Chapter 1
1. Quoted in Giroux (1996), p. 105. John Carey (1904–87) was the long-time executive director and vice president of the American Institute of CPAs and, most of the time, serious.
2. Hermanson, Strawser, and Strawser (1993, p. 3).
5. The audit provisions were repealed, replaced, and changed over the century in various British Companies Acts.
7. Woolf (1912, pp. 164–67, 178–79).
8. Internal controls are the procedures in place to ensure reliable financial reports, such as separation of duties.
9. But often merged with American partners.
12. Zeff (2003). This led to a research paper I coauthored suggesting that audit quality rose and fell with regulatory severity. The empirical data over several decades supported the assumption that lenient regulation was associated with less stringent (“aggressive”) auditing. See Giroux and Cassell (2011).
13. Extensive problems with internal control was somewhat unexpected since internal control requirements had been on the books for decades and subject to federal law based both on the Securities Acts of the 1930s and the Foreign Corrupt Practices Act of 1975. See, for example, Giroux (2013), pp. 297–298 or Giroux (2014), pp. 114–115 for more information on internal controls.
15. For more information see the IIA website at na.theiia.org
Chapter 2
1. The original Roman tithe (literally, a tenth) was a 10 percent tax on harvests; the Romans were all for funding by booty, but the nearly complete conquest of the known world required a shift to various forms of taxes to fund public works and fill the pouches of bureaucrats.
2. This was the basic premise of Thomas Hobbes (1588–1679) in Leviathan, suggesting a social contract for the absolute powers of a sovereign to protect the population from wanton destruction—conveniently written during the English Civil War.
5. Hamilton was later accused of provoking the rebellion as a measure of social discipline. An additional problems was the tax was hard to collect and moonshine has been a problem ever since. See Hogeland (2012), Chapter 8.
6. Quoted in Stanley (1993, pp. 27–28).
7. Congressional Globe (1862, p. 1194).
8. A combination of errors, incompetence, bribery, and other forms of corruptions were likely reasons.
9. Inflation was an issue then. After the excesses of the 1920–30s, market value accounting was not allowed. Accelerated depreciation was considered an adequate alternative to deal with higher expected inflation after World War II.
10. Giroux (1996, pp. 124–125).
13. Most tax rates are for 2015, usually based on government Internet reporting. The rates shown are oversimplified and various other national and local taxes exist.
14. Rates as of 2016.
Chapter 3
3. According to Soll (2014, p. 104): “In his Leviathan (1651), Hobbes ascribed the very birth of logical reasoning to accounting. Without addition and subtraction, it was impossible to find the morally correct thing to do in politics.”
4. See for example Kocka (2016).
6. A Burgess initially was a representative of a borough in the English House of Commons.
7. Only white male landowners need apply. Election costs (including Washington’s) included booze and food for voters on election day. This was long before the secret ballot.
8. Charles Beard (1913) took the position that the framers were the monied interests holding government bonds and a prime motivation for a new constitution called for the finances to pay the interest and principal on this debt. This perspective was not universally accepted; see especially Hogeland (2012) for the elitist interpretation of the Revolution and beyond.
9. According to Hogeland (2012), Hamilton had a dual purpose of putting down the potential of western secession and make whiskey favorable to large distilleries (taxes were based on the size of the still rather than the whiskey produced). By extension, Hamilton signaled the importance of manufacturing and big business in general.
10. Congress had to establish a Treasury Department first, which was done in early September 1790. In fact, Washington had to lobby for all cabinet departments—departments were not mentioned in the Constitution. Hamilton got the job only after Robert Morris, the former Superintendent of Finance of the Continental Congress, turned it down. Unfortunately, Morris was headed for bankruptcy and debtors prison.
12. Federal Accounting Standards Board (undated), www.fasab.gov/mission-objectives.
13. McPherson (1988, pp. 19–20).
14. Woodrow Wilson was president of Princeton and a professor of political science. He was a leader of the progressive movement as part of public administration. He instituted many of the reforms he wrote about first as governor of New Jersey and then as president. See for example Berg (2013).
15. See for example Giroux (1989), Giroux and Shields (1993), Giroux and McLelland (2003).
16. I started a few research projects specifically on users of governmental annual reports. My first attempt was probably the most useful, surveying commercial banks holding municipal bonds. This group (and other bond holders) seemed to be the major user group (see Boyett and Giroux 1978). Later attempts proved more frustrating as various officials in a variety of circumstances (including British local governments) could not identify obvious users except for bond holders, usually resulting in footnotes rather than complete papers. Voters for example usually focused on budgets and headlines (such as fraud) rather than annual reports.
19. Public policy issues are similar, especially determining the fiscal needs of the government, the ability to continue to pay these obligations, and calculating the impact on the credit risk of the governments. A number of major governments such as Detroit have defaulted on debt or declared bankruptcy primarily over this issue. Elected officials seldom face reality when it means cutting current benefits and spending (and facing extreme opposition that would likely results in future election defeat).
20. The AICPA responded by replacing the multiple industry audit guides with two: healthcare organizations and not-for-profit organizations.
21. The IRS lists 27 specific charitable types of organizations subject to tax exempt status.
Chapter 4
1. Probably the major difference today is not risk motivations, but an institutional framework that straight-jackets many activities, requires audits, in other ways regulates large organizations, and limits government complicity. Corruption, fraud, and government corruption remain, but no longer all-pervasive.
2. Beginning in the 19th century and continuing ever since, accountants generally favored financial accounting and disclosure based on “accounting theory,” usually giving meaning to existing accounting practice (or how it should be practiced). Much of this analysis came from economists and engineers using and integrating accounting data within their own perspectives of needed financial and operating information.
4. See www.sec.gov for more information.
5. Commissioners William O. Douglas (later a Supreme Court associate justice) and Robert Healy were on record favoring the SEC to provide accounting standards. The final “vote” of three to two meant a one-vote swing would have changed the last 70 plus years of accounting regulation.
6. Accounting Principles Board (APB) No. 43, Para. 5.
Supplement B
1. In the ancient world violations could be capital offences.
2. See, especially, Andreas (2013).
3. Transparency International calculates a corruption perceptions index, with Somalia, North Korea, Sudan, and Afghanistan the most corrupt. Denmark and New Zealand were the least corrupt, with the United States at 19th place (www.transparency.org).
4. See Giroux (2013) for additional information on specific scandals.
Chapter 5
1. A gold standard is a currency system pegged to the price of gold. At the start of the Great Depression an ounce of gold was pegged to $35. A major reason for the depression was the Federal Reserve attempting to maintain the standard. After World War II the United States was on a gold exchange standard meaning governments could exchange foreign currency for gold at the pegged price. President Nixon went off the gold exchange standard in 1971, meaning the dollar would float against all other currencies; that is, be priced like any commodity.
2. By raising interest rates (and pulling dollars off the market), fewer loans were made, economic activity would slow down, and asset price bubbles prevented. On the downsize, higher rates often caused recessions.
3. A bull market is a period of rising stock prices usually caused by rising investor confidence. A bear market is a downturn in stocks of at least 10 percent usually caused by investor fears of negative factors.
4. The EPA is responsible for air quality, water, land, hazardous waste, and endangered species.
5. According to monetarist economist Milton Friedman it was “too much money chasing too few goods.”
6. The required annual financial report of a public corporation issued to the SEC and publicly available is called a 10-k. It is due within 60 days of the end of the fiscal year for large corporations. Contents include a management letter, financial highlights and various management reports, management discussion and analysis (MDA) including an analysis of financial risks, the financial section (auditor’s reports including internal control, income statement, balance sheet, cash flows statements, and statement of stockholders’ equity), notes which could be extensive, and an operating summary. See the SEC website for current details. Specific summary financial statement and links to 10-ks can be found on various financial websites such as Yahoo Finance.
7. The Sarbanes-Oxley Act changed the funding to be provided by public corporations based on the market cap of the companies.
8. Giroux (2013, Vol 1, p. 216).
9. Principles-based accounting standards are based on some accepted accounting theory or perspective. Actual implementation is usually left up to the judgment of the accountants and auditors involved. Some definition of meeting “economic reality” is common. Rules-based standards are based on detailed and usually rigid rules such as formulas, percentages, or specific dollar amounts. Economic reality is not a major consideration. The best example of rules-based accounting is leases.
10. The eight concept statements to date are: (1) objectives of financial reporting (1978, superseded by Statement 8; (2) qualitative characteristics (1980, superseded by Statement 8); (3) elements of financial statements (1980, superseded by Statement 6); (4) objectives of non-business organizations (1980); (5) recognition and measurement (1980); (6) elements of financial statements (1985); (7) using cash flows and present value (2000); and (8) objectives and qualitative characteristics (2010).
11. Principles-based standards require more judgment and fewer rules, seeking to determine appropriate measurement of economic reality. Because of the potential flexibility there is less uniformity across companies and a greater likelihood for manipulation. Rules-based pronouncements tend to be complex. Rules must be followed regardless of economic consequences and certain types of manipulation are enhanced. For example, most airplanes are leased using long-term contracts by airlines, but treated as operating leases and therefore “off-balance sheet.” Economic substance would require capitalizing these leases but the contracts just meet FASB Statement 13 requirements for operating leases. The use of operating leases using long-term contracts also is common for retail and fast food chains.
12. The vast number of pronouncement has been something of a nightmare for young accountants studying for the CPA exam; I was fortunate, taking the CPA exam just after Statement 1 was issued. After spending almost all of my career using statement numbers, I never fully embraced the shift to the codification.
13. See Financial Accounting Standards Board (2014, pp. 12–13).
14. Horizontal mergers involve acquisitions of companies in the same industry, such as Rockefeller’s Standard Oil buying out competing refineries. A vertical merger involves an acquisition in a related industry, such as Carnegie Steel buying a shipping line to move the company’s steel or iron ore mines. A conglomerate merger is buying a company in an unrelated industry, such as United Technologies buying a book publishing chain.
15. Goodwill is an accounting entry to balance debits to credits and, although recorded as an asset, has no obvious value beyond being a plug figure. Essentially if ABC pays $100,000 for XYZ and the revalued net assets of XYZ total $80,000, goodwill of $20,000 is recorded by ABC—the premium paid which apparently is supposed to mean something.
16. The same “economic substance” can lead to strikingly different entries and amounts. Under current GAAP all acquisitions use the purchase method, which limits manipulation and increases uniformity across companies.
17. Before APB Opinions 16 and 17 companies could use virtually any combination of purchase or pooling; in other words, pretty much record any value they wanted for acquired assets and liabilities. Whatever the reality, virtually any acquisition could seem like a bargain.
18. Conglomerates continue to be common. General Electric and Berkshire Hathaway are major conglomerates for example.
19. Some investment banks had a policy against advising on hostile takeovers, such as Goldman Sachs, claiming hostile takeovers seldom worked. With Goldman’s defense of EBS, a major new profit center developed, defense against hostile takeovers. Goldman often charged annual retainers whether companies were attacked or not and developed a “can’t-lose” strategy. As Goldman partner Steve Friedman put it (quoted in Ellis 2008, p. 278): “First, we’d win if we beat the raider off. Second, we could win by getting the raider to pay a higher price. And we would win if the target company got sold to another company—a white knight.” Along with Goldman, Kidder Peabody, Salomon Brothers, and Dillon Read specialized on the defensive end.
20. Investment grade bonds have Moody’s bond ratings from Aaa (highest) to Baa. These are considered relatively safe and thus “investment grade.” Moody’s ratings below that (Ba to C) are considered speculative and therefor below investment grade or junk bonds. Banks and others selling them prefer the term high income bonds rather the junk.
22. That is, the portfolio would be left at book value rather than written down to fair value.
23. The federal regulator was the Federal Home Loan Bank Board or FHLBB, which did manage to find many violations and started limiting the most reckless practices later in the 1980s. See the S&L entries in Giroux (2013).
24. Giroux (2013, Vol 2, p. 536).
25. Brokers sell goods and services for others. Most real estate is sold by brokers, for example. Dealers are effectively wholesales who buy and take ownership, such as automobile dealerships. Financial broker or dealers can serve either function. Taking ownership usually means greater potential profit but greater potential risks.
26. Quoted in Previts and Merino (1998, p. 369).
27. The original SFAS 123 was a political nightmare. The FASB could price options, wanted options to be expensed, and did require this information to be shown in the notes. However, massive lobbying by tech companies and business groups “convinced” Congress and the SEC not to require stock options to be expensed. FASB bowed to the pressure.
28. Restricted stock is (usually) common stock that can be exercised only after some period of time or certain events (such as some level of income or increased stock price) have happened.
29. See Giroux (2015), especially Chapter 4.
Supplement C
1. This essay involves many complex topics and explaining them in detail is beyond the scope of the book. Suggested additional readings include: Journal of Accounting: Centennial Issue, May 1987, which has several relevant essays; any intermediate accounting textbook; Giroux (1996); Giroux (2006).
2. If it was accounted for as a reported segment, some information was available. Under current GAAP only a single method, the purchase method, can be used.
3. Big corporations are not always accommodating when explaining complex operations, such as derivatives. Cititcorp, for example, presented useful tables for derivative and special purpose entities in 2007. After that, with a looming financial crisis, the tables disappeared. Citi joined other giant banks making analysis difficult.
4. These are expenses of the current accounting period.
5. Bad debts expense is reported in the 10-k, virtually all other allowance or reserve accounts are not. Consequently, a financial analyst has to rely on an analysis of bad debts to signal likely accrual manipulation.
6. Two of my books, Detecting Earnings Management (Giroux 2004) and Earnings Magic and the Unbalance Sheet (Giroux 2006) discuss these points in detail.
7. Canning’s Ph.D. dissertation was The Economics of Accounting.
8. Littleton received the first American PhD in accounting from Illinois. Paton continued to contribute to accounting for most of his 102 years. See Paton and Littleton (1940).
9. Replacement cost is a form of fair value where assets are recast as the cost to acquire them at the financial statement date and other financial statement items adjusted accordingly.
10. Presumably, any other set or sets of fair value such as liquidation value could be included as part of the financial statements.
11. Named for committee chairman Robert Trueblood, chairman of Big Eight firm Touche Ross, now Deloitte & Touche.
12. The AICPA also created the Wheat Commission at the same time, which recommended what became the FASB.
13. Financial Accounting Standards Board (1973), p. 13.
14. Miller, Redding, and Bahnson (1994).
15. Nonarticulation is the third DM alternative, giving up the balancing mechanism. The balance sheet and income statement do not have to balance. For example, earnings could be based on matching revenues and expenses, while assets and liabilities are measured on economic values independent of earnings measurement. The income statement could be based on historical cost, the balance sheet on current cost—presumably each based on the concept of the most relevant information available. After 800 years of double entry, an interesting intellectual exercise.
16. Capital can be maintained using either dollars or constant (inflation-adjusted) dollars under either method.
17. Defined as an estimate of market price of an asset, subject to risk and perceived utility. See SFAS No. 157.
18. See for example Zeff (2012) for a more thorough analysis of the international standards.
20. Critics complained the real purpose was to impose UK-favorable standards on the rest of the world—the “true and fair” view of British accounting. Alternatively, Benson may have favored standards better than available under UK GAAP.
21. Australia, Canada, France, Germany, Japan, Mexico, the Netherlands, UK and Ireland.
23. The SEC was not impressed, although historically, the SEC forced the FASB to back off several standards it disagreed with including oil and gas, troubled debt restructuring, goodwill, and stock options.
24. It seems likely that the FASB would prefer that some issues were banned, such as the use of special purpose entities. That not being an option, the standards setters struggle to deal with these issues.
Chapter 6
4. Forwards are contracts to buy or sell some asset at a specific price on a future date. Futures are standardized forward contracts traded on an exchange.
5. SPEs are now known by other name, including special purpose vehicle (SPVs). See SPE entries in Giroux (2013, Vol 2).
6. McLean and Elkind (2003, p. 155).
8. Swartz and Watkins (2003, p. 310).
14. See Giroux (2013, Volume 2), pp. 621–623.
15. Net assets were $25 billion while intangibles were $33 billion; thus net tangible assets were negative $8 billion.
17. See GAO (2002) and GAO (2006).
18. Considerable anecdotal evidence by former SEC chair Arthur Levitt and others suggested the connection, but audit research found little if any correlation between consulting and auditor independence violations.
19. This was somewhat surprising because internal control is fundamental to monitoring and had been a federal requirement since the Foreign Corrupt Practices Act of 1977.
20. Scrushy later was convicted of bribery in other case and sentenced to seven years in jail. HealthSouth did recover as a smaller company.
21. Partnoy (1996, p. 182).
23. This is a short section for a couple of reasons. First, there have been dozens of books on the scandal, although the analysis of the scandal seems still as much journalism as history. In addition, unlike the tech crash, accounting played only a supporting role, usually involving the same tools as the tech debacle.
24. For more on this point, see Calomiris and Haber (2014).
25. Replacing astrophysicists and microbiologists for using incomprehensible numbers.
27. McLean and Nocera (2010, p. 111).
29. See Giroux (2013), pp. 577–581.
30. Congress passed the Home Ownership and Equity Protection Act in 1994, which banned most predatory practices. The Federal Reserve had enforcement authority, which was basically ignored by Alan Greenspan’s Fed.
31. The hedge fund operators, Ralph Cioffi and Matthew Tannin, were later arrested by the FBI for fraud but not convicted. The lack of success in this case may be one reason none of the other Wall Street perpetrators were ever indicted.
33. Reported in Wessel (2009, p. 3).
34. Reported in Cohan (2009, p. 446).
35. Reported in Wessel (2009, pp. 173–4).
36. The Fed provided liquidity, but not equity—the money had to be paid back.
37. Congress expected the Treasury to buy mortgages and other toxic assets, getting them off the banks’ balance sheets.
38. The bailouts came at a high cost; according to the Special Inspector General for TARP (Barofsky 2012, p. 162). 50 federal programs arguably could have cost $23.7 trillion, as follows:
Federal Reserve |
$6.0 trillion |
FDIC |
2.0 |
Treasury |
7.4 |
Other |
7.2 |
Total |
$23.7 trillion |
39. Former Fed Chairman Paul Volcker proposed banning banks from proprietary trading, trading on their own account—because of insider information and likely conflicts with customers.
40. Specifically, the Basel Committee of the Bank of International Settlement in Basel, Switzerland, with central bank representatives from major countries, beginning in 1988 with Basel I.
Supplement D
1. Son Henry Babbage later built demonstration models of Babbage’s Differential Engine, one of which was discovered at Harvard in the 1930s and incorporated in IBM’s Mark I, built in 1941. It was not binary and used mechanical relays.
5. Transistors, semiconductors with at least three terminals and used initially as a switch replacing vacuum tubes, were developed at Bell Labs in the 1940s. See Gertner (2012).
6. Because of the chaos in 1965, IBM had to physically count their work in process inventory and had underestimated the amount by almost half a billion dollars.
7. At this time, the industry was characterized as “Snow White and the Seven Dwarfs.”
8. Why didn’t Xerox dominate the computer market? They did build the Altos computer but did not market it to the public, because: “The computer will never be as important to society as the copier” (Isaacson 2014, p. 294).
9. See, for example, Hall (2013, Chapter 2).
Conclusions
1. CEOs and governing boards may differ—such as the concept of earnings to improve future good works versus raising executive pay.