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Vol. 27, No. 3, pp. 229-241 , 1997 229

Abstract^This paper is based on a shorter comment sent to the Accounting Standards Board in response to therequest for comments on the exposure draft. Statement of Principles for Financial Reporting. It is intended to be acomprehensive dissent from that ED, and also to suggest an alternative course of action for the ASB. In the firstplace, the ASB's position, according to which the provision of more fair value accounting (FVA )-based informationis a central plank among its principles, is contested on the grounds of both (a) market incompleteness (entailinglimited availability of reliable FVA-based information) and (b) lack of evidence of demand on the part of financialstatement users for FVA-based information. In the second place, the ASB's approach to issues of recognition issubjected to critical analysis and found to be inadequate. Finally, the ASB's decision that the essential function ofits Statement of Principles should be to advocate a set of recognition rules and measurement bases (including somethat are controversial) is contested. Instead, it is proposed that the Statement of Principles should incorporate alarger framework, including a set of procedural principles, according to which the Board would reach conclusionson the various issues with which it has to deal, so that its conclusions would be seen to be authoritative becausethey had been reached by a process of rigorous enquiry in accordance with appropriate procedures. These principleswould incorporate Rawls' (1971) notions of reflective equilibrium and procedural justice.

IntroductionStatement of P rinciples for F i-Reporting, is the first document to set out

mework for financial accounting and re-ven exposure in the form of individual draftt, as the ASB acknowledges in the sec-

In the case of goodwill and other intangibles,

*The author is at the University of Surrey. He wishes to

pointed out, the Financial Accounting StandardsBoard has concluded that such a project 'is notpractical at this time'. Having studied the exposuredraft and read some other comments on it, I sus-pect that the FASB is correct in this judgment.The remainder of the pap er is divided into threemain sections. Section 2 argues that there are goodreasons for doubting the cost-effectiveness of fairvalue accounting as advocated by the ASB; andthat the issue of the role of fair values in financialreporting requires separate, empirically-based en-quiry. Section 3 addresses the issues of recognitionof financial statement elements, including: theinterrelationship between the balance sheet and theincome statement; the problematic nature of theASB's treatment of recognition; and the issuesraised by the ASB's proposed statement of totalrecognised gains and losses (STRGL) and theinterrelationship between it and the profit and lossaccount.

Finally, Section 4 raises more fundamentalquestions regarding the possible nature and role ofa conceptual framework (CF) for financial ac-counting and reporting. The ASB's Statement ofAims includes 'developing principles to guide it inestablishing standards and to provide a frameworkwithin which others can exercise judgment in re-solving accounting issues' (ASB, 1995:128). But

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230 ACCOUNTING AND BUSINESS RESEARCthe aprioristic fashion of the decades prior to the'empirical turn' in accounting research which be-gan in the late 1960s. Instead, a different type ofCF is proposed, namely one which, while lendingitself to what Gaa (1988, chs. 7 and 8) terms a'codificational' approach to standard-setting, paysexplicit heed to the 'side-effects' or economic con-sequences of accounting rules (Gaa, 1988:144),and provides a framework within which stan-dard-setting follows a process of 'reflective equili-brium' (Gaa, 1988:127-8; Power, 1993:49-57; Ar-cher, 1993:102-111).2. On the cost-effectiveness of fair valueaccountingThe ASB has chosen to incorporate a predilectionfor FVA into the substance of its ED, Statementof Principles. This predilection appears to be basedon general theoretical considerations of 'relevanceto the current state of the business' (para. 5.19),rather than more specific evidence that userswould benefit from, and are seeking, a substantialincrease in the amount of FVA-based informationin financial statements. For example, in paras.6.46-6.49, the ED refers to 'financial adaptability'as an important attribute of an enterprise aboutwhich the financial statements in general, and thebalance sheet in particular, may provide informa-tion. However, as Chambers (1966) pointed out, itis exit values which provide information most rel-evant to adaptability; it is not obvious that currentvalue information other than exit values has anyparticular relevance for that purpose.Is the ASB wise, then, to try to move UK fi-nancial accounting substantially towards a fair-value basis? As Mattessich (1995:52) observes:

'Th[e] cost-benefit criterion, as applied not inbu t to accounting, is crucial for a deeper un-derstanding of traditional accounting valua-tion. I very much sympathise with [RobertR.] Sterling's dissatisfaction of [sic] theacquisition cost method from a scientificpoint of view; but in an applied disciplinesuch as accounting, it is ultimately the user,or the users' consensus, that decides whichmethod is considered to be cost-effective.'We may note that the historical cost model isan extension of the double entry financial trans-action record-keeping model from which modemaccounting developed. Various writers on account-

ing theory, including Ijiri (1975) and Littleton (invarious works), have explained the logic behindthis development, the implications of which cast

'The source of the facts on [financial] state-ments may be either an independent 'inven-tory' or a re-arrangement of double-entbookkeeping data. The modem developmenhas been in the direction of the latter...' (em-phasis added).The 're-arrangement of bookkeeping data' cetred around the notions of costs 'attaching' product, and of being 'matched' against revenuderived from the sale of product, during an acounting period. These notions were more thmere rules of thumb; they were consistent with tthinking of the classical economists, e.g. the vieof assets as stored-up services and of profit arisionly 'if goods changed masters' (Littleto1933:152).'On the one hand, from the viewpoint of a

counting thinkers trained in neo-classical (as oposed to classical) economics, the failure of htorical cost accounting to incorporate fair valuis an aspect of that model's general theoretical adequacy (see, for example, Boulding, 1962). Acording to this view, the 're-arrangement of bookeeping data' should be replaced by a mocoherent set of rules offering congruence with economists' view of value.On the other hand, the major result of the 'eolution from bookkeeping to accountidescribed by Littleton was that asset values, stead of being inputs to the accounting data-necessary if financial statements were to be pduced, were now expected to be outputs from(as a result of the 're-arrangement of double-enbookkeeping data' using subsidiary ledgers suchstock and fixed asset records). A move towaFVA may therefore be seen either as a motowards a 'post-modem' accounting model, ora move back towards a pre-modem accountmodel dependent on values being input regulafor financial reporting purposes. The dangers such a move become more apparent when one cosiders the implications of agency theory and traactions cost economics, together with the evidenof empirical studies of the implementation of crent cost accounting.

The evidence gathered from research into trial period of SSAP 16 (Archer and Steele, 198and also more recent work in Australia by Jonand Love (1995), illustrate the empirical probleof implementation, and will be discussed furtbelow. The theoretical as well as practical signcance of these implementation problems are wcaptured by Ijiri's (1975) concepts of 'hardne' Littleton was well known for his predilection for defend

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SUMMER 1997 231and 'measurement slack' (see also Archer,1996:59-60). Ijiri (1975:35^0) used the term'hardness' to refer to a characteristic of a measure,as follows: the smaller the 'measurement slack'(the extent to which the measure can be manipu-lated up or down), the greater the measure's 'hard-ness'. As he noted:

'To a great extent, corporate accountants en-gage in [a] process to present the best finan-cial appearance of the corporation under agiven set of rules. It is obvious, however, thattoo much discretion on the accoun tants' partcan destroy the basic purpose of accountingmeasurement.'The draft statement, paras. 4.40-4.50, discussesthe issue of the 'hardness' of accounting measures(without using the term), but fails to exhibit any

awareness of the implications of agency and trans-actions costs theories for such issues. These relateparticularly to the problems arising from informa-tion asymmetry between management and finan-cial statement users, and the possibility of oppor-tunistic behaviour on management's part.Accounting (together with auditing) is an impor-tant form of 'monitoring'the term employed byagency theorists to refer to the scrutiny of manage-ment's activities in order to protect investors' in-terests. Excessive 'measurement slack' allows man-agers to manipulate the information provided forthis purpose, in ways to which auditors typicallywill not be able to raise effective objections; hencethe destructive consequences for the basic purposeof accounting measurement noted by Ijiri.^Research has indicated that 'measurement slack'is a particular problem with FVA. A major pitfall(and this was true for SSAP 16) lies in the incom-pleteness of markets. In the absence of secondarymarkets for many types of asset, how is fair valueto be ascertained, and how is the reliability ofproxy measures (such as those obtained for currentcosts using indexation-based methods under SSAP16) to be judged? To quote from Archer and Steele(1984:85):

'With regard to fixed assets, we suggest thatit is helpful to recognise that they belong toone of two categories:1. Those for which active secondary (second-hand) markets exist or to which an identical^ A somew hat similar argu me nt again st the use of FVA infinancial reporting is presented by Fearnley and Page (1996).These authors make the agency-theoretic point that: ' . . . if youare running your own business, it is fine to work out how much

to pay yourself on the basis of your estimates of the business'sfuture cash flows and the current value of its assets, but if youare employing people to run the business for you it is not a

(or very similar) asset can be purchased newat a known price;2. Those for which the above-stated condi-tions do not apply.For the second category, the current costof an asset which is not new is a theoreticalconstruct with no market equivalent.^ Sincethere is no market equivalent, there is nomeans of checking the accuracy of any cal-culation of current cost. Strictly speaking,current cost is indeterminate.'Given the applicability of such remarks to cur-rent replacement cost, similar comments could bemade regarding the broader concept of fair valueto the business (ED, Statement of P rinciples, para.5.23) for such fixed assets, which also includes netrealisable value and economic value in use (EV).In effect, 'fair value' for such assets can only mean

the latter; and EV is a measure no toriously lackingin 'hardness'. As Barth and Landsman (1995:101)put it:'[F]air value accounting based on value-in-use will be the most difficult to implementbecause estimating value-in-use involvesincorporating firm-specific and potentiallyprivate information.'

These issues are partly acknowledged in para.5.28 of the ED. However, the ASB appears to beoptimistic about the development of secondarymarkets in such a way as to reduce significantlythe difficulties just discussed.A more recent Australian study of current valueaccounting (Jones and Love, 1995:282) concluded:[T]he wider acceptance of CVA practices inAustralia will be continually dogged by busi-ness concerns into its implementationMuch of the CVA literature to date hastended to focus on the decision relevance ofdifferent valuation philosophies, the analyti-cal refinement of measurement techniques,and the conceptual weaknesses of conven-tional historical cost accounting. However,...more intensive systematic research effortsdevoted to identifying and overcoming theimplementation problems of CVA [are]pressing issues...'.In the context of research carried out in the US,Barth and Landsman (1995:98n) put the matter asfollows:'Although the FASB's present fair value fo-cus is on financial instruments,... the mostimportant attribute of an asset as it relates

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232 ACCOUNTING AND BUSINESS RESEARCHto fair value accounting is whether an esti-mate of its fair value is readily obtainable,either because active markets exist for it orthere are accepted techniques for estimatingits fair value. Nonetheless, in practice, oftenit is more difficult to obtain fair values fornon-financial assets because they typicallyare not actively traded nor are there acceptedtechniques for estimating their fair values.'Given market incompleteness and the agencytheoretic issues relating to 'hardness' and'measurement slack', the superiority of FVA overthe historical cost model (with indexation in caseof significant inflation) cannot therefore be takenfor granted on grounds of decision relevance''; norhas it been plausibly argued that the additionalbenefits of fair value-based accounting informa-tion exceed its additional costs.' By contrast, thereare solid grounds for believing that FVA wouldprovide a paradise for creative accounting. More-over, recent research (e.g. Bouwman, Frishkoffand Frishkoff, 1995) suggests that improvements(both quantitative and qualitative) in segmentinformation would be greatly welcomed by profes-sional users of financial statements. There wouldappear to be no comparable enthusiasm on thepart of users for fair value information.I am not seeking to deny that fair value-basedinformation has a role in financial reporting; but

for the reasons indicated above, its role may beconsiderably smaller than the whole thrust of theED would have us suppose. For example, it maybe confined mainly to financial assets and liabili-ties and to real estate with an active secondarymarket. T his is a major issue, which the E D simplybegs.There is evidence that in a financial reportingenvironment characterised by semi-strong infor-mational efficiency of capital markets, accountingstandard-setters would do better to devote moreattention to improving disclosure, and less to try-ing to resolve normative issues of accountingmeasurement (Beaver, 1989, ch.6). This, indeed, iswhat professional users appear to want. In parti-cular, there is evidence cited earlier that more dis-aggregation of profit, cash fiow and asset/liabilityinformation by business segment, and of costinformation into fixed and variable categories,would be welcomed by analysts.If the ASB wishes to promote FVA, then itshould:

As Barth and Lan dsm an (1995:98n) put it: 'In the morerealistic setting, measurement error in fair value estimates ex-ists, affecting their relevance.'' The costs and the benefits do not necessarily affect the same

1. Provide evidence that having substantiallymore FVA-based information in financial state-ments is a high priority for financial statementusers;2. Identify categories of item for which activemarkets exist so that fair value measures can beproduced with an acceptable degree of 'hardness';and3. Establish a programme for producing FVAmeasurement standards for each of these cate-gories of item.3. Issues of recognition and ofinterrelationships between financialstatements3.1. The Nature of Assets and Liabilities and theRelationship Between the Income Statementand the Balance SheetThe essence of the 'matching-attaching' para-digm from which the ASB seems at times to betrying to escape is not historical cost per se as ameasurement principle. Rather, it lies within thenature of the recognition criteria for assets and li-abilities. As the US Accounting Principles Boardput in its Statement No. 4 (APB, 1970:24-25),within that paradigm:

'assets...[and]...liabilities...are economic re-sources...[and] economic obligations ... thatare recognised and measured in accordancewith generally accepted accounting prin-ciples. Assets and liabilities also include itemsthat are no t economic resources or obligationsbut which are recognised and measured inaccordance with generally accepted account-ing principles' (emphasis added).The main problem the APB faced was account-ants' tendency to interpret 'matching-attaching' asjustifying the deferral as 'assets' of certain costswhich arguably provide economic benefits (or'value potentials') applicable to future periods butwhich do not represent either 'resources controlledby [the] enterprise' (IASC, 1989b), or rights tosuch resources. The IASC itself, having proposedas its 'preferred treatment' in E32 (IASC, 1989a)that development costs should no longer be recog-nised as assets, was obliged to reverse its positionand to accept recognition as an asset subject tospecific criteria (the 'alternative treatment' in E32)as its preferred treatment. The 'specified criteria'do no t include the existence of transferable intel-lectual property rights, because when that criterionis met the asset is a patent.The ASB's position on this issue is not clear.Para. 3.10 of the ED, Statement of Principles, men

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S U M M E R 1 9 9 7 233development costs that meet certain criteria notincluding the existence of legal rights? Para. 3.18also allows for 'assets' of which the enterprise can-not dispose, provided they can be 'separately iden-tified from the business as a whole'. Whether suchseparate identification must be physical or legal,or whether it may be merely conceptual (as in thecases of development costs, or of brands for whichno secondary market exists), is not explained.For the balance sheet to play a role beyond th atof a depositary for deferrals and accruals betweenincome statements within the 'matching-attaching'paradigm, it is not necessary to move to fair valueaccounting; it would suffice that deferrals and ac-cruals be recognised as assets and liabilities onlywhen legal rights to economic resources or serv-ices, or legal obligations to transfer such resourcesor services, attach to them. The recognition of as-sets and liabilities that do not meet this criterionis essentially a form of 'income smoothing'.A justification of such smoothing has been of-fered on the grounds that what are being recog-nised are value-components (or changes in these)which cannot be captured using more rigorouslydefined concepts of assets or liabilities because ofmarket incompleteness (Whittington, 1983, ch.3).*A major problem w ith this line of reasoning is thatit makes the location of the boundary betweenpermissible use of deferrals and accruals on theone hand , and impermissible income sm oothing onthe other hand, quite arbitrary. In fact, it leads tothe definition of accounting income (gains minuslosses in the ED's terms) being made circular; afeature of APB Statement No. 4 to which APBmember George C. Catlett scathingly referred inhis dissent from the Statement (see Archer,1993:79). The ASB's approach seems to ignorethese issues and raises the further problems dis-cussed below.3.2. Th e ASB's Treatment of RecognitionThe ASB devotes Chapter 4 of ED, Statementof Principles, to the topic of recognition. Its treat-ment of the topic raises a number of problems,including an undesirable conflation of recognitionand measurement.

* ED, Statement of Principles, para. 42 acknowledges that'[a] balance sheet does not purport to show the value of anenterprise', and refers to the omission from the balance sheetof some assets and liabilities for reasons 'stemming from reli-ability of measurement and cost-benefit considerations'. Withimperfect and incomplete markets, however, another majorreason is the so-called 'aggregation problem', i.e. that asset val-ues may not be additive. In addition, the reference to assetsand liabilities 'not...being included in a balance sheet' suggeststhat the ASB is overlooking the distinction between value-com-ponents that meet the criteria for recognition as assets or lia-bilities, and those which do not (e.g. components of goodwill).Given the attention paid to this distinction in the goodwill and

The criteria given for recognising a potential fi-nancial statement item rely entirely on the defini-tions of financial statement elements, andespecially of assets and liabilities, given in C hapter3. Thus, these definitions in Chapter 3 are the 'rec-ognition criteria' in the normal sense of the term;they indicate the rules for a debit or cost item be-ing treated (say) as an asset rather than as a lossor a distribution, or for a credit item being treatedas a liability rather than as a gain or acontribution.But in addition, the Statement's approach torecognition in Chapter 4 does not seem to start inthe familiar way with the existence of an item (theresult of a transaction or event) whose treatmenthas to be decided. Recognition according to theStatement involves three stages: initial recognition,subsequent remeasurement and derecognition.Para. 4.6, Initial recognition, states (with remark-able opacity):

'An element should be recognised if: (a) thereis sufficient evidence that the change in assetsor liabilities inherent in the element has oc-curred (including, where appropriate, evi-dence that a future inflow or outflow of ben-efit will occur); and (b) it can be measuredat a monetary amount with sufficient reli-ability' (emphasis add ed).Paras. 4 .11^.14, Past events, clarify the situa-

tion somewhat:'Recognition is triggered when a past eventgives rise to a measurable change in the assetsor liabilities of an entity [R]ecognition ofone element, or of a change in an element,will inevitably result in the recognition of an-other element or change....Many recognisedelements are the results of past transactions...Some elements, however, are recognised asthe result of other events...' (emphasis inoriginal).However, the importing of measurement (and'remeasurement') into the recognition process hasthe undesirable effect of conflating recognition andmeasurement. As I have argued elsewhere (Archeret al., 1995:13), recognition (i.e. the process of de-ciding that an item satisfies the criteria for mem-bership of a particular category of element) is log-ically prior to measurement: logically, one decideson recognition and then one measures what hasbeen recognised. It may be possible to 'measure'items (e.g. on the basis of historical cost) that do

not meet the recognition criteria, and thus 'meas-urability' per se is not a sufficient condition for rec-ognition, although it is a necessary one. Moreover,

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234 ACCOUNTING AND BUSINESS RESEARCHFrom para. 4.24, it appears that what the ASBhas in mind is the recognition of unrealised hold-ing gains and losses:'Some of the events that trigger subsequent re -measurement involve the remeasurement of theflow of benefits associated with an asset or li-ability....\W\hile [some] change[s] in value[are]...candidate[s] for recognition, not allsuch changes are recognised. Whether or nota change is recognised will depend on theparticular circumstances of each case' (em-phasis in original).The implication would seem to be that, when'remeasurement' can be carried out with sufficientreliability, then it should be carried out (subject tomateriality and in some cases prudence). No at-tempt is made to establish that such 'remeasure-ment' is cost-effective, i.e. that it provides informa-tion whose value exceeds its cost.

3.3. The ASB's Proposed Treatment of Gains andLosses in Two Separate StatementsThe elucidation of the concept of comprehensiveincome is one of the more valuable products of theFASB's monumental, yet largely intellectuallysterile, conceptual framework project. However,the practical implementation of this concept in fi-nancial reporting raises a number of problems.The ASB's attempts to deal with these in ED,Statement of Principles, achieve only limitedsuccess.Paras. 6.18-6.33 eschew a single statement ofcomprehensive income in favour of a system oftwo 'statements offinancialperformance': a 'profitand loss account' (gains and losses from 'operat-ing' activities) and a 'statement of total recognisedgains and losses' (gains and losses on assets andliabilities 'held on a continuing basis primarily toenable the entity's operations to be carried out').It would have been helpful if we had been givenmore details about the rationale, functioning andinterrelationship of these two statements. Relevantmatters have been discussed in the recent US re-search literature, such as Barth and Landsman(1995:104) and Johnson, Reither and Swieringa(1995). In particular, a major issue is whether thereis a subset of the components of comprehensiveincome, sometimes called 'core earnings', whichought to be distinguished and which could be re-ported in a separate statement. As Barth andLandsman (1995:104) cautiously note:'It is possible that a partition of incomebased on operating versus non-operatingactivities is informative if operating earningshave different value implications than non-operating [income], e.g. different risk char-

valuing the firm. However, fair value ac-counting and the concept of core earningsare unrelated in that the former relates to ac-counting measurement and the latter relatesto disaggregation of recognised amounts.Thus, standard-setters should consider theirconcept of core earnings apart from their con-sideration of air value accounting' (emphasissupplied).Johnson et al. (1995:133) issue a more pointedwarning:'At its broadest, a project on comprehensiveincome could encompass the requirementsfor recognition and measurement of incomeitems. Such a project would include acomprehensive re-examination of the presentstandards for accounting for income items.However, that would be a massive undertak-ing that would raise a multitude of formi-dable and complex issues that are sure to behighly controversial. They are issues towhich the [FASB] and its predecessors havedevoted a large amount of time and effortwith only moderate success....In addition, nostrong clamour of support for undertakingsuch a project has been heard from any ofthe Board's constituents. Accordingly, the[FASB] has concluded that [such] a project...is not practical at this time.'The ASB, however, is evidently not to be de-terred. Its proposals for reporting comprehensiveincome are made very much in the context of aproject of the kind that the FASB rejected as 'notpractical'. It is therefore hardly surprising thatthese proposals raise more questions than theyanswer.Presumably, the ASB's proposed profit and lossaccount is the statement of 'core earnings', but thecriteria for inclusion in this statement are notclear. Leaving the reader to assume that the totalof the profit and loss account will be one of the

line items in the statement of total recognised gainsand losses (STRGL), para. 5.25 states that thesestatements should 'report only the gains and lossesthat arise during the period'. Veterans of currentcost accounting will immediately wonder whereholding gains on stock (inventories) are to be re-ported. If recognised in respect of stock heldduring the period before sale (i.e. as unrealisedholding gains), should they appear in the profitand loss account or only in the STRGL? Thewording of paras. 6.27 and 6.28 suggests that theyshould appear in the former, while their realisationon sale would be reported only with historicalcost-based information in the notes (para. 6.24).It is probably wise of the ASB to propose re-

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SUMMER 1997 235ment of such gains is an outcome of operatingdecisions regarding the timing of purchases andeconomic stock levels. But cannot the same be saidof unrealised holding gains/losses on non-currentitems such as property (the outcome of a manage-ment decision to buy rather than to rent) or fixedinterest debt (the outcome of a treasury manage-ment decision to offer afixedrather than a floatingrate)? The exclusion of such items from 'core earn-ings' requires more explanation and justificationthan the ED provides.

These conside rations, linked to the difficulties ofdefining 'core earnings', call into question thesoundness of separating the profit and loss accountfrom the statement of total gains, rather than us-ing a single statement of comprehensive income,within the kind of framework which the ASB isproposing.Perhaps the explanation for the ASB's choicelies in the fact that the Board's intention regardingthe recognition of unrealised holding gains/lossesfor particular categories of asset or liabihty is thatthey should be recognised as and when themeasurement problems acknowledged in paras.5.28 and 5.38 are overcome (this decision beingapparently left to individual entities).' It is, how-ever, hard to see how such an ad hoc approachcould improve the financial statements' informa-tion quality.In addition to the issue of 'hardne ss' (see Section2 above), there are also those of cross-sectionaland longitudinal comparability. The ASB's argu-ments as to why the dichotomy of gains into 'op-erating' and 'holding ' is of benefit to financialstatement users are aphoristic in character, andmake no reference to the empirical research litera-ture that suggests it is the time-series property ofpersistence of an earnings component, no t whetherit is 'operating' or 'holding', that is value-relevant(Beaver, 1989, ch.5).As those of us who have tried to estimate op-erational gearing know, there is a dichotomy (re-lated to persistence) which would be of much moreuse to financial analysts: namely, that betweenvariable and fixed expenses (see, for example.Lord, 1995:319). Published financial statements inDenmark used to disclose variable and fixed ex-penses separately; this was abandoned when theEC's Fourth Directive was implemented in Den-mark, to the detriment of the profit and loss ac-count's usefulness (Christiansen, 1995:126-7). Inthis respect, therefore, as with its relative neglect

' A referee of an earlier version of this paper commented: 'Isit not obvious that the ASB is trying to work with the existingP&L and building onto it a comprehensive income statement?Here there is a clear [incrementalist] politics of working withwhat already exists and is accepted.' However, the logic of an

of segmental information, the ASB as it presentsitself in its ED Statement of Principles can hardlyclaim to be 'the financial statement users' friend',since its approach to financial reporting placesdogma before an informed sensitivity to users'needs. Instead, on the basis of the ED, the ASBlooks much more like being 'the creative account-ants' friend'.4. On the idea of a conceptual frameworkand the ASB's Statement of Aims4.1. The ASB's Approach to Developing a CFThe failure of the FASB's conceptual frame-work project to achieve any significant succesd'estime has evidently not deterred other standard-setting bodies such as the International Account-ing Standards Committee and the ASB from is-suing or seeking to issue statements setting out aconceptual framework, albeit at much less lengththan the set of six Statements of Accounting Con-cepts produced by the FASB. It is understandabletha t standard-setting organisations continue to feelthe need for some body of theory on which toground their prescriptions. Yet what they come upwith is statements of' NAT, which beg the questionas to their own authoritative character. To be sure,statements of accounting standards are essentiallynormative, in that, as well as being prescriptions,they embody value judgments as to what methodsof accounting are desirable. However, a character-istic of NAT has been a failure to spell out ade-quately the criteria in the light of which the valuejudgments as to the desirability of accountingmethods are to be made.

Mattessich (1995, ch.ll) suggests that a majorweakness of NAT is the failure of normative ac-counting theorists to place their prescriptionswithin a framework of means-end relations (in-strumental hypotheses) in which the means are re-lated to, and conditional upon, the ends pursued.This point is discussed further below, with parti-cular reference to the issue of 'economicconsequences'.The ASB states on p.7 of its Statement of Prin-ciples that the ED has been produced in accord-ance with its Statement of Aims, which include'developing principles to guide it in establishingstandards and to provide a framework withinwhich others can exercise judgment in resolvingaccounting issues'. The principles in questioncould be of two types, which need no t be mutuallyexclusive.1. Principles of normative accounting theory;and

2. Methodological principles.With regard to the former, one of the problemsof accounting theory has been a failure to distin-

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236 ACCOUNTING AND BUSINESS RESEARCHprudence), the distinction is that principles aremeta-mles, or higher-order rules that govern a setof lower-order rules. The ASB's 'principles' con-tain a number of rules of recognition and measure-ment that are lower-order rules rather than prin-ciples as found in legal theory. The latter aregenerally of the nature of methodological prin-ciples, such as the principle oi stare decisis or legalprecedent.*Another difference between 'principles', as un-derstood by the ASB, and methodological prin-ciples is the consideration that may be given towhat have been termed the 'economic conse-quences' of accounting standards. Various ac-counting thinkers (including some as illustrious asStephen Zeff and David Solomons) have taken theview that to allow economic consequences to be-come important criteria in accounting standard-setting is objectionable, since it leads to the sub-ordination of accounting principles to pressuregroup politics. Yet experience shows that a con-ceptual framework for accounting standard-settingthat takes no account of likely economic conse-quences fails to provide the standard-setter witheffective protection against pressure group politics,as Dopuch andSunder (1980) pointed out.

This was true, for example, of the US concep-tual framework and the overriding of SFAS 19 (Fi-nancial Accounting an d Reporting by Oil and GasProducing Companies) by SFAS 25. In addition,SFAS 14 (Financial Reporting for Segments of aBusiness Enterprise) was so framed as to allow re-porting entities considerable latitude in reporting,which seriously detracts from the usefulness of theresultant information. Moreover, the IASC'sframework was ineffectual in that it did not enablethe IASC to adhere to its plan, stated in E32, tomake the expensing of R&D costs (as in SFAS 2)its preferred method.One does not need to subscribe to Watts andZimmerman's (1986) 'market for excuses' theoryof the origins of NAT in order to understand thereasons for that failure. The essential reason is tha taccounting standards are liable to have economicconsequences, and NAT by its nature has treatedsuch consequences as externalities.By contrast, methodological principles canincorporate consideration of economic conse-quences into a framework of due process. As Ihave argued elsewhere (Archer, 1993:106-111), theability to show that such consequences had beencarefully considered and weighed in reaching aproposed standard would add to the standard-set-ter's authority andprovide protection against theeffects of lobbying by pressure groups. One doesnot protect oneself against such lobbying by rely-

ing on a set of principles that deliberately excludesconsideration of economic consequences.It has been suggested (Dopuch and Sunder,1980) that private sector bodies such as the ASBmay have no legitimate authority for makingdecisions involving economic consequences; hence,such bodies may be obliged to act as though suchconsequences are irrelevant to their decisions. Ifthis is true, then it should be clear that the efficacyof such bodies faces a major obstacle. Dopuch andSunder also suggest that, for such bodies, a con-ceptual framework of NAT acts as a kind ofideological figleaf (see also Archer, 1993:91).One major weakness of NAT as espoused by theASB lies in its interpretation of the 'objectives offinancial reporting' in terms that appear to involvereification of accounting measures such as profitsand asset values. In other words, what seems to beassumed is some obfectively existing 'economic reality' that financial statements are supposed to'present fairly', or of which they should give a 'trueand fair view'; NAT (as espoused by the ASB) isconcerned with how this is to be achieved. Fromsuch an external realist perspective on accounting,what matters is whether an accounting method isconducive to the 'representational faithfulness' offinancial statements, and it is assumed that if theprocess of standard-setting leads tofinancialstate-ments being 'representationally faithful', then thisconstitutes a fair and just outcome.Yet, as several writers have pointed out (e.g.Ijiri, 1975; Hines, 1988; Archer, 1996) 'economicreality' does not exist 'objectively', in the sense ofexisting independently of the social actors who col-lectively experience it and contribute to it. In epis-temological terms, it is intersubjectively con-structed by the social actors in question.Accounting concepts and methods are cruciallyimplicated in this process of intersubjective con-struction. Given that in general no objective, ex-ternal realist criterion of 'representational faith-fulness' is available for evaluating an accountingmethod, it is hard to see how normative account-ing theorists can be justified in excluding issues ofeconomic consequences and their fairness from thedomain of their theory. This is not to say that in-tersubjectively constructed reality is 'not real'; see,for example, Putnam (1981:49-50) on 'internal re-alism'. For an interpretation of the notions of 'fairpresentation' and 'a true and fair view' from aninternal realist perspective, see Archer(1996:58-60).Returning to Dopuch and Sunder's (1980) pointabout legitimacy, however, standard-setting bodiesmay feel more at ease with an external realist cri-terion of 'representational faithfulness', as thisseems to provide them with an epistemological ba-

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SUMMER 1997 237ultimately stultifying view of the relationship be-tween accounting and reality, tant pis.In the light of these considerations, I believe thatprinciples of the type set out in the ED will be oflimited value to the ASB and the accountingprofession (c.f. Gaa's critical comments on theFASB's SFAC 5; Gaa, 1988:154). To be sure, astandard-setting body needs some set of criteria tohelp it achieve a degree of consistency in its use ofaccounting concepts. It is no doubt appropriatefor the Board to be developing a set of such cri-teria. But the Board appears to be making thedouble error of incorporating a questionable pref-erence for FVA into its proposed principles, whileassuming that its Statement of Aims will be satis-fied as regards the development of principles byissuing statements of normative (and tendentious)accounting theory.

Another misgiving abou t the ASB 's approach todeveloping a CF arises from the title of Chapter 1of the ED, 'The objective of financial statements'.As Dopuch and Sunder (1980) and Gaa (1988)have pointed out, 'the concept of an objective isunclear when applied to an activity (i.e. financialreporting) rather than to individuals or groups.People have goals and objectives motivating themto perform their activities; but the activities them-selves do not have goals or objectives' (Gaa,1988:148). A similar comment could be made re-garding the attribution of objectives to financia lstatements.However, w hile it is problematic to attribute ob-jectives to an activity, rather than to the individ-uals who carry out that activity, it may be appro-priate to speak of an activity having a purpose,and of an artefact such as a building or a toolbeing designed for a specific purpose. The purposeof the artefact refiects the objectives of its designerin designing it for that purpose; but it could beused for other purposes (e.g. a tool may be usedas a murder w eapon). In that sense, a set of finan-cial statements and notes (a 'financial reportingpackage') could have a purpose; this would reflect

the objectives of the 'package's' designers (c.f.Mattessich's 'conditional-normative accountingmethodology' (Mattessich, 1995, ch.ll)). Thisraises the question of how a CF could serve inguiding the design of such a 'package' and itscomponents.

4.2. Alternative Methodologies for a CFPower (1993) has pointed out that to consider aCF as a body of theory from which accountingstandards are to be derivable in a normative-de-ductive manner is to take an unduly scientisticview of accounting standard-setting. Observationof accounting standard-setting in various countries

character or validity of which results from the le-gitimacy of the process whereby they aredeveloped and promulgated (Archer, 1994, 1996).Therefore, a conceptual framework in the form ofNAT is inadequate as a source of authority foraccounting standards. Rather, what may beneeded is a framework that establishes the stan-dard-setting process in a manner which conformsto Rawls' (1971) notion of'procedural justice', i.e.that they result from following procedures that arerecognised as generally producing just outcomes.Rawls (1971) distinguishes between three formsof procedural justice: perfect, imperfect and pure.In the case of imperfect procedural justice, there isno perfect procedure for ensuring a just outcome,but there are imperfect procedures (such as the dueprocess of law) which go substantially towardsthis, and also for subjecting outcomes to reviewand potential revision (e.g. appeal procedures).The validity of financial accounting standardsmay be thought of as a matter of imperfect pro-cedural justice, and this could apply even whenthey lacked legal backing, for the following rea-sons. On the one hand , in the case of financialreporting, it would seem that an independent cri-terion as to whether outcomes are just is available,namely the meta-rule of 'providing a true and fairview' (or, alternatively, that of 'fair presentation').On the other hand, since the application of thismeta-rule is subjective, there is no guarantee thatthe just outcome (e.g. fair presentation) will result.

The situation therefore fits neither perfect norpure, but imperfect, procedural justice. In the ab-sence of a criterion such as 'fair presentation', wewould be left with pure procedural justice, a lesssatisfactory situation (Archer, 1996; see also Gaa,1988:136-7).Nevertheless, there could be a role for a differ-ent kind of CF, as suggested by Power (1993), Ga a(1988, chs. 7 and 8) or the present writer (Archer,1993). For Power, the role of a CF is to 'establishgeneral criteria that...provide boundaries or limitsto the process whereby particular judgments are

made...and guide the process [of standard-setting]by giving a structure to the communicative pro-cesses involved'. These general criteria reflect 'in-tuitions of accountability and accou nting' (Power,1993:55-6).Somewhat similarly, for Gaa a CF has a role toplay within a 'codificational' approach to themethodology of standard-setting. In such an ap-proach, accounting standards are developed as acodification of accepted accounting practices in thelight of considered judgments about such prac-tices, a process that includes removing conceptualinconsistencies and weeding out existing practicesthat are discrepant, and w hich is guided in this bya C F .

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238 A C CO U N TIN G AND BUSINESS RESEARCH

Figure 1'Reflective equilibrium' for financial reporting

'Forward 'a rgument

Principlesof justice

'Backward 'argument

Originalposition Conceptionof well-orderedsociety

In t u i t i ons 'of justiceRawls' model of 'reflective equilibrium'

Accountingstandards'Forward 'a rgument 'Backward 'argument

Conceptualframework Acceptedaccountingpractice

Intui t ionsof accountabilityand accountingSource: Power (1993, pp. 52 and 56)

epistemological model into which a CF fits andplays a role. An idea of such a larger model isprovided by the bottom panel of Figure 1, whichdepicts Power's use of Rawls' model of reflectiveequilibrium. In this model, the CF is shown as 'ex-erting a normative influence within the reflectiveequilibrium process [with its] dual "backward"and "forward" argument structure' (Power,1993:56).The deductive 'forward argument' starts froman 'original position', which 'interprets our moralintuitions as "disassembled" parts of some con-struction' that is both grounded in, and grounds,actual practices; this provides deductive inferences

'backward arguments' on the same issues. In thissense, Rawls' theory of reflective equilibrium pro-vides a framework for '(re)constructing commonlyheld intuitions' (Power: 52-3).Gaa (1988:125-6) provides a different but com-parable model in which a CF forms part of the'background theories' within a larger epistemolog-ical model of the reflective equilibrium process offinancial accounting standard-setting.While Power leaves open the question of how'the economic consequences view' would fit intohis model, stating that it is a task for the future,Gaa is prepared to go further:

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SU M M ER 1997 239

Figure 2Hierarchical relationships in the codification of f inancial accounting standards

Background theoriesScientific theoriesConceptual frameworkEconomic theories

System of standardsc .Considered judgments about practicesf'Accounting practices

Business practices

Source: Gaa (1988 p. 125)

able consequences. The standard-setter maychoose to re-examine the acceptability of thereasons which originally provided its justifi-cation....The reflective equilibrium nature ofthe process of codification...[that is,] the pro-cess of justifying bo th th e financial accou nt-ing standards and the underlying theory "isthe delicate one of making mutual adjust-ments" between theory and practice (Good-ma n , 1919:64)....An accounting theory, ofwhatever kind, is not logically sufficient forjustifying the promu lgation of an accountingstandard....It must be emphasised that the de-cision to promulgate (or to refrain frompromulgating), amend or rescind a financialaccounting standard is basically an ethicaljudgm ent on the part of the standard-setter'(Gaa, 1988:127-8, emphasis supplied).'The side effects [economic consequences] ofrules are not...irrelevant...[s\en if] theprimary task of the standard-setter is tojudge the quality of information producedaccording to the standards' (Gaa, 1988:144,emphasis supplied).

The 'gross balance method' described by the pres-ent writer (Archer, 1993:104-5) may also be con-

re-evaluation of policy alternatives (e.g. alternativeresponses to a standard-setting issue) in the lightof critical parameters, including personal and po-litical values. The main difference between thismethodology and that suggested by Power is asfollows: less weight is given to existing practices asa basis for a 'backward argument', while moreweight is given to the processes of establishing areasonable degree of both agreement about pur-poses or ends and knowledge as to which practiceswould constitute effective and acceptable means tosuch ends. In these respects, my proposals aremore similar to those of Gaa, with his emphasison the role of non-accounting theories and of con-sidered judgments about practices (Gaa,1988:125).'5. Concluding remarksI argued above that if, for reasons connected withthe perceived limits of their legitimacy, private sec-

' Such an approach need not be confined to financial ac-counting. There is thus some affinity with Mattessich's 'con-ditional-normative accounting methodology' (Mattessich, 1995,ch . l 1). However, while he acknowledges that in accounting (asin various other domains) empirical knowledge of causalmeans-end relationships can be seriously deficient, one may

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240 ACCOUNTING AND BUSINESS RESEARCHtor bodies such as the ASB feel obliged to act asthough the economic consequences of their actionsare irrelevant to their decisions, then the efficacyof such bodies faces a major obstacle. I further-more suggested that what is needed is a frameworkthat establishes the standard-setting process in amanner which conforms to Rawls' notion of 'pro-cedural justice', i.e., such that accounting stan-dards are outcomes of procedures that generallyproduce just outcomes.This implies that the ASB should not attemptto revise the existing ED, Statement of Principles,although it should assemble a set of 'backgroundtheories' that would need to be 'accepted andamended as a result of the dynamic interplay be-tween them and the standards they help to justify'(Gaa, 1988:127). This would need to be donewithin the framework of an approach wherein theBoard expresses its principles in terms of proce-dural justice and fairness to legitimately interestedparties.The result would be a document quite differentfrom the ED, perhaps in part resembling an up-dated form of The Corporate Report (AccountingStandards Steering Committee, 1975), but with thefollowing differences. A larger framework wouldbe provided that would not, in the first instance,focus on providing answers to complex issues suchas rights to, and obligations to provide, financialaccounting information (disclosure), and qualita-tive characteristics of various forms of suchinformation (e.g. different 'measurement' bases).Instead, this larger framework wouldfirstconcernitself with specifying the procedures (the refiectiveequilibrium process) to be used in dealing withsuch issues.

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