Everyone, it seems, likes to complain about the decisions of the FASB and IASB.  Some complain that the Boards are too beholden to the wishes of preparers, by allowing them to park debt off their balance sheets, hide volatile income numbers in the Statement of Changes in Shareholder’s Equity (rather than running through earnings), and delay taking impairments on a timely basis.  I am not sure I agree with these criticisms, but they form a plausible and coherent story:  Standard setters aren’t necessarily dumb, they’re just greedy.  Since this is an academic blog, instead of saying ‘greedy’ I will say they have succumbed to a form of ‘regulatory capture‘, which suggests that standard setters are being rational, but self-interested, and their self-interest lies in advancing the interests of the parties they regulate (the preparers).

But this story doesn’t work nearly as well for the criticisms of standard setters coming from the academic community.

Many academics have a completely different set of complaints, arguing that the FASB and IASB are making serious mistakes by eschewing conservatism and embracing fair value reporting.  And, to hear many academics say it, these positions aren’t just misguided, they are awful and indefensible.  I recall Zoe-Vonna Palmrose, in a very well-attended panel discussion at the AAA, using children’s stories and hand puppets to imply (if not explicitly state) that even children could understand the problems with fair value accounting.* Watts has made the point that conservatism and verifiability are bedrock aspects of accounting for hundreds of years, so the Boards are turning their back on time-honored traditions that work well.  Ohlson and Penman rely heavily on ‘common sense’ in justifying their alternative conceptual framework. And I can’t count the number of colleagues who have told me (as Ohlson and Penman as primary authors for an AAA-FASC report) that the Boards are crazy to focus on assets and liabilities, instead of focusing on a meaningful income number.

What I find remarkable about these criticisms is that they don’t seem well-explained by regulatory capture.  Many preparers, if not most, are strongly opposed to fair value accounting, which they see as expensive and impractical.  I suspect that many preparers also prefer conservatism in accounting standards, which allows them to show smoother earnings (especially when they have flexibility in reserves, which they typically do).  Preparers certainly don’t care for the asset-liability approach, which generally puts highly volatile numbers (fair value changes) into the income statement.

Perhaps the Boards are worried more about the SEC or Congress than about the preparers.  But Watts, in his analysis of ‘what the invisible hand has achieved’ in accounting,  implies that political pressures should lead accounting policy-makers to be conservative, not neutral, and to embrace verifiability rather than speculation—exactly the opposite of what the Board is doing.  So it seems unlikely that the Boards’ positions on these matters are simply politically expedient.

Let me emphasize, I am not saying that my academic colleagues are wrong on the substance of what good accounting standards should look like.  Fair Value accounting has its problems, conservatism does have a long tradition, and users do seem to want meaningful measures of persistent income.  I think the academics have defensible positions.  My question to those who back these criticisms is:  why do the standard setters seem to make such awful decisions?

  • It isn’t to curry favor with preparers, who seem to largely agree with the academics (but perhaps I am mistaken on what preparers prefer).
  • It isn’t to protect against SEC or Congressional action.
  • Perhaps it is to curry favor with financial statement users, like the CFA Institute.  But wouldn’t that be exactly what the standard setters should be doing?  Unless, of course, the users are dumb themselves, and don’t know what they want.  But that is not an argument I would expect to hear from many of the academic critics, who are also adherents to the Efficient Markets Hypothesis.

What am I missing?

*UPDATE:  Bill Kinney informs me my recollection is flawed — Zoe-Vonna did tell stories, and use voices for different characters, but as far as he recalls, did not use hand puppets.  Also, she did not tell children’s stories, but instead performed a skit/dialog with introductory accounting students.  Thanks to Bill for correcting the record.  However, I think my basic point goes through unchanged:  Zoe-Vonna implied that the errors of the FASB’s ways were so obvious that even introductory accounting students could identify them…again, begging the question of why the Board would make such decisions.