose.
They can produce the accounting numbers they wish because the prescribed principles and
rules of historical cost accounting require significant managerial judgments with respect
to such matters as the expected life of fixed assets, recoverability of debts, defined cost of
inventory, and fair value of financial assets lacking substantial markets. They also benefit
from accounting rules that are sufficiently flexible to permit alternative numbers without
deliberate managerial deceit. For example, Nurnberg (2004) recently revealed the impact on
supposedly objective cash flow accounting numbers of a variety of permissible treatments
for premiums and benefits in company-owned life insurance schemes. The problem is that
accounting numbers derived from historical cost accounting not only determine the level of
corporate performance reported but also managerial compensation in terms of bonuses and
share options. Managers can manipulate legitimately and illegitimately within this system
and auditors can do little to challenge so long as their function is ensuring compliance
within a flexible and subjective process of calculation. There is therefore no incentive for
managers to change to a reporting system in which there is objectivity, consistency, and
coherence because subjectivity, inconsistency, and incoherence provide adequate economic
rewards for them. There is even empirical evidence that corporate managers are willing to
permit their companies to bear a considerable tax burden on their fictitious profits (Erickson
et al., 2004).
Auditors, too, have little to complain about with rule-based accounting calculations because they can verify these numbers in terms of rule compliance procedures. Accounting
standards flexibility, exceptions and interpretations, and virtually unverifiable managerial
forecasts and estimates, assist in increasing the ambiguity of the overall professional standard by which the public can judge the performance of auditors, and they receive ample
economic rewards for rule compliance audits. In addition, public accountants image management techniques over the decades with respect to matters such as conceptual frameworks
445
imply they have an expert body of knowledge required to interpret and apply accounting
rules from mandated standards. In other words, conceptual frameworks and accounting
standards suggest an expertise to penetrate a highly technical series of connected accounting numbers supplemented by dense verbal explanations concerning context, method, and
purpose. Under these circumstances, there is therefore little economic incentive for public
accountants to change their systems of accounting education and training based on historical
cost accounting.
Legislators and regulators also have incentives to retain historical cost accounting. Its
inherent subjectivity and flexibility within a standardised accounting practice create a continuous need to monitor, regulate or legislate, and investigate and punish when required. If
the accounting system changed to incorporate practices that were objective and inflexible,
thus reducing accounting choice and potential managerial manipulation and reporting deceit, it is hard to envisage the need for the current level of legislation and regulation. Thus,
there are no obvious incentives for legislators and regulators to change to a reporting system
in which accounting information is objective, consistent, coherent, and likely to need less
monitoring. Finally, it is not unreasonable to suggest that academic accountants also benefit
from historical cost accounting because it provides continuous classroom, textbook, and
research material. It is a complex subject to teach and practice failure is an ideal subject
matter for classroom illustration and research projects. In particular, it is relevant to scientific researchers concerned with the difficulties it creates in judgments and decisions
in auditing, and the information content of numbers in financial accounting statements. As
suggested earlier, it remains to be seen whether the FASB (2002) initiative to link conceptual
frameworks to accounting standards will do anything other than reinforce and complicate
the conventional system of accounting.
7. Review and conclusions

7.1. Summary
The previous analyses use events taken from the history of corporate financial reporting
to help identify issues connected with its current state. The historical sequence is undeniable.
Protection first came from government, and public accountants only later and reluctantly
entered the system in order to retain control of the bodies of knowledge of accounting and
auditing. This was and remains an uneasy partnership that attempts to balance the social
concept of public interest with the economic concepts of free markets and self-interest.
Central to the unease is the confusing role of the public accountancy profession. It has a
historical covenant to protect the public interest, needs to contract with specific clients,
and also must demonstrate its professional status in order to enjoy the economic and social
rewards associated with professionalism.
Corporate financial reporting has struggled to improve its quality in this uncertain world.
It has received continuous criticism, particularly when reporting deceit becomes a matter
of public record. Protector responses to deceit typically result in a gradual and expanding
exposure of the accounting body of knowledge. Private accounting conventions have become
explicit principles, and public rules have required exceptions and interpretations. Auditing
446
practice in this area has evolved from individual practitioner interpretation and judgment
to mandated procedures concerned with accounting rule compliance, despite the presence
of legal residual clauses containing undefined reporting overrides such as fair presentation
and true and fair view (Evans, 2003; see also Alexander and Archer, 2003). Academic
accountancy has translated from a teaching subset of practice to a community dominated
by elite researchers concerned with their own brand of professionalism. Meantime, there
have been frequent reporting deceits that damage corporate stakeholders, and the recent
government intervention in the US diminishes the reputation and professional status of
public accountants.
These analyses at least permit answers to be offered to the three questions posed at the
beginning of the essay. First, corporate financial reporting is in an unsatisfactory state because the public interest that should dominate report protection is not the primary focus
of protectorsdespite expectations to the contrary. All protection groups have economic
self-interests that serve to maintain a status quo and provide financial reports with a quality
that is sidewardly rather than upwardly mobile in terms of achievement. Reporting quality
obviously changes from time to time at the margin with the clarification of accounting
rules and additional disclosures. However, the accounting fundamentals of representation
have not altered in a hundred and fifty years. Corporate economic activity is predominantly
represented by accounting numbers based on subjectively-allocated historical costs. Second, managers fool auditors continuously because historical cost accounting is a system
of calculation based on manipulable or flexible rules requiring managerial judgments that
are difficult for auditors to effectively challenge. It is therefore unsurprising to find leaders in public accountancy openly complain that their profession and its values have been
significantly diminished (Wyatt, 2003; Zeff, 2003). In addition, public accountants economic self-interest, coupled with an ability and willingness to settle out of court when
sued for alleged negligence, relegate their public interest mission to a secondary status.
Third, public accountants need to demonstrate professionalism has diverted their attention
away from the primary function of offering effective protection to corporate financial report
users.
Two connected constants appear in this analysis. The first is the professionalisation
project of public accountants and the second is the arbitrary process of calculating accounting numbers. It is a fundamental argument of this essay that the professionalisation
project distracts public accountants from a public interest duty to resolve the problem of
arbitrary accounting calculations. That legislators and regulators have permitted the production, verification, and reporting of accounting numbers that have little or no apparent
economic meaning for more than one hundred and fifty years is a tribute to accountants
successful image management, and an indictment of their failure to act according to their
historical covenant with the public. It is also an indication of legislators and regulators lack
of understanding of the poverty of conventional accounting numbers. Arguably the worst
aspect of historical cost accountings long-term survival is public accountants use of its
weaknesses to create images of professionalism such as the conceptual framework, with
its notions of informational relevance to decisions and faithful representations of economic
substance. It is therefore to be hoped that the recent FASB (2002) initiative to operationalise these qualities in practice will not end up as a chimera to reinforce historical cost
accounting.
447
Both of these constants in corporate financial reporting require attention if its war is to
end and the following paragraphs attempt this task, starting with the professionalism of
public accountants.
7.2. Examination of professionalism
It is odd to suggest that there is a need to examine what sort of professionals public accountants should be in relation to corporate financial reporting. After all, public accountants
have pursued their claim of professionalism for one hundred and fifty years. However, they
have done so persistently in an economically self-interested way. Macintosh and Shearer
(2000) are correct in their genealogical analysis that the original professional covenant to
protect the public interest no longer exists because it has been replaced with specific client
contracts. Williams (2004), too, is correct in his argument that public accountants have been
slow and reluctant to accept their public role. Thus, it is the contention of this paper that the
long-lived juggling of public and self-interest has exceeded its sell-by date and it is time
to focus on how best public accountants as professionals can protect the public interest in
corporate financial reporting. Trust in public accountants has reached the point in the US at
least that government has intervened to manage the provision of audit services. There can
be no better time for reflection and reassessment of this issue.
Put simply, public accountants need to understand the fundamentals of professionalism
when providing a service such as the audit of the corporate financial report, in which there
is a legal contract with an individual client and an expectation of wider use and reliance
on the content of the report. Public accountants must recognise that, when they provide
a public service such as a corporate audit, they must also protect the public interest and
self-regulate when protection is not given. In other words, protecting the public interest
is a professional duty, beyond the contractual specifics, and not a claim to professional
status. Professionalism in this sense puts the public first; relegates economic self-interest
to a secondary status; and places the strategy of doing nothing in the historical archive.
However, such a revolutionary change will not take place without commitment, time, and
resources. More specifically, it will need two things to happen. First, change depends on
transparency, in which the professional actions of public accountants are visible when providing, protecting, and self-regulating. They cannot continue to hide their actions behind
claims to professionalism and, instead, must explicitly evidence their capacity to behave as
professionals. Second, these changes depend on relevant education and training of entrants
to the profession. The practices of one hundred and fifty years have conditioned and handicapped existing members of the profession. Only individuals not habituated to the strategy
of doing nothing are likely to wholeheartedly accept radical change.
This recommendation is consistent with more specific solutions provided by recent critics
of public accountancy such as Wyatt (2003) and Zeff (2003). Between them, they encourage
practice changes in organisational structure, leadership, service provision, staff recruitment,
and compensation. However, none of these specific changes will be effective unless public
accountants understand the fundamental characteristics of professionalism. As such, this
recommendation is not a plea for a return to a golden age (see Tinker, 2002) because public
accountancy professionalism has never had such a golden age. Instead, it is a call for a
different type of public accountancy professional.
448
7.3. Representing social reality by accounting numbers

Historical cost accounting developed as the number generator of choice when corporate activity and managerialism began to dominate market economies. As the only accounting game in town, it was inherited first by government protectors and then by the
public accountancy profession as its guardian. Historical cost accounting calculations
came to depend on rules derived from general and arbitrary principles called GAAP that
were designed by accountants. These rules gave it an inherent flexibility that favours report deceit and contain faults that are well known and debated publicly from time to
time. As previously argued, despite these problems, historical cost accounting has survived because protectors do not have sufficient incentives to replace it. All protection
groups working with historical cost accounting manage to maintain their professionalism despite its faults, and receive significant economic and social rewards for working
within the system. Much of their protectionist effort has conformed to the current fashionable term spin and there is therefore an unwitting alliance of self-interests driving the corporate financial reporting train. The engine is historical cost accounting, its
driver is corporate management, and report protectors are its passengers. From the foregoing analysis, this paper argues that the system needs replacement and, until there
is understanding and acceptance of this basic point by all concerned, the war of corporate financial reporting will continue with damaging effect on capital markets and
stakeholders.
Replacing historical cost accounting, however, is not a simple matter and needs to be
preceded by an examination of the subject matter of accounting. Conventional accounting numbers emerge from a confusing mixture of past transactions, current market valuations, and future estimates, and they fail most tests of what measurement means (Sterling,
1989). A common charge against historical cost accounting is that many of its numbers
have no empirical referents and fail to faithfully represent any underlying economic substance. Thus, historical cost accounting is related to the complex notion of economic reality
prescribed in conceptual frameworks in terms such as reliability, representational faithfulness, and economic substance over legal form (e.g. FASB, 1980; IASB, 1989). But
these terms are not defined or discussed in depth in these prescriptions, and it is therefore
difficult to determine their accounting representation. However, a number of accounting researchers in recent times have recognised the issue and started to debate it (e.g. Alexander
and Archer, 2003; Macintosh et al., 2000; Mattessich, 2003). In different ways and consistent with philosophers such as Searle (1995), they reveal much of the subject matter
of accounting to be social realityi.e. it comprises human constructions with communally agreed functions and constructive rules. Such social reality includes economic constructs such as income and capital that refer recursively to other economic constructs such
as revenue, and excludes what Searle describes as brute facts that exist independent of
humans.
Writers such as Macintosh et al. (2000) specifically argue that much of accounting
now represents pure abstraction with no empirical referents and termed hyperreality (e.g.
financial derivatives), and that accounting standard-setters need to grasp this issue and set
their standards accordingly. To the contrary, writers such as Mattessich (2003) argue that
underlying all accounting numbers is some form of economic substance that is possible
449
to represent with accounting numbers.21 Whatever the truth of the matter, what is relevant
to this study is that historic cost accounting does not appear to be capable of representing
social reality of an economic nature in a meaningful way. Public accountants therefore need
to consider in their teaching, researching, and practicing an effective means of representing
social reality constructed by humans in accounting terms. In turn, this leads to examining
the nature and construction of social reality in corporate activityspecifically, its functions,
the degree to which these functions are collectively intended, and the rules by which it is
constructed.
It is, therefore, time to return to a time of thought and debate over normative issues.
Again, this is not a plea to return to a golden age of theorising. The academic offerings of
the 1950s and 1960s did much to highlight alternatives to historical cost accounting but little
or nothing concerning the reliable representation of social reality. Good quality information
is at the heart of capital market activity. Corporate reports are public goods and deserve to
be upwardly mobile in terms of quality. They reside in the public domain and are easily
accessible by a variety of decision makers. However, the latter have little choice other than to
trust that the reports they access are safe to use. They must rely on the methods that produce
and verify their content. If the quality of these methods is poor, the resultant reports are
potentially damaging to their users. As with all public goods, their producers and verifiers
cannot anticipate who will use them and what form that use will take. However, whatever
replaces historical cost accounting needs to accommodate agreed notions of user need,
producer capability, and audit feasibility regarding social reality. Report content, therefore,
need not entirely comprise sets of accounting numbers, and other information forms are
available for discussion, testing, and implementation.
The first requirement to removing historical cost accounting within the context of considering accounting for social reality is a climate of understanding and acceptance that
failed to materialise during the so-called golden age of normative accounting research. In
particular, there is a pressing need for a full debate on the nature and role of social reality
indicators as control tools in human activity. In the UK media, for example, considerable
time and space is currently devoted to issues surrounding the calculation, manipulation, and
use of representational indicators in areas of social reality as diverse as crime, education, and
health. These issues include the potential for indicators to become more important than the
performance itself and to induce dysfunctional behaviour by the professionals concerned
(e.g. the manipulation by health care professionals of patient waiting times for medical
treatment). This is precisely the problem in corporate financial reporting where accounting
representations of social reality of an economic nature, such as earnings per share, develop
a life of their own beyond the referent reality from which they derive.
7.4. Role of academic accountants
The previous suggestions to end the war of corporate financial reporting have profound
implications for the academic accountancy community. Indeed, it is reasonable to argue that
there needs to be a revolution in the academy with respect to both teaching and research.
21
Mattessich has been arguing in this vein for several years. See Mattessich (1991).
450
Teaching has to return to the forefront of academic activity. For too long the elite of academic
accountancy have been researchers who have done little or nothing to protect the public
interest in corporate reporting. Teaching has become a secondary issue and emphasis has
been placed on students rote learning of the rules of accounting and auditing (Zeff, 1989).
Theory currently appears in disguise in the typical curriculum as it has little to do with
the conceptual underpinnings of practice, focusing instead on advanced practice issues
dependent on standards interpretation. The alternative curriculum suggested in this essay
has two things to offer future public accountants. The first is the nature and role of professions
and the second concerns the construction and accounting representation of social reality.
The key to successful professional practice is understanding what a profession is and
how professionals should behave. These matters go beyond memorising aspects of codes of
ethics such as auditor independence rules. Students should study professionalism generally
and with specific regard to the nature and role of public accountancy. They also need to
study ethical behaviour generally and specifically in relation to business activity. These
subjects are considerably more relevant to future professionals than memories of rule sets.
By knowing what it means to be a professional practitioner, public accountants are better
equipped to cope with pressures on their role to protect the public interest when providing
professional services such as auditing.
Students must also understand the nature and purpose of representation and distinguish
it from arithmetical calculation. At the heart of representation is the issue of two contrasting realities recognised by Searle (1995). The first belongs to the physical world, can exist
independent of humans, is empirically observable, and explainable by theories of sciences
such as physics and biology. The second is a human construction dealing with abstractions
that may have no empirical referents, but which does have rules that effectively provide its
existence and a function that is collectively intended. Accounting and auditing currently
have to cope with social reality, although accountants are not made aware of this in their education and training programmes. Social reality such as income and capital are recognised
and calculated in accounting terms as if they were equivalent to physical reality. Most of
the problems of accounting arise because these distinctions are not recognised or accommodated. Public accountants in the future must be able to identify, classify and reliably
represent social reality and much of the responsibility for this rests with their teachers and
trainers.
Accounting researchers also need to focus on Tinker (2002) commodity forms in corporate financial reporting that require attention. Projects require to be initiated on the nature
and form of professionalism and the representation of social reality as both relate to corporate activity. In this respect, there is a need to re-orientate academic priorities in terms of
research and publishing. Editors and reviewers must regard their journals as depositories of
useful ideas and suggestions as well as scientific facts and that not everything in research
conforms to so-called scientific design. In particular, they need to recognise that normative contributions were once highly regarded in accounting and remain so in most other
researchable areas, including adjoining disciplines such as economics and finance. What
is currently happening in most elite research journals in accounting and auditing is a form
of academic apartheid and deserves condemnation. In effect, it is anti-intellectual and nonscientific and professional academic bodies such as the American and British Accounting
Associations need to regain the high ground and assume a leadership that is consistent with
451
their implicit covenant with the public. If they fail to do this or even try, they will condemn
the war of corporate financial reporting to a further fifteen decades of sideward mobility in
terms of quality aspirations and achievement.
Acknowledgements
This paper has gone through several versions and received helpful commentaries from
participants at research workshops at the Universities of Dundee and Newcastle-Upon-Tyne,
Professors Brian West and Bob Sterling, and the editor and two anonymous reviewers at
this journal. The writer wishes to express his grateful thanks to all of these individuals and
to emphasise the usual caveat.
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Critical Perspectives on Accounting 17 (2006) 419455

The war of the sidewardly mobile corporate

E-mail address: leeatom@aol.com.

T.A. Lee / Critical Perspectives on Accounting 17 (2006) 419455

1. Preface and caveat

T.A. Lee / Critical Perspectives on Accounting 17 (2006) 419455

T.A. Lee / Critical Perspectives on Accounting 17 (2006) 419455

3. Initial thoughts on war

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3.1. Recent events

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To emphasise the persistence of reporting deceit, it is salutary to examine briefly a

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4.1. Public accountancy responses

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consequently restricted to rule compliance rather than intellectual interpretation. In other

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Evidence of a social hierarchy in UK research is not available although there is no reason

5. Explanations of current state

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5.3. Public exposure

See also Corfield (1995) for a study of professions prior to 1850.

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6. Flawed public good

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for management to manipulate accounting numbers. None of these arguments, however,

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7. Review and conclusions

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7.3. Representing social reality by accounting numbers

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Carlino B. Nations auditors need a makeoverand quick! Acc Today 2002(January):6.

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T.A. Lee / Critical Perspectives on Accounting 17 (2006) 419455

T.A. Lee / Critical Perspectives on Accounting 17 (2006) 419455

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