Chapter 7

Fairness, disclosure
and future trends
in accounting
 Fairness in accounting
This is generally associated with the
measurement and reporting of
information in an objective and neutral
way
It implies that accounting statements
have not been subject to undue
influence or bias
Unfortunate consequences of
the fairness principle
A failure to rely on concepts of justice that
dedicate instead a fairness in distribution
A failure to expand the scope of the
disclosure in financial statements beyond
conventional financial accounting
information towards a fairness in
disclosure
Creates flexibility in income and earnings
smoothing
Creates a climate for fraudulent practices
 True and fair doctrine

There is no comprehensive definition of

the concept of true and fair
Much confusion exists among producers
and users of accounting information as
to its exact meaning
 Williams definition of
fairness
Williams characterised fairness as an
evaluation process with the following
attributes:
the evaluator is aware of the
conditions that any consequences of
his or her actions will be judged as
fair or unfair
the evaluation attempts to adopt a
perspective of impartiality
 Fairness in distribution
According to Williams:
decision usefulness (the principle of
organising accounting research and
practice) is incomplete, while
accountability at least possesses
fairness as an inherent property
the concern of accounting with
efficiency makes accountings fairness
judgement implicit, not absent
 Social accounting
Pallot proposed that a community
perspective be added to the
predominantly individualistic
perspective in accounting
Corporate social responsiveness as an
expression of fairness involves the
identification, measurement and
disclosure where necessary of the social
costs and benefits of a firms economic
activities
Fairness as a moral concept
of justice
Rawls theory of justice is an egalitarian one
under which people choose two principles:
1. Each person is to have an equal right to
the most extensive basic liberty
compatible with a similar liberty for
others.
2. Social and economic liberties are to be
arranged so that they are both:
to everyones advantage
attached to positions and offices open
to all
 Rawls economic system
Rawls theory would probably involve a
constitutional democracy, which
preserves equal basic liberties while
promoting equal opportunity and
guaranteeing a social minimum and a
market-based economy
There is great disagreement over
whether or not Rawls difference
principle (calling for the establishment
of social minimums) would assure an
adequate supply of goods and services
 Fairness in accounting
according to Rawls
Rawls calls for an accounting choice that will
eventually lead to solutions that are neutral,
fair and socially just
Rawls suggests expanding the role of
accounting in the creation of just institutions
and the definition of the social minimum
Expanding accountings role in creating just
institutions would lead to the elimination of
those aspects of the social world and
accounting that seem arbitrary from a moral
point of view
 Nozicks theory of justice
Nozick argues that theories such as Rawls,
which are based on the patterned and end-state
principles, violate peoples rights and exclude
the entitlement principle
According to Nozick:
a person who acquires a holding in
accordance with the principle of justice in
acquisition is entitled to that holding
a person who acquires a holding in
accordance with the same principle from
someone else entitled to that holding is also
entitled to it
no one else is entitled to a holding except
through the above applications
 Fairness in accounting
according to Nozick

Nozicks is a libertarian theory of

distribution based on justice in
acquisition and transfer
Nozicks view sees distributive justice
as relying on a free-market
mechanism, and does not allow for
dealing adequately with fairness as a
distributive function
 Gerwiths theory of justice
Gerwiths theory sees rights to freedom and
well-being as generic, fundamental and universal
Gerwith asserts that every agent logically must
acknowledge certain generic obligations,
including:
he ought to refrain from coercing and from
banning his recipients
he ought to assist them to have freedom and
well-being [when there is] no comparable loss
to himself
Gerwiths Principle of Generic Consistency (PGC)
is: act in accord with the generic rights of your
recipients as well as yourself
 Fairness in accounting
according to Gerwith
Gerwithian principles demand
recognition of the rights of all those
affected by the activities of the
organisation
Gerwiths view supports the emphasis
in value-added reporting to report the
total return of all members of the
production team, such as
shareholders, bondholders, suppliers,
labour, government and society
 Fairness in disclosure
The fairness in disclosure principle calls
for an expansion of conventional
accounting disclosures to accommodate
all other interest groups in addition to
investors and creditors
Bedford called for the development of
new tools under diverse new disciplines
to provide management and decision-
makers with useful information
 Characteristics of disclosure
to be expanded
The scope of users should expand to include
public groups
The scope of users should expand to providing
for inter-company coordination, meeting
specific user information needs and developing
public confidence in the firms activities
The type of information disclosed should
expand to reveal both internal activities and
the environmental setting of those activities of
a socioeconomic nature
 Characteristics of disclosure to be
expanded (contd)
Measurement techniques should expand to
encompass the total management science
area
The quality of disclosure should expand to
offer improved relevance for specific
decisions
Disclosure devices should expand to
encompass multimedia disclosures based
on the psychology of human
communications
Levs theory of equitable and
efficient accounting policy
Equity of the capital markets
Equality of opportunity or symmetric
information
Risk-adjusted returns identical across
investors
The standard for the equity concept is:
The interests of the less informed
investors should, in general, be
favored over the more informed
investors
 Gaas user primacy
In Gaas user primacy, the interests of
one group of users is given preference
over others
A standard setter would be established
to enforce user primacy, thereby
redressing imbalances between
investors and managers
The standard setter would aid all
securities market agents in exploiting
the potential trading gains provided by
such a market
 The Jenkins Committee
The Jenkins Committee was established
by the AICPA in 1991 to improve
external reporting
The committees aim was to determine:
the nature and extent of information
that should be made available to
others by management
the extent to which the auditors
should report on the various elements
of that information
 Jenkins Committee findings
The Committee found that, in order to meet
users need for information, financial
statements should be enhanced in the
following ways:
improved disclosure of business-segment
information
disclosures and accounting for innovative
financial instruments to be addressed
improved disclosures about the identity,
opportunities and risks of off-balance-sheet
financing arrangements, and accounting for
such to be reconsidered
Jenkins Committee findings (contd)
the effects of core and non-core activities
and events to be reported separately, and
non-core assets and liabilities to be
measured at fair value
improved disclosures about uncertainty of
measurements of certain assets and
liabilities
improved quarterly reporting by reporting
separately in the fourth quarter and by
including business-segment data
 Jenkins Committee model
The model proposed by the Jenkins Committee
enabled users to make projections, value
companies or assess the prospect of loan
repayments on the basis of the following five
broad categories.
1. Financial and non-financial data:
financial statements and related disclosures
high-level operating data and performance
measurements that management uses to
manage the business
2. Management analysis of the financial and non-
financial data:
reasons for changes in the financial, operating
and performance-related data, and the identity
and past effect of key trends
 Jenkins Committee model (contd)
3. Forward-looking information:
opportunities and risks, including those
resulting from key trends
managements plans, including critical
success factors
comparison of actual business performance
to previously disclosed opportunities, risks
and managements plans
4. Information about management and
shareholders:
directors, management, compensation,
major shareholders, and transactions and
relationships among related parties
 Jenkins Committee model (contd)
5. Background about the company:
broad objectives and strategies
scope and description of business and
properties
impact of industry structure on the
company
 Expanded accounting
disclosures
The distinction between recognition and
disclosure is emphasised by the FASB and is
consistent with the Australian position, in that
recognition is seen stated in the FASB Concepts
Statement No. 5 as:
the process of formally recording or
incorporating an item into the financial
statements of an entity as an asset, liability,
revenue, expense, or the like
[including] depiction of an item in both words
and numbers, with the amount included in the
totals of the financial statements
Expanded accounting disclosures (contd)
The FASB statement also says that:
since recognition means depiction of an item
in both words and numbers, with the amount
included in the totals of the financial
statements, disclosure by other means is not
recognition
Disclosure of information about the items in
financial statements and their measures that
may be provided by notes or parenthetically
on the face of financial statements, by
supplementary information, or by other
means of financial reporting is not a substitute
for recognition in financial statements for
items that meet recognition criteria
 Purposes of disclosure
The FASB statement sees the purposes of
disclosure as being:
1. To describe recognised items and to
provide relevant measures of those
items other than the measures in the
financial statements
2. To describe unrecognised items and to
provide a useful measure of those items
3. To provide information to help investors
and creditors assess risks and potentials
of both recognised and unrecognised
items
 Purposes of disclosure (contd)

4. To provide important information that

allows financial statement users to
compare within and between years
5. To provide information in future cash
inflows or outflows
6. To help investors assess return on their
investments
 Required financial statement
disclosures an analysis
1. The most frequently required disclosures
relate to amounts recognised in the
financial statements, particularly to
disaggregating them and providing relevant
measures other than the measure in the
financial statements disaggregation of
recognised amounts represents 26 per cent
of all required disclosures
2. Six subjects stockholders equity, leases,
pensions, income taxes, other post-
retirement employee benefits and
 Required financial statement
disclosures an analysis (contd)
commitments and contingencies account
for 45 per cent of all required disclosures;
five standards SFAS nos 15, 87, 88, 106
and 109 account for 28 per cent
4. Few disclosures explicitly provide
information on future cash inflows or
outflows
5. Few disclosures provide measures of
unrecognised items
6. Disclosure requirements have increased
over time; few have been eliminated
New accounting disclosures
New accounting disclosures under
the principle of fairness in disclosure
are:
value-added reporting
employee reporting
human resource accounting
social accounting and reporting
budgetary information disclosures
cash flow accounting and reporting
 Value-added reporting
Value added is the increase in wealth
generated by the productive use of the
firms resources before its allocation
among shareholders, bondholders,
workers and the government
 Computing value added
Step 1: The income statement computes retained
earnings as a difference between sales revenue, on
one hand, and costs, taxes and dividends, on the
other:
R = S B DP W I DD T (1)
where:
R = retained earnings
S = sales revenue
B = bought-in materials and services
DP = depreciation
W = wages
I = interest
DD = dividends
T = taxes
 Computing value added (contd)

Step 2: The value-added equation can be

obtained by rearranging the profit equation
as:
S B = R + DP + W + I + DD + T (2)
or
S B DP = R + W + I + DD + T (3)

Equation 2 expresses the gross value-added

method
Equation 3 expresses the net value-added
method
 Computing value added (contd)

Step 2 (contd)
In both cases, the left part of the equation
shows the value added among the groups
involved in the managerial production
team (workers, shareholders, bondholders
and the government)
The right-hand side is also known as the
additive method and the left-hand side as
the subtractive method
 Benefits of the value-added
statement
With the disclosure of value added,
employees get the satisfaction of knowing
the value of their contribution to the total
wealth of the firm
Value added represents a better base for the
computation of worker bonuses
Value added information has been proven to
be a good predictor of economic events and
market reaction
 Benefits of the value-added
statement (contd)
Value added is a better measurement of
size than sales
Value added may be useful to employee
groups because it can affect the
aspirations and thoughts of its negotiating
representatives
Value added may be extremely useful in
financial analysis by relating various crucial
events to added variables
 Employee reporting
Employee reporting has been
necessitated by the emergence of
employees and unions as potential users
of accounting information. Examples of
headings for an employment report are:
number of people employed (analysed
in various ways)
location of employment
age distribution of permanent
workforce
hours worked during the year
(analysed)
 Employee reporting (contd)

employee costs
pension information
education and training (including
costs)
recognised trade unions
additional information (race relations,
health and safety statistics etc.)
employment ratios
Aims and reasons for reporting
to employees
A survey of financial reporting literature by
Lewis and others found that the main
reasons for reporting to employees between
1919 and 1979 were:
heralding changes
presenting management propaganda
promoting interest in understanding of
company affairs and performance
explaining management decisions
explaining the relationship between
employees, management and shareholders
 Aims and reasons for reporting to
employees (contd)
explaining the objectives of the company
facilitating greater employee participation
responding to legislative or union pressure
building company image
meeting information requirements peculiar
to employees
responding to management fears of wage
demands, strikes and competitive
disadvantages
promoting a higher degree of employee
interest
 Increased interest in
reporting to employees
Lewiss survey found that in the years
between 1919 and 1979, the level of
interest in reporting to employees was
higher when four socio-economic factors
were present:
1. use of new technology in the workplace
2. increased mergers in the corporate
sector
3. emergence of anti-union sentiment
4. fears of economic recession
Reasons for increased levels of
employee reporting
Lewiss survey also speculated that
management may have hoped to:
allay fears of lost rank, skill or employment
due to technological advances
counter fears of bigness, monopoly power,
employee relocation and loss of identity
through corporate mergers
take advantage of community anti-union
sentiments by bypassing union
communication channels, emphasising
management prerogatives and the need
 Reasons for increased levels of
employee reporting (contd)
to control wages and associated costs,
and generally weakening the unions
potential to disrupt operations
prepare employees for hard times, confirm
or dispel rumours of imminent company
failure, allay fears of unemployment and
urge employees to greater efforts in
difficult economic times
 Management benefits of
employee annual reports
Taylor, Webb and McGinley identified the
following personal benefits that management
might attempt to seek for itself by providing an
annual report to employees:
building a favourable employee impression
of the management group
reducing the resistance of employees to
changes initiated by management
providing a useful response to union
pressure for more corporate financial
information from management
 Employee benefits from
employee reporting
Taylor, Webb and McGinley also identified the
following personal benefits that might accrue to
employees through employee reporting:
having the basis for deciding whether to
continue employment with the company or an
organisation section of the company
having the basis for assisting the relative
position of the employees within the corporate
structure, particularly in terms of getting a fair
go
understanding the image of the company as a
basis for deciding at a personal level whether
to identify with its image
 Arguments for direct
disclosure to employees
Foley and Maunders identified arguments
supporting disclosure direct to employees:
feedback of information to employees will
improve job performance via learning effects
and also serve to increase motivation
the role of employee reporting is crucial to
effective worker participation, which will
contribute to the efficiency of the company
the fundamental change in the nature of the
firm and its social responsibility legitimises
employee reporting
Arguments for direct disclosure to
employees (contd)
employee reporting may be seen by some
employers as a possible way of
resurrecting the concept of joint
consultation as a means of avoiding
unionisation
the socialist tradition, with its ultimate
objective of changing the basis of
ownership and the control of resources,
sees employee reporting as a step to
increase workers control and develop
workers self confidence
 Socialist arguments for
employee reporting
The case for employee reporting using the
socialist argument rests on two fundamental
principles:
1. that employee reporting helps employees
establish greater democratisation of
decision-making in industry
2. that employee reporting may usefully act
as a check on those aspects of the market
system which result in adverse external
effects in the form of pollution and
environmental degradation
 Social accounting and
reporting
The measurement of social
performance falls in the general area
of social accounting. The four various
activities are:
1. social responsibility accounting
(SRA)
2. total impact accounting (TIA)
3. socioeconomic accounting (SEA)
4. social indicators accounting (SIA)
 Definition of social
accounting
Ramanathan defines social accounting as:
the process of selecting firm-level
social performance variables,
measures and measurements
procedures; systematically developing
information useful for evaluating the
firms social performance and
communication of such information to
concerned social groups, both within
and outside the firm
 Who is pushing for corporate
social reporting?
According to Gray and others, corporate
social reporting (CSR) is a dialectic between
four different positions, which are:
1. the extreme left wing of politics
2. acceptance of the status quo
3. the pursuit of subject/intellectual
property rights
4. the extreme right wing of politics
 Who is pushing for corporate social
reporting? (contd)
Position 2 appears to represent the true
advocates of CSR and seems to include people
who assume that:
CSRs purpose is to enhance a firms corporate
image, and who see corporate behaviour as
fundamentally benign
the purpose of CSR is to discharge an
organisations accountability, assuming that a
social contract exists and that this demands the
discharge of social accountability
CSR is effectively an extension of traditional
financial reporting and its purpose is to inform
investors
Arguments for measuring and
disclosing social performance
1. The existence of a social contract
2. Rawls and Gerwiths models argue
for a concept of fairness that is
favourable to social accounting
3. Users needs
4. The existence of social investment
 Budgetary information
disclosure
Accountants and non-accountants alike have
recommended that forecast information be
incorporated into financial statements
One objective of financial reporting set forth
in the Trueblood Report supports such
disclosures:
An objective of financial statements is to
provide information useful for the predictive
process. Financial forecasts should be
provided when they will enhance the
reliability of users prediction
 Including forecasts in
accounting reports
In the UK, the revised version of the City
Code on Takeovers and Mergers requires
profit forecasts to be included in takeover-
bid circulars and prospectuses
In February 1975, the US Securities and
Exchange Commission (SEC) first announced
its intention to require companies disclosing
the forecasts to conform with certain rules to
be laid down by the SEC
In 1976, the SEC called for voluntary filing of
forecasts
Problems encountered by the SEC
The definition of earnings forecasts:
concerns determining which forecasted
items are to be disclosed (the two possible
solutions are disclosing budgets or
disclosing probable results (forecasts))
Ijiri makes the distinction as follows:
Forecasts are estimates of what the
corporation considers to be the most
likely to occur, whereas budgets may be
inflated from what the corporation
considers to be most likely to occur in
order to take advantage of the
motivational function of the budget
 Problems encountered by the SEC
(contd)
from the point of view of the user,
therefore, the disclosure of forecasts,
rather than budgets, may be more
relevant
the trend seems to be in favour of the
disclosure of forecasts
Whether disclosure should be mandatory or
optional:
the principle argument in favour of
mandatory disclosure is that it creates a
similar and uniform situation for all
companies
 Problems encountered by the SEC
(contd)
mandatory disclosure could create an
unnecessary burden in terms of competitive
advantage, and certain firms would have to be
viewed as exceptions
some firms lack adequate technology,
experience and competence to disclose
forecasts adequately, and outlays to correct
this situation may create an unnecessary
burden on these firms
The possible advantages of such disclosure:
both companies and analysts have been
unsuccessful in accurately forecasting
earnings
 Ijiris primary issues in
corporate financial forecasts
Reliability:
related to the relative accuracy of the
forecasts
Responsibility:
related to the possible large liabilities of
firms making forecasts and accountants
auditing such forecasts
Reticence:
related to the degree of silence and inaction
of firms that are at a competitive
disadvantage due to forecast disclosure
The usefulness of published
forecasts
Acccording to Mautz, three kinds of difference
must be considered when evaluating the
usefulness of published forecasts:
1. differences in the forecasting agilities of
publicly owned firms
2. differences in the attitudes with which
managements in publicly owned companies
might be expected to approach the forecasting
task
3. differences in the capacities of investors to use
forecasts
 Cash flow accounting and
reporting
Stewardship function
Management is entrusted with control of
the financial resources provided by capital
suppliers
The purpose of financial statements is to
report to concerned parties to facilitate the
evaluation of managements stewardship
To accomplish this objective, the reporting
system favoured the accrual system
 The accrual basis of
accounting
Refers to a form of keeping those
records not only of transactions that
result from the receipt and disbursement
of cash, but also of amounts that the
entity owes others and that others owe
the entity
At the core of this system is the
matching of revenues and expenses
The system is challenged by proponents
of cash flow accounting
 Cash flow accounting
Defined as the recording not only of
cash receipts and disbursements of the
period, but also of the future cash flows
owed to or by the firm as a result of
selling and transferring the title to
certain goods (the accrual basis of
accounting)
 Accrual accounting versus
cash flow accounting
Accrual accounting facilitates the evaluation
of managements stewardship and is
essential to the matching of revenues and
expenses
The efficiency of the accrual system has
been questioned
Many decision-usefulness theorists advocate
a cash flow accounting system based on the
investors desires to predict cash flows
Accrual accounting versus cash flow
accounting (contd)
Most advocates of cash flow accounting
feel that the problems of asset valuation
and income determination are so
formidable as to warrant a separate
accounting system, and propose the
inclusion of a comprehensive cash flow
statement in company reports