THE RISE OFECONOMIC CONSEQUENCES

The impact of accountingreports on decisionmaking may be the mostchallenging accountingissue of the 1970s.by Stephen A. Zeff

Since the 1960s, the American accountingprofession has been aware of the increasinginfluence of "outside forces" in the standard-setting process. Two parallel developmentshave marked this trend. First, individualsand groups that had rarely shown any inter-est in the setting of accounting standardsbegan to intervene actively and powerfullyin the process. Second, these parties began toinvoke arguments other than those whichhave traditionally been employed in account-ing discussions. The term "economic conse-quences" has been used to describe thesenovel kinds of arguments.

By "economic consequences" is meant theimpact of accounting reports on the decision-making behavior of business, government,unions, investors and creditors. It is arguedthat the resulting behavior of these individu-als and groups could be detrimental to theinterests of other affected parties. And, theargument goes, accounting standard settersmust take into consideration these allegedlydetrimental consequences when deciding onaccounting questions.* The recent debates in-volving foreign currency translation and theaccounting for unsuccessful exploration ac-tivity in the petroleum industry have reliedheavily on economic consequences argu-

Copyright © 1978 by Stephen A. Zeff.*Ed. note: For the opinion of an accounting standardsetter, see Oscar S. Gellein's article in Statements inQuotes, p. 75.

ments, and the Financial Accounting Stan-dards Board and the Securities and ExchangeCommission have become extremely sensitiveto the issue.'

The economic consequences argumentrepresents a veritable revolution in account-ing thought. Until recently, accounting policymaking was either assumed to be neutral inits effects or, if not neutral, it was not heldout to the public as being responsible forthose efEects. Today, these assumptions arebeing severely questioned, and the subjectof social and economic consequences "hasbecome the central contemporary issue inaccounting."^ That the FASB has commis-sioned research papers on the economic con-sequences of selected standards and has helda conference devoted entirely to the subject^underscores the current importance of thisissue.

Accounting policy makers have beenaware since at least the 1960s of the third-

' Several articles have been written on "economic con-sequences." See, e.g.. Alfred Rappaport, "EconomicImpact of Accounting Standards—Implications for theFASB," JofA, May77, pp.89-98; Arthur R. Wyatt,"The Economic Impact of Financial Accounting Stan-dards," JofA, Oct.77, pp.92-94; and Robert J. Swie-ringa. "Consequences of Financial Accounting Stan-dards," Accounting Forum, May 1977, pp.25-39.2 Report of the Committee on the Social Consequencesof Accounling Information (Sarasota, Fla.: AmericanAccounting Association, 1978), p.4.3 Conference on the Economic Consequences of Finan-cial Accounting Standards (Stamford, Conn.: FASB,1978).

STEPHEN A. ZEFF, Ph.D., is professor of accountingat Rice University, Houston, Texas. The AmericanAccounting Association's 1977 distinguished interna-tional lecturer in Latin America, he is the editor ofthe Accounting Review. Professor Zeff is rhe authorof Forging Accounling Principles in Five Countries:A History a/id an Analysis of Trends (Champaign,111.: Stipes Publishing Company, 1972) and a coeditorof Essays in Honor af William A. Paton: Pioneer Ac-counting Theorist (Ann Arbor, Mich.: Division ofResearch, Graduate School of Business Administra-tion, University of Michigan, 1978). This article is anabridged version of a paper presented on June 9, 1978,at the Stanford Lectures in Accounting, GraduateSchool of Business, Stanford University.

56 The Journal of Accountancy, December 1978

party intervention issue,* while the issue ofeconomic consequences has surfaced only inthe 1970s. Indeed, much of the history of theAccounting Principles Board during the1960s was one of endeavoring to understandand cope with the third-party forces whichwere intervening in the standard-settingprocess. In the end, the inability of the APBto deal effectively with these forces led to itsdemise and the establishment in 1973 of theFASB.

The true preoccupations of the interveningthird parties have not always been madeclear. When trying to understand the third-party arguments, one must remember thatbefore the 1970s the accounting model em-ployed by the American Institute of CPAscommittee on accounting procedure (CAP)and the APB was, formally at least, confinedto technical accounting considerations(sometimes called "accounting principles" or"conceptual questions") such as the measure-ment of assets, liabilities and income and the"fair presentation" of financial position andoperations. The policy makers' sole concernwas with the communication of financial in-formation to actual and potential investors,for, indeed, their charter had been "granted"by the SEC. which itself had been chargedby Congress to assure "full and fair disclo-sure" in reports to investors. Third-party in-tervenors, therefore, would have had an ob-vious incentive to appeal to the accountingmodel used by policy makers rather thanraise the .specter of an economic consequen-ces model preferred by the third parties.

When corporate management began inter-vening in the standard-setting process to anincreasing degree, therefore, its true positionwas probably disguised. An examination ofmanagement arguments suggests the follow-ing range of tactical rhetoric. Argumentswere couched in terms of1 The traditional accounting model, wheremanagement was genuinely concerned aboutunbiased and "theoretically sound" account-ing measurements.2 The traditional accounting model, wheremanagement was really seeking to advance

^In this article, I am chiefly concerned with third-party intervention in the standard setting for unregu-lated industries. Accounting policy makers in thiscountry hnve been alive for several decades to the ac-counting implications of ihe rules and regulations ofrale-making in the energy, transportation and com-munication industries. See, e.g., George O. May, Fi-nanciid Accounting: A Distillation of Experience (NewYork: The Macmillan Company, 1943), chs. 7-8, andWilliam A. Paton, "Accounting Policies of the FederalPower Commission—A Critique," JofA, June44, pp.432-60.

its self-interest in the economic consequencesof the contents of published reports.3 The economic consequences in whichmanagement was self-interested.

If one accepts Johnson's dictum that it re-quires a "lively imagination" to believe thatmanagement is genuinely concerned with fairpresentation when choosing between account-ing alternatives,^ it could be concluded thatthe first argument has seldom been employedin third-party interventions. In recent years,particularly since the early 1970s, manage-ment has become more candid in its dia-logues with the FASB, insistently advancingthe third argument and thus bringing eco-nomic consequences to the fore.

" . . .outs ide parties intervened in thestandard setting process by an appeal tocriteria that transcended the traditionalquestions of accounting measurement andfair presentation. They were concerned in-stead with,the economic consequences...."

Two factors tend to explain why economicconsequences did not become a substantiveissue before the 1970s. First, managementand other interested parties predominantlyused the second argument cited above, en-couraging the standard-setting bodies to con-fine themselves to the traditional accountingmodel. Second, the CAP and APB, with fewexceptions, were determined to resolve, orappear to resolve, standard-setting controver-sies in the context of traditional accounting.

Early Uses of EconomicConsequences ArgumentsPerhaps the first evidence of economic conse-quences reasoning in the pronouncements ofAmerican policy makers occurred as longago as 1941. In Accounting Research Bulle-tin no. 11, Corporate Accotmting for Ordi-nary Stock Dividends, the CAP, in accord-ance with "proper accounting and corporatepolicy," required that fair market value beused to record the i.ssuancc of stock dividendswhere such market value was substantiallyin excess of book value.*

Evidently, both the New York Stock Ex-

5 Charles E. Johnson, "Management's Role in ExternalAccounring Measuremenls." in Robert K. Jaedicke,Yuji Ijiri and Oswald Nielsen (editors), Research inAccounting Measurement ([n.p.], AAA, 1966), p.9L* Accounting Research Bulletin no. U, Corporate Ac-counting for Ordinary Stock Dividends (New York:American Institute of Accountants, 1941), pp.102-03.

The Journal of Accountancy, December 1978 57

change and a majority of the CAP regardedperiodic stock dividends as "objectionable,"'and the CAP acted to make it more difficultfor corporations to sustain a series of suchstock dividends out of their accumulatedearnings. As far as this author is aware, theU.S. is still the only country in which an ac-counting pronouncement requires that stockdividends be capitalized at the fair marketvalue of the issued shares,' and this positionwas originally adopted in this country, atleast in part, in order to produce an impacton the stock dividend policies of corpora-tions.

A second evidence of economic conse-quences' entering into the debates surround-ing the establishment of accounting stan-dards, this time involving managetnent repre-sentations, occurred in 1947-48. It was theheight of the postwar infiation. and severalcorporations had adopted replacement costdepreciation in their published financialstatements.' Among the arguments employedin the debate involving the CAP were thepossible implications for tax reform, the pos-sible impact on wage bargaining and theneed to counteract criticisms of profiteeringby big business. Despite the pressures for ac-counting reform, the CAP reaffirmed its sup-port of historical cost accounting for depre-ciation in ARB no. 33, Depreciation 'andHigh Costs, and in a letter issued in Octo-ber 1948.

A clear use of the economic consequencesargument occurred in 1958, when three sub-sidiaries of American Electric Power Com-pany sued in the federal courts to enjoin theAICPA from allowing the CAP to issue a let-ter saying that the deferred tax credit ac-count, as employed in the then-recentlyissued ARB no. 44 (Revised), Declining-Balance Depreciation, should be classified asa liability.'" The three public utility com-panies were concerned that the SEC, underauthority granted by the Public Utility Hold-ing Company Act, would not permit them toissue debt securities in view of the unfavora-

7 George O. May, letter to J. S. Seidman. dated Julyt4. 1941 (deposited in the national office library ofPrice Waterhouse & Co. in New York), p.l.' Price Wateihouse International, A Survey in 46Countries: Accounting Principle.s and Reporting Prac-tices (fn.p.], PWI. 1975), table 145.'* Depreciation Policy Wlten Price Levels Change (NewYork: Controller.ship Foundation, Inc., 1948), ch. 14.'OT/ip AICPA Injunction Cose—Re: ARB [No.] 44(Revised), Cases in Public Accounting Practice [no. 1](Chicago, 111.: Arthur Andersen & Co., 1960).

ble debt-to-equity ratios which the proposedreclassification would produce. The casereached the U.S. Supreme Court, where cer-tiorari was denied. In the end. the clarifyingletter was issued. Nonetheless, the SEC ac-commodated the public utility companies byconsenting to exclude the deferred tax creditfrom both liabilities and stockholders' equityfor purposes of decisions taken under thePublic Utility Holding Company Act."

Shortly after the creation of the APB, theaccounting treatment of the investment taxcredit exploded on the scene. The tbree con-frontations between the APB and the cotn-bined forces of industry and the administra-tions of Presidents Kennedy, Johnson andNixon bave already been amply discussed inthe literature.'^ The government's argumentwas not that the accounting deferral of theinvestment tax credit was bad accounting butthat it diluted the incentive effect of an in-strutnent of fiscal policy.

In 1965, the subject of segmcntal report-ing emerged from a hearing of the SenateSubcommittee on Antitrust and Monopolyon the economic effects of conglomeratemergers. The aim of the senatorial inquirywas not to promote better accounting prac-tices for investor use but to provide the sub-committee and other government policy mak-ers with accounting data that would facilitatetheir assessment of the economic efficacy ofconglomerate mergers. Company manage-ments naturally looked on such disclosures aspotentially detrimental to their merger ambi-tions. Pressure applied by this powerful sub-committee eventually forced the hand of theSEC to call for product-line disclosures inpublished financial reports. The repercus-sions of this initiative, which had its originin a Senate hearing room, are still beingfelt.'s

In 1967-69, the APB responded to an an-guished objection by the startled Investment

^^ SEC Administrative Policy Re: Balance-sheet Treat-ment of Deferred Income-Tax Credits, Cases in PublicAccounling Practice [nos. 5 and 61 (Chicago. Jll.: Ar-Ihur Andersen & Co.. 1961), pp.35-59."See Maurice Moonilz, "Some Reflections on the In-vestment Credit Experience." Journal of AccountingResearch. Spring 1966. pp.47-61; John L. Carey, TheRi.se of the Accounting Profession: To Responsibilityand Authority 1937-1969 (NewYork: AICPA, 1970),pp.98-104; and Stephen A. Zeff, Forging AccountingPrinciples in Five Countries: A History and an Analy-sis of Trends (Champaign, III.: Stipes Publishing Com-pany. 1972), pp.178-80, 201-2. 219-21 and 326-27.13 Charles W. Plum and Daniel W. Collins, "BusinessSegment Reporting," in James Don Edwards andHomer A. Blnck (editors). The Modern Accountant'sHandbook (Homewood, III.: Dow Jones-Irwin, Inc..1976), pp.469-511.

58 The Joumal of Accountancy, December 1978

Bankers Association of America (todayknown as the Securities Industry Association)to a provision, once thought to be innocuous,in APB Opinion no. 10, Omnibus Opinion-1966, which imputed a debt discount to con-vertible debt and debt issued with stock war-rants. The IBA was concerned about the im-pact of the accounting procedure on the mar-ket for such securities. In Opinion no. 14,Accounting for Convertible Debt and DebtIssued With Stock Purchase Warrants, theAPB rescinded its action in regard to con-vertible debt while retaining the rest."

From 1968 through 1971, the banking in-dustry opposed the inclusion of bad-debt pro-visions and losses on the sales of securities inthe net income of commercial banks. Bank-ers believed that the new measure would re-flect unfavorably on the performance ofbanks. Eventually, through a concerted effortby the APB, the SEC and the bank regula-tory agencies, generally accepted accountingprinciples were made applicable to banks.'^

From 1968 through 1970, the APB strug-gled with the accounting for business combi-nations. It was flanked on the one side by theFederal Trade Commission and the Depart-ment of Justice, which favored the elimina-tion of pooling-of-interests accounting in or-der to produce a slowing effect on the mergermovement and on the other by merger-minded corporations that were fervent sup-porters of pooling-of-interests accounting.The APB, appearing almost as a pawn in agame of political chess, disenchanted manyof its supporters as it abandoned positions ofprinciple in favor of an embarrassing seriesof pressure-induced compromises.'*

in 1971, the APB held public hearings onaccounting for marketable equity securities,leases and the exploration and drilling costsof companies in the petroleum industry. Inall three areas, powerful industry pressuresthwarted the board from acting. The insur-ance industry was intensely concerned aboutthe possible effects on its companies' stockprices of including the unrealized gains and

"Zeff, pp.202, 2U.15 Carey, p. 134; Maurice Moonitz, Ohlainin^ Agree-ment on Stamtards in the Accounting Profession,Studies in Accounting Research no. 8 (Sarasota, Fla.:AAA, 1974), pp.38-39; Zeff, pp.210-lt.1* Robert Chalov, Corporate Financial Reporting: Pub-lic or Private Control? (New York: TTie Free Press,1975), pp. 212-22; and Zeff, pp.212-16.

losses on portfolio holdings in their incomestatements." The leasing initiative wassquelched after senators, representatives andeven the secretary of transportation re-sponded to a letter-writing campaign bymaking pointed inquiries of the SEC andAPB. The letter writers raised the specter ofinjury that the board's proposed actionwould supposedly cause to consumers and tothe viability of companies in several key in-dustries." The petroleum industry was un-able to unite on a solution to the controversyover full costing versus successful effortscosting, as it was alleged that a general im-position of the latter would adversely affectthe fortunes of the small, independent ex-ploration companies.'' Using its considerablepolitical might, the industry succeeded in per-suading the board to postpone consideration

• of the sensitive subject.^°

On each of the occasions enumeratedabove, outside parties intervened in the stan-dard-setting process by an appeal to cri-teria that transcended the traditional ques-tions of accounting measurement and fair

'The procedural machinery establishedfor the FASB is even more elaboratethan that which existed iathe final years of the APB."

presentation. They were concerned insteadwith the economic consequences of the ac-counting pronouncements.

"Economic consequences" have been in-voked with even greater intensity in the shortlife of the FASB. Such questions as account-ing for research and development costs, self-insurance and catastrophe reserves, develop-ment stage companies, foreign currency fluc-tuations, leases, the restructuring of troubled

"•Charles T. Horngren. "The Marketing of Account-ing Standards," JofA, Oct.73, pp.63-64.'8 Leonard M. Savoie, "Accounting Attitudes," in Rob-ert R. Sterling (editor). Institutional Issues in PublicAccounting (Lawrence, Kan.: Scholars Book Co.,1974), p.326."See the testimony and submissions in APB PublicHearing on AccourUin;; and Reporting Practices in thePetroleum Indu.stry, Cases in Public Accounting Prac-tice [no.] 10 (Chicago, III.: Arthur Andersen & Co.,1972).M Savoie, p.326.

The Journal of AccoimtaJKy, December 1978 59

debt,'' domestic inflation and relative pricechanges, and the exploration and drillingcosts of companies in the petroleum industryhave provoked widespread debate over theireconomic consequences.^' The list is both ex-tensive and impressive, and accotmting aca-demics are busily investigating the empiricalvalidity of claims that these and other ac-counting standards may be linked with thespecified economic consequences.

The Standard-Setting Bodies RespondWhat have been the reactions of the stan-dard-setting bodies to the intervention byoutside parties and the claitn that accountingstandards should or should not be changedin order to avoid unhealthy economic or so-cial consequences? In the 1940s and 1950s,the CAP enhanced its liaison with interestedthird parties through a wider circulation ofexposure drafts and subcommittee reports.From 1958 to 1971, through appointmentsto key committees, joint discussions and sym-

21 At the FASB's public hearing, some bankers warnedof the dire economic consequences of requiring bankslo write down (heir receivables following lestructur-ings. Walter Wrislon, chairman of Citicorp, assertedthat the resiructuring of New York City's obligationsmight just noi have occurred if the banks would havebeen required to write down the carrying value of theirreceivables. Walter B. Wrislon. Transcript of PublicHearing on FASB discussion memorandum. Account-ing by Debtors and Creditors When Debt Is Restruc-tured' {\911-\o\. 1-part 2). pp.69-70. Yet the FASB.in its lengthy "Basis for Conclusions" in Statement no.15. Accounting by Debtors and Creditors for TroubledDebt Restructurings (in which the feared write-downswere not required), did not refer to bankers' claimsabout the economic consequences of requiring signifi-cant write-downs. Does that omission imply that theFASB paid no attention to those assertions? Did theFASB conduct any empirical research (as it did con-cerning the economic consequences claims raised inconnection with Statement no. 7, Accounting and Re-porting by Development Stage Enterprises) to deter-mine whether there was adequate ground to sustainsuch claims?

22 See. e.g.. Joseph M. Burns, Accounting Standardsund International Finance: With Special Reference toMultinationals (Washington. D.C: American EnterptiseInstitute for Public Policy Research. 1976); Committeeon the Social Consequences of Accounting Informa-tion, pp.9-12; Rappaport, pp.90, 92; FASB, Conferenceon the Economic Consequences of Financial Account-ing Standards: U.S. Department of Energy, commentsbefore the Securities and Exchange Commission. "Ac-counting Practices—Oil and Gas Producers—FinancialAccounting Standards." unpublished memorandum,dated April 3, 1978.

Evidence attesting to the attention given by theFASB to economic consequences issues may be foundin the "Basis for Conclusions" sections of the applicablestatements. Tn addition to companies and industrygroups, government departments (such as the Depart-ment of Commerce, in Statement no. 7, and the De-partments of Energy and Justice, in Statement no. 19,Financial Accounting and Reporting by Oil and GasProducing Companies) were actively involved in thediscussion of economic consequences.

posiums, mass mailings of exposure draftsand formal public hearings, the Institute andthe APB acted to bring interested organiza-tions more closely into the standard-settingprocess. The hope was, one supposes, thatthese organizations would be satisfied thattheir views were given full consideration be-fore the final issuance of opinions. These ac-commodations were, however, of a proce-dural sort, although it is possible that theseoutside views did have an impact on the sub-stantive content of some of the resultingopinions. It would appear that the APB wasat least somewhat influenced by economicconsequences in its prolonged deliberationsleading to the issuance of Opinions no. 16,Business Combinations, and no. 17, Intangi-ble Assets.^^ During the public hearings in1971 on marketable equity securities and tbeaccounting practices of companies in thepetroleum industry, management representa-tives on several occasions asserted economicconsequences as relevant considerations. Yettnembers of the APB's subject-area commit-tees neither asked for proof of those asser-tions nor, indeed, questioned their relevanceto the setting of accounting standards.^^

Since it was the APB's inability to copewith the pressures brought by outside organi-zations that hastened its demise, it is worthnoting that the FASB includes the FinancialExecutives Institute (FEI) among its co--sponsors. In my opinion, the incorporation ofthe FEI in the formal structure of the Finan-cial Accounting Foundation (FAF, theFASB's parent) is one of the most significantadvantages which the FASB possesses in re-lation to its predecessor."

The procedural machinery established forthe FASB is even more elaborate than thatwhich existed in the final years of the APB.The object of these additional procedures hasbeen to expand and intensify the interactionbetween the board and interested outsideparties, notably companies, industry associa-

23 Wyatt. pp.92-93.2'* Proceedings of Hearing on Accounting for EquitySecurities. Accounling Principles Board (New York:AICPA. 1971). section A—Transcript: and APB Pub-lic Hearing on Accounting and Reporting Practices inihe Petroleum Industry.25 The inclusion of Ihe FEf could arguably become theundoing of the FASB. If the FEI were to lose confi-dence in the board, it is possible that many of thecompanies which now contribute to the Financial Ac-counting Foundation might decline to continue doingso. provoking a financial crisis that could threaten theboard's viability.

60 The Journal of Accountancy, December 1978

tions and government departments and agen-cies. A task force drawn from a broad spec-trum of interested groups is appointed priorto the preparation of each discussion memo-randum. The DM itself is much bulkier thanthe modest document the APB had issued be-fore its public hearings; it contains a neutraldiscussion of the entire gamut of policy is-sues that bear on the resolution of the con-troversy before the board. A FinancialAccounting Standards Advisory Council(FASAC), composed of representatives of awide array of interested groups, was ap-pointed to be a sounding board for theFASB. The board itself has been composedof members drawn from accounting practice,the universities, companies and government—again, so that it would be responsive, andwould appear to be responsive, to the con-cerns of those "constituencies." In an effortto persuade skeptics of the merit of its recom-mendations, the board includes in its state-ments a lengthy explanation of the criteria,arguments and empirical considerations itused to fashion the recommended standards.

Following criticism from within the pro-fession of the board's operations and proce-dures, the FAF conducted a study in 1977of the entire FASB operation. Among theFAF's many recommendations were propo-sals that the board expand its formal and in-formal contacts with interested groups andthat it include an economic impact analysisin important exposure drafts. On this latterpoint, the FAF's structure committee con-cluded: "The Board need not be unduly in-fluenced by the possibility of an economicimpact, but it should consider both the possi-ble costs and the expected benefits of a pro-posal."" In addition, the structure committeerecommended actions that would strengthenthe roles of the task forces and the FASAC.^In 1978, under pressure from Congress, theboard began to conduct virtually all itsformal meetings (including those of theFASAC) "in the sunshine."

The history of the APB and the FASB isone of a succession of procedural steps takento bring the boards' deliberations into closerproximity to the opinions and concerns ofinterested third parties. As in the case of theAPB, it is possible that an effect of thesemore elaborate procedures has been a change

2* Financial Accounting Foundation structure commit-tee. The Strtjctttre of Establishing Einancial Account-ing Standards (Stamford, Conn.: FAF, 1977), p.51.37 Ibid., pp.23-25.

in the substance of the FASB's conclusionsand recommendations.

By the middle 1970s, however, it was de-cided that the FASB should add economic(and social) consequences to the substantiveissues it normally addresses. The inclusion of"probable economic or social impact" amongthe other "qualities of useful information" inthe board's conceptual framework DM,'" theboard's announcement of its interest in em-pirical studies of economic consequences**and the recommendation of the FAF struc-ture committee that the board inform itselfadequately on the "various impacts its pro-nouncements might have"^° collectively con-firm this new direction. The issue of eco-nomic consequences has, therefore, changedfrom one having only procedural implica-tions for the standard-setting process to onewhich is now firmly a part of the standardsetters' substantive policy framework.

Economic ConsequencesAs a Substantive IssueEconomic consequences have finally becomeaccepted as a valid substantive policy issuefor a number of reasons:• The tenor of the times. The decade of the1970s is clearly one in which American soci-ety is holding its institutions responsible for

the social, environmental and economic con-sequences of their actions, and the crystal-lized public opinion on this subject eventu-ally became evident (and relevant) to thoseinterested in the accounting standard-settingactivity.

28 Financial Accotinting Standards Board discussionmemorandum. Conceptual Framework for FinancialAccounting and Reporting: Elements of FinancialStatements and Their Measurement (Stamford, Conn. :FASB, 1976), par. 367.29 Financial Accounting Standards Board, Stains Re-port, no. 45, February 7, 1977.^ S t r u c t u r e committee, p .31 .

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n The sheer intractability of the accountingproblems being addressed. Since the mid-1960s, the APB and the FASB have beentaking up difficult accounting questions onwhich industry positions have been well en-trenched. To some degree, companies thatare sensitive to the way their performancesare evaluated through the medium of re-ported earnings have permitted their deci-sion-making behavior to be influenced bytheir perceptions of how such behavior willbe seen through the prism of accountingearnings. Still other such companies have tai-lored their accounting practices to reflecttheir economic performances in the best light—and the managers are evidently loathe tochange their decision-making behavior in or-der to accommodate newly imposed account-ing standards. This would also be a concernto managers who are J>eing paid under incen-tive compensation plans.^'n The enormity of the impact. Several ofthe issues facing the APB and the FASB inrecent years have portended such a high de-gree of impact on either the volatility or levelof earnings and other key financial figuresand ratios that the FASB can no longer dis-cuss the proposed accounting treatmentswithout encountering incessant argumentsover the probable economic consequences.Particularly apt examples are accounting forforeign exchange fluctuations, domestic in-flation and relative price changes and the ex-ploration and drilling costs of companies inthe petroleum industry.n The growth in the information economics-socia! choice, behavioral, income smooth-ing and decision usefulness literature in ac-counting. Recent writings in the informationeconomics-social choice literature have pro-vided a broad analytical framework withinwhich the problems of economic consequen-ces may be conceptualized. Beginning withStedry," the literature on the behavioral im-plications of accounting numbers has grownsignificantly, drawing the attention of re-searchers and policy makers to the impor-tance of considering the effects of accountinginformation. The literature on incomesmoothing has suggested the presence of amanagerial motive for influencing the mea-surement of earnings trends. Finally, the de-cision usefulness literature, although it is

3' Alfred Rappaport, "Executive Incentives vs. Corpo-rate Growth," Harvard Business Review, July-August1978, pp.81-88.32 Andrew C. Stedry. Budget Control and Cost Be-havior (Englewood Cliffs, N.J.: Prentice-Hall, Inc.,1960).

conflned to the direct users of accounting in-formation, has served to lessen the inclina-tion of accountants to argue over the inherent"truth" of different accounting incomes and,instead, to focus on the use of informationby those who receive accounting reports."n The insufficiency of the procedural re-forms adopted by the APB and the FASB.Despite the succession of procedural stepswhich both boards have taken to provideoutside parties with a forum for expressingtheir views, the claims of economic conse-quences—and the resulting criticisms of theboards' pronouncements—have continuedunabated. The conclusion has evidently beenreached that procedural remedies alone willnot meet the problem.

• The Moss and Metcalf investigations. Bythe middle of 1976, it was known that Con-gressman John E. Moss (D-Calif.) and thelate Senator Lee Metcalf (D-Mont.) wereconducting investigations of the performanceof the accounting profession, including itsstandard-setting activities, and it could rea-sonably have been inferred that the respon-siveness of the standard-setting bodies to theeconomic and social effects of their decisionswould be an issue.n The increasing importance to corporatemanagers of the earnings figure in capital-market transactions. Especially in the 1960s,when capital markets were intensely com-petitive and the merger movement was fastpaced, the earnings figure came to be viewedas an important element of managerialstrategy and tactics. This factor is of im-portance in today's markets, as the pace ofmerger activity has once again quickened.• Accounting figures came to be viewed asan instrument of social control. The socialcontrol of American enterprise has been wellknown in the rate-regulated energy, trans-portation and communications fields, but inrecent years the earnings figure has, to anincreasing degree, been employed as a con-trol device on a broader scale.^ Examplesare fiscal incentives (such as the investmenttax credit and redefinitions of taxable incomethat diverge from accounting income) that

33 Committee on concepts and standards for externalfinancial reports. Statement on Accounting Theory andTheory Acceptance (Sarasota, Fla.: AAA, 1977), pp.5-29.34 DR Scott, though writing in a different context,nonetheless was prophetic in his prediction that ac-counting would increasingly be used as a means of so-cial control. DR Scott, Cultural Significance of Ac-counts (New York: Henry Holt and Co., 1931), esp.ch. 14.

62 The Journal of Accountancy, December 1978

have an influence on debates surroundingfinancial reporting,^^ the price-control me-chanism of Phase II in 1972-73" and thedata base contemplated by the Energy Policyand Conservation Act of 1975.D The realization that outsiders could in-fluence the outcome of accounting debates.Before the 1960s, accounting controversieswere rarely reported in the financial press,and it was widely believed that accountingwas a constant, if not a fixed parameter, inthe management of business operations. Withthe publicity given to the accounting for theinvestment credit in 1962-63, to the frac-tious dialogue within the AICPA in 1963-64over the authority of the APB and to otheraccounting disagreements involving the APB,managers and other outside parties havecome to realize that accounting may be avariable after all—that the rules of account-ing are not unyielding or even unbending.n The growing use of the third argument,advanced earlier in the article, in accountingdebates. Mostly for the reasons enumeratedabove, outside parties began to discard thepretense that their objections to proposedchanges in accounting standards were solely,or even primarily, a function of differencesover the proper interpretation of accountingprinciples. True reasons came out into theopen, and accounting policy makers couldno longer ignore their implications.

It is significant that economic consequenceshave become an important issue at a timewhen accounting and finance academicshave been arguing that the U.S. capitalmarkets are eflicient with respect to publiclyavailable information and, moreover, thatthe market cannot be "fooled" by the useof different accounting methods to reflectthe same economic reality.^''

The Dilemma Facing the FASBWhat are the implications of the economicconsequences movement for the FASB? Ithas become clear that political agencies(such as government departments and con-gressional committees) expect accountingstandard setters to take explicitly into con-

35 The "required tax conformity" issue of the early1970s (see Zeff, pp.218-19) is another instance.36 Robert F . Lanzillotti, Mary T. Hamilton and R.Blaine Roberts, Phase II in Review; the Price Com-mission Experience (Washington, D . C : Brookings In-stitution. 1975), pp.73-77; and C. Jackson Grayson,Jr., and Louis Neeb, Confessions of a Price Controller(Homewood, 111.: Dow Jones-Irwin, Inc., 1974), pp.71-76.37 See, e.g., William H. Beaver, "What Should Be theFASB's Objectives?" JofA, Aug.73, pp.49-56.

sideration the possible adverse consequencesof proposed accounting standards. This ex-pectation appears to be strongest where theconsequences are thought to be significantand widespread—and especially where theymight impinge on economic and social poli-cies being pursued by the government. Inthese instances, the FASB must show thatit has studied the possible consequences butthat the benefits from implementing the stan-dards outweigh the possible adverse conse-quences. Where the claimed consequenceshave implications for economic or socialpolicies of national importance, the FASBshould not be surprised if a political resolu-tion is imposed by outside forces.

To what degree should the FASB haveregard for economic consequences? To saythat any significant economic consequencesshould be studied by the board does notimply that accounting principles and fairpresentation should be dismissed as the prin-cipal guiding factor in the board's determina-tion. The FASB is respected as a body ofaccounting experts, and it should' focus itsattention where its expertise will be acknowl-edged. While some observers might opt fordetermining accounting standards only withregard to their consequences for economicand social welfare, the FASB would surelypreside over its own demise if it were toadopt this course and make decisions pri-marily on other than accounting grounds.

The board is thus faced with a dilemmawhich requires a delicate balancing of ac-counting and nonaccounting variables. Al-though its decisions should rest—and be seento rest—chiefly on accounting considerations,it must also study—and be seen to study—the possible adverse economic and socialconsequences of its proposed actions. Inorder to deal adequately with this latter func-tion, the board may find it convenient todevelop a staff of competent analysts fromallied disciplines, notably economics.

Economic consequences bids fair to be themost challenging accounting issue of the1970s. What is abundantly clear is that wehave entered an era in which economic andsocial consequences may no longer beignored as a substantive issue in the settingof accounting standards. The profession mustrespond to the changing tenor of the timeswhile continuing to perform its essential rolein the areas in which it possesses undoubtedexpertise. •

The Journal of Accountancy, December 1978 63