For a while,
as the story of the Enron Corporation's collapse and the role of
accountants at Arthur Andersen broke onto the front pages, I was
spending 10 hours a week on the phone, talking about little else.
At the other end of the line were lawyers, reporters, and congressional
aides, all looking with new urgency for information and insight
about the American public accounting system. Many were as unfamiliar
with the hows and whys of the system as we in the accounting profession
are with our newfound notoriety. Most brought up the demands, heard
often these days, for extensive regulation. I believe that would
be a mistake.
The challenge of accounting measurement is to condense into three
or four pages of financial statements (and 10 to 20 pages of footnotes)
information about millions of current and future events affecting
a business, each carrying risk: How many current debts are going
to end up unpaid? What is the value of a recently acquired brand
name? Unlike the price at closing of 1,000 shares of Intel on June
15, the numbers that represent the answers to these questions are
usually uncertain. Reasonable men and women may differ about them,
and they may all be proved wrong.
What accountants call GAAP, short for "generally accepted accounting
principles," is a mixture of norms, laws, and premises developed
to guide the evaluation of uncertainty. But if these principles
are applied too formally or become too restrictive (say, in response
to a publicized crisis like the collapse of Enron), they will only
ensure that the public gets mediocre, and not very useful, information.
Take bad debts, for example. Using an accepted accounting principle,
accountants can fix the range of loans that go sour during a time
of generally low credit risk at between 2 and 4 percent. Unfortunately,
even this range can penalize the best managers--those who are the
most adept at selecting customers likely to pay their bills and
at keeping a watchful eye on their receivables. Investors can't
recognize the good performers or even avoid the bad ones if all
businesses are reported within the "generally accepted" range. Overly
strict adherence to the form of accounting principles at the expense
of good accounting judgment and evaluation is, to my mind, what
lies at the heart of the Enron debacle.
Of course, lodged within accepted ranges of honest error are opportunities
for manipulation and dishonesty. And in the past five years, the
range of honest measurement error became wider. During the "irrational
exuberance," to use Federal Reserve Chairman Alan Greenspan's description
of the recent stock market run-up that peaked in March 2000, the
accounting system was tested more intensely than at any time since
the 1929 Crash. We saw an increased emphasis on derivatives, special-purpose
entities, and other risk-management vehicles. New business models
were created for which there were limited measurement benchmarks.
And the incentives to misrepresent information increased significantly
with emphasis on stock options and the growth of opportunities at
companies whose stock was on the way up.
To be sure, there is a need for reform. Deceit must be punished.
And we need to examine closely the structure of incentives that
make dishonest behavior tempting. Yet it's worth pointing out that
with the evaporation of trillions of dollars from the stock market
in the last two years, among the thousands of publicly traded companies
that file with the Securities and Exchange Commission, remarkably
few audit failures have surfaced. Andersen appears to have relaxed
its internal vigilance at a time when others of accounting's Big
Five did not.
Accountants know that in order to serve the public interest--and
indeed to continue to work--they need to demonstrate a healthy skepticism
about the quality of information reported by companies. But it would
be a serious mistake to respond to the fall of Enron and the moral
and professional errors of individuals at Arthur Andersen by prescribing
overly stringent restrictions on accountants' judgment, whether
in the form of internal professional codes or outside law and regulation.
That would be sacrificing skepticism for cynicism.
G. Peter Wilson
G. Peter Wilson is the Joseph E. Sweeney Professor of Accounting
in BC's Carroll School of Management. A more detailed analysis by
Professor Wilson of accounting reform issues can be found at The
Full Story, on the BCM
Web site: www.bc.edu/bcm
Photo: AP Photo/Kenneth Lambert