Whittington Article Summary

The profession of an accountant and the accounting practices

The profession of an accountant and the accounting practices have gone through some drastic alterations during the half of the past century. The initial discussion by the experts, academics, setters, and practitioners around the financial reporting's measurement method. In his article, Whittington provides a detailed overview of financial reporting measuring methods over the past fifty years. The article traces the measurement evolution methods from current accounting cost, fair value, and the subsequent confidence loss in fair value accounting and academic research shift that turned from deductive to empirical. This summary concerns the limitations concepts of the current cost accounting rise in the 1960’s, Golden Era decline and the debate surrounding fair value accounting.

Gain in prominence of current cost accounting: 1965-1980

Whittington (551) points out that in 1965, historical cost (HC) accounting was the dominant measurement method with current values limited in their usage. However, the 1960’s was a period of rising inflation, which got to its peak in the 1970’s and 1980’s and as a result, it was the primary concern for accounting regulators at the same time; it posed a serious challenged to HC accounting. In addressing this problem, academics proposed using constant purchasing power (CPP) accounting to measure inflation. Others proposals included using “exit” and “entry” values, replacement cost accounting, and value to the owner (VTO). As inflation surged in the 1970’s, the use of CPP accounting grew in Latin America, Australia, and Europe. A limitation of CPP is that it still uses HC as a base and provides adjustments in a supplementary statement through a general price index. The effect was making the statements complex and crucially, did not report on the current prices, and as a result, CPP did not garner enough support. Most governments favored a measurement method to capture specific rather than general price movements. The 1970’s saw confusion arise over inflation accounting, particularly in the U.K and this led to the passing of SSAP 16 on making adjustments on inflation on monetary items. By the year 1980, the U.S and U.K were leading the movement for the use of CCA; as a replacement cost which is capped by the recoverable value of the business (Zeff 57).

The 1960’s is the “golden age” in accounting research

The 1960’s is the “golden age” in accounting research where scholars such as Edwards and Bells made a significant contribution in the field of inflation accounting. Another scholar is Chambers who proposed CoCoa measurement method; assets measured at “current cash equivalent.” Most of this research was deductive, and it relied on the previously theories proposed by economists. A significant limitation of this approach was the disagreement by academics on the issue of inflation accounting and calls for reconciling ideas did not yield fruits. The effect was the decline in the interest in inflation accounting, and deductive research was phased out by the growing empirical research paradigm in the 1970’s. A benefit of this new approach was that it would help in determining the practical effect of measurement methods and financial information on the users. The 1980’s shifted the debate of accounting research from the technical analysis (the how) to the why and what of empirical research.

The phasing out of CCA: 1980-1990

As earlier pointed out, CCA was the method used in the U.S and U.K, and the respective accounting bodies had issued disclosures in this respect. However, the 1990’s saw the withdrawal of CCA standards because of little support from the users and preparers of financial statements. Empirical studies showed little evidence of the use of CCA information by both internal and external users and they did not ask for its recognition. Also, auditors and board of directors were against CCA resulting in loss of credibility and limited use. Also, the fall of inflation in the 1990’s as a result of the tight monetary and fiscal policies made accounting for price level changes no longer required (Zijl and Whittington 121). Rutherford (246) observes efforts to establish inflation accounting was ill-tempered, arduous, and unsuccessful with Whittington (556) makes the crucial point that all this discussion did not solve the initial challenge of measuring specific assets.

The rise of fair value: 1990-2006

Whittington (551) pointed out that even in the absence of inflation, specific assets undergo price changes. There has been pressure to recognize these changes, particularly in valuing financial instruments. Fair value (FV) was proposed as an alternative to the collapsed CCA and in the early stages, there was confusion on the treatment of transaction costs. Also, it was not clear from which point would measurement occur: the seller or buyer but the FASB ended this debate in 2006 by concluding that it is a selling price. Hitz (323) point out that fair-value accounting relies on market-based measures which provide information in an efficient and objective manner relevant to the future cash-flows of a firm. The standard setting bodies further showed their support for FV, for instance, the IASC (now IASB) passed IAS 39. However, opponents argued that FV ignores the stewardship role of financial reports and rejects prudence as a practice. It makes the flawed assumption that the markets are efficient and liquid enough to allow the reliable estimation or measurement of exit prices.

The fall of fair value: 2007-2015

The decline in support of fair value after the year 2006 was as a result of opposition from the preparers. The article also identifies the changing composition of the standard-setting boards such as IASB. For instance, all the technical experts retired in 2001, and the replacements have less technical knowledge but have an orientation towards diverse business backgrounds, a move heavily criticized. The IASB also has been facing challenges in lobbying for the adoption of FV in the developing countries whose capital markets are not well developed.

The global financial crisis

The global financial crisis is the primary turning point where some individuals argue that fair value accounting was responsible (Laux and Leuz 826). However, empirical research on the issue found little evidence that FV lead to the global financial crisis. According to Laux and Leuz (93), fair values have a limited role in the income statements of financial statements and as a result, there is little reason that FVA was behind the banking industry problems. However, these studies did little to restore the damaged confidence in FV as a measurement method for financial reporting.

Academic research: 1980-2015

Empirical research was the main form after doing away with deductive reasoning that led to CCA. Major contributions made during this period relate to valuation models, the social and political context of accounting policies, and the reaction of the stock markets to financial reporting information. Over this period, the focus of theoretical research has been on the incorporating the concept of valuation in standards as well as expanding the conceptual framework of financial accounting. Also, there has been significant progress made on other measurement approaches such as VTO and replacement cost.

Conclusion

However, Whittington (565) makes the sobering conclusion that despite all the research and endless debates, little has been achieved in the area of a measurement method for assets and liabilities. Historical cost is still the predominant method in the financial reports, the same situation in 1965. All the debate on CCA and FV has yielded nothing in developing an appropriate measurement base. It is, however, essential to appreciate the fact that financial reports are more informative because they include disclosures which contain alternative measures such as FV and recoverable amounts. The article also points out that bodies such as the IASB and FASB have the challenge of developing a framework that allows comparability of the financial reports all over the world.

In conclusion

In conclusion, the past fifty years have seen the development of various measurement methods for financial accounting. Historical accounting was the predominant means in the 1960’s, but it was becoming less useful because of the inflationary pressure at the time. CPP and then CCA were the alternatives, but they faced resistance from the users and preparers as well as being made irrelevant by the changing economic conditions (decline in inflation). Fair value accounting was then touted as the method to resolve the issue of price changes in specific assets but events such as the global financial crisis dented the confidence of the users. Therefore, there has been massive progress in understanding of current value measurement methods, but the predominance of historical accounting is an indicator that academics and standard setters have to develop a framework that allows the application of similar measures to similar items in similar situations.

Works Cited

Hitz, Joerg-Markus. "The decision usefulness of fair value accounting–a theoretical perspective." European Accounting Review 16.2 (2007): 323-362

Laux, C. and Leuz, C., 2009. The crisis of fair-value accounting: Making sense of the recent debate. Accounting, organizations and society, 34(6), pp.826-834

Laux, Christian, and Christian Leuz. "Did fair-value accounting contribute to the financial crisis?." The Journal of Economic Perspectives 24.1 (2010): 93-118

Rutherford, Brian A. "Financial reporting in the UK: a history of the accounting standards committee, 1969-1990." (2007)

Whittington, Geoffrey. "Measurement in Financial Reporting: Half a Century of Research and Practice." Abacus 51.4 (2015): 549-571

Zeff, Stephen A. "The SEC rules historical cost accounting: 1934 to the 1970s." Accounting and Business Research 37.sup1 (2007): 49-62

Zijl, Tony van, and Geoffrey Whittington. "Deprival value and fair value: a reinterpretation and a reconciliation." Accounting and business research 36.2 (2006): 121-130