At the last round table session, we were discussing something and a comment came up about “history matters….” I was thinking that I should clarify where that comment comes from .. give an example. Just a couple of years ago, I had no idea what that phrase meant.

Here goes …

Should the accounting differ depending on the path something took to get where you are now?

Simple example: Consider a company that has a callable bond payable. Under US GAAP, that’s treated all as a liability. The call option (which is an asset to the person who has the bond payable) is an asset, but we do not break it out under current GAAP.

Consider an otherwise identical company that has a plain vanilla bond payable. They enter into a separate contract — a call option on that bond payable. Here the accounting is different because of the history (how they got there). Here, there would be a call option asset on the books and a bond payable.

Should the accounting be different here?  The economics of things are the same between the 2 situations?

During the session, somebody asked me about research on this topic, as I made a remark that this was a big deal topic worthy of research. I offered to sell my ideas, but nobody took me up on that one. Wonder why?

How about a free idea, then, here! I am working on a paper now (thought piece) with Bud Fennema at Florida State on mental accounting and its use in financial reporting topics. The low down is that this theory accomodates ideas such as history matters to people. Now you’d have to be creative to think about how to map it into the financial reporting domain, but that’s the fun of research eh?

The similarity has to do with the lost theatre ticket study by Kahneman and Tversky. Kahneman and Tversky (1984) show that individuals are less willing to buy a ticket to a play after having lost their ticket than after having lost an equivalent sum of money. Buying a second ticket is unattractive because it is included in the same mental account for the theatre outing, but the loss of the money is not. From an economic standpoint, the loss of money should be equally painful in both situations.

You might be thinking the parallel is a bit far fetched. Perhaps it is .. and i have not thought about this for days on end. But … maybe we can help understand some difficult issues in financial reporting by trying to think broadly. You never know…