fairness, disclosure and future trends in accounting

5/28/2018 Fairness, disclosure and future trends in accounting

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Chapter 7

Fairness, disclosureand future trendsin accounting


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Fairness in accounting

This is generally associated with themeasurement and reporting ofinformation in an objective and neutral

way

It implies that accounting statementshave not been subject to undue

influence or bias


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Unfortunate consequences ofthe fairness principle

A failure to rely on concepts of justice thatdedicate instead a fairness in distribution

A failure to expand the scope of the

disclosure in financial statements beyondconventional financial accountinginformation towards a fairness indisclosure

Creates flexibility in income and earningssmoothing

Creates a climate for fraudulent practices


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True and fair doctrine

There is no comprehensive definition ofthe concept of true and fair

Much confusion exists among producersand users of accounting information asto its exact meaning


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Williams definition of

fairnessWilliams characterised fairness as anevaluation process with the followingattributes:

the evaluator is aware of theconditions that any consequences ofhis or her actions will be judged as

fair or unfair the evaluation attempts to adopt a

perspective of impartiality


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Fairness in distribution

According to Williams:

decision usefulness (the principle oforganising accounting research and

practice) is incomplete, whileaccountability at least possessesfairness as an inherent property

the concern of accounting withefficiency makes accountings fairnessjudgement implicit, not absent


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Social accounting

Pallot proposed that a communityperspective be added to thepredominantly individualistic

perspective in accounting Corporate social responsiveness as an

expression of fairness involves theidentification, measurement and

disclosure where necessary of the socialcosts and benefits of a firms economicactivities


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Fairness as a moral concept

of justiceRawls theory of justice is an egalitarian oneunder which people choose two principles:

1. Each person is to have an equal right to

the most extensive basic libertycompatible with a similar liberty forothers.

2. Social and economic liberties are to bearranged so that they are both:

to everyones advantage

attached to positions and offices opento all


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Rawls economic system

Rawls theory would probably involve aconstitutional democracy, whichpreserves equal basic liberties whilepromoting equal opportunity and

guaranteeing a social minimum and amarket-based economy

There is great disagreement overwhether or not Rawls difference

principle (calling for the establishmentof social minimums) would assure anadequate supply of goods and services


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Fairness in accountingaccording to Rawls

Rawls calls for an accounting choice that willeventually lead to solutions that are neutral,fair and socially just

Rawls suggests expanding the role ofaccounting in the creation of just institutionsand the definition of the social minimum

Expanding accountings role in creating just

institutions would lead to the elimination ofthose aspects of the social world andaccounting that seem arbitrary from a moralpoint of view


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Nozicks theory of justice

Nozick argues that theories such as Rawls,which are based on the patterned and end-state principles, violate peoples rights andexclude the entitlement principle

According to Nozick:

a person who acquires a holding inaccordance with the principle of justice inacquisition is entitled to that holding

a person who acquires a holding in

accordance with the same principle fromsomeone else entitled to that holding is alsoentitled to it

no one else is entitled to a holding exceptthrough the above applications


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Fairness in accountingaccording to Nozick

Nozicks is a libertarian theory ofdistribution based on justice in

acquisition and transfer Nozicks view sees distributive justice

as relying on a free-market

mechanism, and does not allow fordealing adequately with fairness as adistributive function


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Gerwiths theory of justice Gerwiths theory sees rights to freedom and

well-being as generic, fundamental anduniversal

Gerwith asserts that every agent logically mustacknowledge certain generic obligations,

including: he ought to refrain from coercing and frombanning his recipients

he ought to assist them to have freedom andwell-being [when there is] no comparable lossto himself

Gerwiths Principle of Generic Consistency (PGC)is: act in accord with the generic rights of yourrecipients as well as yourself


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Fairness in accountingaccording to Gerwith

Gerwithian principles demandrecognition of the rights of all thoseaffected by the activities of the

organisation Gerwiths view supports the emphasis

in value-added reporting to report thetotal return of all members of the

production team, such asshareholders, bondholders, suppliers,labour, government and society


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Fairness in disclosure

The fairness in disclosure principle callsfor an expansion of conventionalaccounting disclosures to accommodate

all other interest groups in addition toinvestors and creditors

Bedford called for the development ofnew tools under diverse new disciplinesto provide management and decision-makers with useful information


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Characteristics of disclosureto be expanded

The scope of users should expand to includepublic groups

The scope of users should expand to providing

for inter-company coordination, meetingspecific user information needs and developingpublic confidence in the firms activities

The type of information disclosed should

expand to reveal both internal activities andthe environmental setting of those activities ofa socioeconomic nature


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Characteristics of disclosure to beexpanded (contd)

Measurement techniques should expand toencompass the total management sciencearea

The quality of disclosure should expand tooffer improved relevance for specificdecisions

Disclosure devices should expand to

encompass multimedia disclosures basedon the psychology of humancommunications


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Levs theory of equitable andefficient accounting policy

Equity of the capital markets

Equality of opportunity or symmetricinformation

Risk-adjusted returns identical acrossinvestors

The standard for the equity concept is:

The interests of the less informedinvestors should, in general, befavored over the more informedinvestors


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Gaas user primacy

In Gaas user primacy, the interests ofone group of users is given preferenceover others

A standard setter would be established

to enforce user primacy, therebyredressing imbalances betweeninvestors and managers

The standard setter would aid all

securities market agents in exploitingthe potential trading gains provided bysuch a market


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The Jenkins Committee

The Jenkins Committee was establishedby the AICPA in 1991 to improveexternal reporting

The committees aim was to determine:

the nature and extent of informationthat should be made available toothers by management

the extent to which the auditorsshould report on the various elementsof that information


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Jenkins Committee findings

The Committee found that, in order to meet

users need for information, financialstatements should be enhanced in thefollowing ways:

improved disclosure of business-segmentinformation

disclosures and accounting for innovativefinancial instruments to be addressed

improved disclosures about the identity,opportunities and risks of off-balance-sheetfinancing arrangements, and accounting forsuch to be reconsidered


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Jenkins Committee findings (contd)

the effects of core and non-core activitiesand events to be reported separately, andnon-core assets and liabilities to bemeasured at fair value

improved disclosures about uncertainty ofmeasurements of certain assets andliabilities

improved quarterly reporting by reporting

separately in the fourth quarter and byincluding business-segment data


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Jenkins Committee modelThe model proposed by the Jenkins Committee

enabled users to make projections, valuecompanies or assess the prospect of loanrepayments on the basis of the following fivebroad categories.

1. Financial and non-financial data:

financial statements and related disclosures

high-level operating data and performancemeasurements that management uses tomanage the business

2. Management analysis of the financial and non-financial data:

reasons for changes in the financial, operatingand performance-related data, and theidentity and past effect of key trends


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Jenkins Committee model (contd)

3. Forward-looking information:

opportunities and risks, including thoseresulting from key trends

managements plans, including criticalsuccess factors

comparison of actual businessperformance to previously disclosedopportunities, risks and managementsplans

4. Information about management and

shareholders: directors, management, compensation,

major shareholders, and transactions andrelationships among related parties


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Jenkins Committee model (contd)

5. Background about the company: broad objectives and strategies

scope and description of business andproperties

impact of industry structure on thecompany


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Expanded accountingdisclosures

The distinction between recognition anddisclosure is emphasised by the FASB and isconsistent with the Australian position, in thatrecognition is seen stated in the FASB Concepts

Statement No. 5 as: the process of formally recording or

incorporating an item into the financialstatements 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 thetotals of the financial statements


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Expanded accounting disclosures (contd)

The FASB statement also says that:

since recognition means depiction of an itemin both words and numbers, with the amountincluded in the totals of the financialstatements, disclosure by other means is notrecognition

Disclosure of information about the items infinancial statements and their measures thatmay be provided by notes or parentheticallyon the face of financial statements, by

supplementary information, or by othermeans of financial reporting is not asubstitute for recognition in financialstatements for items that meet recognitioncriteria


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Purposes of disclosure

The FASB statement sees the purposes ofdisclosure as being:

1. To describe recognised items and toprovide relevant measures of those

items other than the measures in thefinancial statements

2. To describe unrecognised items and toprovide a useful measure of those items

3. To provide information to help investorsand creditors assess risks and potentialsof both recognised and unrecogniseditems


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Purposes of disclosure (contd)

4. To provide important information thatallows financial statement users tocompare within and between years

5. To provide information in future cash

inflows or outflows6. To help investors assess return on their

investments


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Required financial statementdisclosures an analysis

1. The most frequently required disclosuresrelate to amounts recognised in thefinancial statements, particularly todisaggregating them and providing relevant

measures other than the measure in thefinancial statements disaggregation ofrecognised amounts represents 26 per centof all required disclosures

2. Six subjects stockholders equity, leases,pensions, income taxes, other post-retirement employee benefits and


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Required financial statementdisclosures an analysis (contd)

commitments and contingencies accountfor 45 per cent of all required disclosures;five standards SFAS nos 15, 87, 88, 106and 109 account for 28 per cent

4. Few disclosures explicitly provideinformation on future cash inflows oroutflows

5. Few disclosures provide measures of

unrecognised items

6. Disclosure requirements have increasedover time; few have been eliminated


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New accounting disclosures

New accounting disclosures underthe principle of fairness in disclosureare:

value-added reporting

employee reporting

human resource accounting

social accounting and reporting

budgetary information disclosures

cash flow accounting and reporting


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Value-added reporting

Value added is the increase in wealthgenerated by the productive use of thefirms resources before its allocationamong shareholders, bondholders,

workers and the government


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Computing value addedStep 1:The income statement computes retainedearnings as a difference between sales revenue,on one hand, and costs, taxes and dividends, onthe other:

R= SBDPWIDDT (1)

where:

R = retained earningsS = sales revenue

B = bought-in materials and services

DP = depreciation

W = wagesI = interest

DD = dividends

T = taxes


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Computing value added (contd)

Step 2: The value-added equation can beobtained by rearranging the profit equationas:

SB= R+ DP+ W+ I+ DD+ T (2)

or

SBDP= R+ W+ I+ DD+ T (3)

Equation 2 expresses the gross value-addedmethod

Equation 3 expresses the net value-addedmethod


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Computing value added (contd)

Step 2 (contd)

In both cases, the left part of the equationshows the value added among the groupsinvolved in the managerial productionteam (workers, shareholders, bondholdersand the government)

The right-hand side is also known as the

additive method and the left-hand side asthe subtractive method


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Benefits of the value-addedstatement

With the disclosure of value added,employees get the satisfaction of knowingthe 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 tobe a good predictor of economic events andmarket reaction


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Benefits of the value-addedstatement (contd)

Value added is a better measurement ofsize than sales

Value added may be useful to employeegroups because it can affect theaspirations and thoughts of its negotiatingrepresentatives

Value added may be extremely useful infinancial analysis by relating various crucialevents to added variables


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Employee reporting

Employee reporting has been

necessitated by the emergence ofemployees and unions as potential usersof accounting information. Examples ofheadings for an employment report are:

number of people employed (analysedin various ways)

location of employment

age distribution of permanentworkforce

hours worked during the year(analysed)


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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


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Aims and reasons for reportingto employees

A survey of financial reporting literature byLewis and others found that the mainreasons for reporting to employees between1919 and 1979 were:

heralding changes

presenting management propaganda

promoting interest in understanding ofcompany affairs and performance

explaining management decisions

explaining the relationship betweenemployees, management and shareholders


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Aims and reasons for reporting toemployees (contd)

explaining the objectives of the company facilitating greater employee participation

responding to legislative or union pressure

building company image

meeting information requirements peculiarto employees

responding to management fears of wagedemands, strikes and competitivedisadvantages

promoting a higher degree of employeeinterest


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Increased interest inreporting to employees

Lewiss survey found that in the yearsbetween 1919 and 1979, the level ofinterest in reporting to employees was

higher when four socio-economic factorswere present:

1. use of new technology in the workplace

2. increased mergers in the corporate

sector3. emergence of anti-union sentiment

4. fears of economic recession


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Reasons for increased levels ofemployee reporting

Lewiss survey also speculated thatmanagement 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 identitythrough corporate mergers

take advantage of community anti-unionsentiments by bypassing unioncommunication channels, emphasisingmanagement prerogatives and the need


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Reasons for increased levels ofemployee reporting (contd)

to control wages and associated costs,and generally weakening the unionspotential to disrupt operations

prepare employees for hard times,confirm or dispel rumours of imminentcompany failure, allay fears ofunemployment and urge employees togreater efforts in difficult economic times


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Management benefits ofemployee annual reports

Taylor, Webb and McGinley identified thefollowing personal benefits that managementmight attempt to seek for itself by providingan annual report to employees:

building a favourable employee impressionof the management group

reducing the resistance of employees tochanges initiated by management

providing a useful response to unionpressure for more corporate financialinformation from management

E l b fit f


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Employee benefits fromemployee reporting

Taylor, Webb and McGinley also identified thefollowing personal benefits that might accrueto employees through employee reporting:

having the basis for deciding whether to

continue employment with the company oran organisation section of the company

having the basis for assisting the relativeposition of the employees within thecorporate structure, particularly in terms ofgetting a fair go

understanding the image of the company asa basis for deciding at a personal levelwhether to identify with its image


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Arguments for directdisclosure to employees

Foley and Maunders identified argumentssupporting disclosure direct to employees:

feedback of information to employees will

improve job performance via learning effectsand also serve to increase motivation

the role of employee reporting is crucial toeffective worker participation, which willcontribute to the efficiency of the company

the fundamental change in the nature of thefirm and its social responsibility legitimisesemployee reporting


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Arguments for direct disclosure toemployees (contd)

employee reporting may be seen by someemployers as a possible way ofresurrecting the concept of jointconsultation as a means of avoidingunionisation

the socialist tradition, with its ultimateobjective of changing the basis ofownership and the control of resources,

sees employee reporting as a step toincrease workers control and developworkers self confidence


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Socialist arguments foremployee reporting

The case for employee reporting using thesocialist argument rests on two fundamentalprinciples:

1. that employee reporting helps employeesestablish greater democratisation ofdecision-making in industry

2. that employee reporting may usefully act

as a check on those aspects of the marketsystem which result in adverse externaleffects in the form of pollution andenvironmental degradation


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Social accounting andreporting

The measurement of socialperformance falls in the general areaof 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)

f f


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Definition of socialaccounting

Ramanathan defines social accounting as:

the process of selecting firm-levelsocial performance variables,

measures and measurementsprocedures; systematicallydeveloping information useful forevaluating the firms socialperformance and communication ofsuch information to concerned socialgroups, both within and outside thefirm


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Who is pushing for corporate social


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Who is pushing for corporate socialreporting? (contd)

Position 2 appears to represent the trueadvocates of CSR and seems to include peoplewho assume that:

CSRs purpose is to enhance a firmscorporate image, and who see corporate

behaviour as fundamentally benign the purpose of CSR is to discharge an

organisations accountability, assuming that asocial 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 informinvestors

A f i d


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Arguments for measuring anddisclosing social performance

1. The existence of a social contract

2. Rawls and Gerwiths models argue

for a concept of fairness that isfavourable to social accounting

3. Users needs

4. The existence of social investment

Budgetary information


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Budgetary informationdisclosure

Accountants and non-accountants alike haverecommended that forecast information beincorporated into financial statements

One objective of financial reporting set forth

in the Trueblood Report supports suchdisclosures:

An objective of financial statements is toprovide information useful for the predictive

process. Financial forecasts should beprovided when they will enhance thereliability of users prediction

I l di f t i


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Including forecasts inaccounting reports

In the UK, the revised version of the CityCode on Takeovers and Mergers requiresprofit forecasts to be included in takeover-bid circulars and prospectuses

In February 1975, the US Securities andExchange Commission (SEC) first announcedits intention to require companies disclosingthe forecasts to conform with certain rules to

be laid down by the SEC In 1976, the SEC called for voluntary filing of

forecasts


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Problems encountered by the SEC

The definition of earnings forecasts:

concerns determining which forecasteditems are to be disclosed (the two possiblesolutions are disclosing budgets ordisclosing probable results (forecasts))

Ijiri makes the distinction as follows: Forecasts are estimates of what the

corporation considers to be the mostlikely to occur, whereas budgets may beinflated from what the corporationconsiders to be most likely to occur inorder to take advantage of themotivational function of the budget

P bl t d b th SEC


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Problems encountered by the SEC(contd)

from the point of view of the user,therefore, the disclosure of forecasts,rather than budgets, may be morerelevant

the trend seems to be in favour of thedisclosure of forecasts

Whether disclosure should be mandatory oroptional:

the principle argument in favour of

mandatory disclosure is that it creates asimilar and uniform situation for allcompanies

P oblems enco nte ed b the SEC


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Problems encountered by the SEC(contd)

mandatory disclosure could create anunnecessary burden in terms of competitiveadvantage, and certain firms would have tobe viewed as exceptions

some firms lack adequate technology,experience and competence to discloseforecasts adequately, and outlays to correctthis situation may create an unnecessaryburden on these firms

The possible advantages of such disclosure: both companies and analysts have been

unsuccessful in accurately forecastingearnings

Ijiris primary issues in


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Ijiris primary issues incorporate financial forecasts

Reliability:

related to the relative accuracy of theforecasts

Responsibility: related to the possible large liabilities offirms making forecasts and accountantsauditing such forecasts

Reticence: related to the degree of silence and inaction

of firms that are at a competitivedisadvantage due to forecast disclosure

Th f l f bli h d


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The usefulness of publishedforecasts

Acccording to Mautz, three kinds of differencemust be considered when evaluating theusefulness of published forecasts:

1. differences in the forecasting agilities ofpublicly owned firms

2. differences in the attitudes with whichmanagements in publicly owned companiesmight be expected to approach the forecastingtask

3. differences in the capacities of investors touse forecasts

C h fl ti d


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Cash flow accounting andreporting

Stewardship function

Management is entrusted with controlof the financial resources provided by

capital suppliers The purpose of financial statements is

to report to concerned parties tofacilitate the evaluation of

managements stewardship To accomplish this objective, the

reporting system favoured the accrualsystem


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The accrual basis ofaccounting

Refers to a form of keeping thoserecords not only of transactions thatresult from the receipt and

disbursement of cash, but also ofamounts that the entity owes othersand 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


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Cash flow accounting

Defined as the recording not only ofcash receipts and disbursements of theperiod, but also of the future cash flows

owed to or by the firm as a result ofselling and transferring the title tocertain goods (the accrual basis ofaccounting)

l


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Accrual accounting versuscash flow accounting

Accrual accounting facilitates the evaluationof managements stewardship and isessential to the matching of revenues and

expenses

The efficiency of the accrual system hasbeen questioned

Many decision-usefulness theoristsadvocate a cash flow accounting systembased on the investors desires to predictcash flows


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Accrual accounting versus cash flowaccounting (contd)

Most advocates of cash flow accountingfeel that the problems of asset valuationand income determination are so

formidable as to warrant a separateaccounting system, and propose theinclusion of a comprehensive cash flowstatement in company reports

fairness, disclosure and future trends in accounting

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