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Contractors Estimation And Accounting System World History Essay Help

Explain a Contractors Estimation and Accounting System

A contractors accounting system consists of the methods and records used to identify, assemble, analyze, classify, record, and report a contractors transactions, assets, and liabilities (Defense Contract Management Agency (DCMA), 2019). Conversely, a contractors cost estimation system refers to the policies, practices, and procedures for generating cost data and other data included in cost proposals that are submitted to the government in the expectation of obtaining contract awards (DCMA, 2019). An adequate cost estimation system should maintain a consistent approach, utilize sound estimation techniques, make use of appropriate source data, and follow established procedures as per the federal acquisition regulations (FAR) (DCMA, 2019). A good accounting system needs to be well-designed to prevent mistakes and provide reliable accounting data (DCMA, 2019). The adequacy of a contractors accounting and cost estimation systems determines whether or not they receive a contract offer. This research paper seeks to determine what the literature identifies as the primary characteristics of an adequate accounting and estimation system.

Background to the Study

The requirements for effective cost estimation and accounting systems for government contractors are covered in the Federal Acquisition Regulations (FAR). FAR 15.407-5 acknowledges that acceptable contractor cost estimation systems benefit both the contractor and the government by increasing the reliability and accuracy of individual proposals. For this reason, contractors are required to subject their cost estimation systems to regular audit reviews geared at assessing their reliability. The auditor is to record results of such reviews in a report that also indicates deficiencies and corrective action. Significant deficiencies not corrected by the contractor are a consideration in subsequent proposal negotiations for government contracts. Similarly, the need for an adequate cost accounting system is emphasized in FAR 31.201-1. This provision requires the contractor to accurately capture all direct and indirect costs allocable to the contract, while properly adjusting for applicable variances. The FAR provisions point to the importance of maintaining an adequate cost estimation and accounting system, thereby providing a rationale for this study.

Literature Review

Factors Influencing Accuracy of Cost Estimates

Researchers have carried out multiple studies to identify the factors influencing the adequacy of project cost estimation and accounting systems. Although studies focused specifically on government contractors are limited, a lot of literature is available on cost estimation and accounting in projects generally. In one such study, Hatamleh et al. (2017) distributed a questionnaire to 265 construction project managers to identify the factors that influence the accuracy of cost estimation systems. The study findings showed that the accuracy of cost estimation systems is influenced by several factors including: past pricing experiences, project complexity, how well the scope of the project is defined, the accuracy and reliability of cost information, the cost estimation techniques adopted, and availability of historical data (Hatamleh et al., 2017). Another study conducted by Arif et al. (2015) to analyze the factors influencing the accuracy of cost estimates in construction projects found that that obtaining timely input from subcontractors as well as material manufacturers and suppliers significantly helped to increase the accuracy of cost estimates.

Factors Influencing Quality of Accounting Systems

The accuracy of cost estimates largely depends on the effectiveness of the accounting system (DCMA, 2019). The Defense Procurement and Acquisition Policy (DPAP) identifies several qualities of a good accounting system including: alignment with generally accepted accounting principles applicable to the contractor, proper segregation of direct and indirect costs, a logical and consistent method of allocating indirect costs to cost objectives, exclusion from costs charged to government contracts of amounts not allowable under FAR Part 31, allowing for progress payments, and segregation of preproduction and production costs (DPAP, n.d.). The aspect of segregation of direct and indirect costs is further emphasized in a study by Fitrios (2016), which sought to identify the factors affecting the quality of accounting information from 42 Indonesian hospitals.

Knowledge Gaps

Evidently, a lot of literature exists on the determinants of effective cost estimation systems. However, most studies focus on projects in general, without specific focus on government contracts. This research applies the concepts obtained from the literature review to the context of government contracts.


From the conducted literature review, one could deduce crucial insights on the characteristics of an adequate cost estimation and accounting system. An adequate cost accounting system for a contractor would have the following qualities: a) align with generally accepted accounting principles (GAAP) and FAR; b) properly and accurately segregate direct and indirect costs; c) consistently and logically allocate indirect costs to cost objectives; and d) segregate pre-production from production costs (DCMA, 2019; DPAP, n.d.). The accounting system forms the basis of future cost estimation and hence, a good accounting system increases the likelihood of obtaining accurate cost estimates (DCMA, 2019). Thus, an effective accounting system is one of the requirements for an effective cost estimation system. Other crucial features of an adequate cost estimation system include: a) it provides for the use of historical accounting information, b) the contractor integrates information from other relevant management systems, c) the system employs scientifically-proven cost-estimation techniques, d) the system identifies the sources of data and rationale used in developing estimates, e) the system provides for the timely detection and correction of errors, and f) the contractor assures that personnel have adequate training on cost estimation (DCMA, 2019).


Based on the above findings, this research makes several conclusions. First, the effectiveness of a contractors accounting system determines the accuracy of their cost estimates and hence, how good their cost estimation system is. The auditor thus needs to assess the effectiveness of the contractors accounting system, including how well it segregates direct and indirect costs, allocates indirect costs to cost objectives, and aligns with generally accepted accounting principles.


This research sought to identify the features of an effective cost estimation and accounting system. Data was collected through a systematic review of literature focused on cost estimation and cost accounting in projects. The study found that a good accounting system accurately segregates direct and indirect costs, logically allocates indirect costs to cost objectives, and aligns with generally-accepted accounting principles applicable to the contractor. At the same time, an effective cost estimation system makes use of accurate accounting data, takes into account historical accounting information, employs scientifically-proven cost-estimation techniques, integrates data from all relevant management systems, and allows for the early detection of errors. It is prudent that auditors investigate these areas when assessing the effectiveness of a contractors cost estimation and accounting system.

Future Research Recommendations

Most of the studies reviewed in this research were based on construction projects outside the United States. It is not clear whether the findings would be applicable to government contracts in the US. There is a need for empirical studies focused specifically on government contractors in the US to determine whether the findings would be similar.


Arif, F, Lodi, S., & Azhar, N. (2015). Factors Influencing Accuracy of Construction Project Cost Estimates in Pakistan: Perception and Reality. International Journal of Consruction Management, 15(1), 59-70.

Defense Contract Management Agency (DCMA) (2019). Contractor Business Management. Defense Contract Management Agency (DCMA). Retrieved from

Defense Procurement and Acquisition Policy (DPAP) (n.d.). Reviewing the Contractors Pricing and Accounting Practices. Defense Procurement and Acquisition Policy (DPAP). Retrieved from

Fitrios, R. (2016). Factors that Influence Accounting Information System Implementation and Accounting Information Quality. International Journal of Scientific and Technology Research, 5(4), 192-98.

Hatamleh, M., Hiyassat, M., Sweis, G., & Sweis, R. (2017). Factors Affecting the Accuracy of Cost Estimate: Case of Jordan. Engineering, Construction and Architectural Management, 25(1), 113-131.

Primary Goods and Services Traded By the US history assignment help book: history assignment help book

As postulated by David Ricardo, a system of perfectly free commerce translates to high benefits to participating trading countries (Ricardo, 1951). In this section, the paper engages trade barriers in the US during the 1980s. Furthermore, advantages and disadvantages of these factors are considered in this segment.

Primary Goods and Services Traded By the US Internationally

Around the 1980s, the US held a dominant position in many export markets. The latter was because of its economic prowess and advancements in the manufacturing and technology segments. Consequently, most of its export product groups included electrical and computer machinery, aircraft, and spacecraft, and vehicles (Baily & Bosworth, 2014). The country also exported educational, financial, and legal expertise in addition to military related services but imported crude oil, pharmaceuticals, machines, and engines. Lastly, people service imports such as installation, maintenance, and troubleshooting of parts and equipment were imported by the nation.

Trade Barriers

During the 1980s, import policies such as tariffs, quotas, and customs inhibited favorable trade between the US and its trading partners. Additionally, limits on foreign equity participation locked out American firms from having a significant stake in foreign industries (Baily & Bosworth, 2014). Besides, some nations restricted the extent of service provision by foreign professionals. As a result, these factors slowed favorable trade between the US and its partners.

Pros and Cons of Trade Barriers

Pros of Import Policies

Tax revenues for the government.

Domestic producers receive higher prices for goods and services.

Cons of import policies

Costlier imports were translating to higher prices for consumers.

Increased cost of doing business in a foreign nation.


Enterprise resource planning (ERP) remains an integral element in smoothing business processes contributing towards the overall growth of firms (Schniederjans & Yadav, 2013). However, the success of this process relies on sufficient standardization of processes across a companys segments through an understanding of existing gaps and intended goals. In this section, the implementation ERP in LG Electronics, a global electronics consumers giant is discussed.

Standardization of Processes across LG

LG Electronics focused on harmonizing the firms HR functions. This was meant to counter challenges that include high maintenance costs, inefficient decision-making, manual processes, and lack of transparency in local controls (Bradford, et al., 2014). In addition, the company faced issues with disengaged employees and limited localized resources meant to fund employee learning and training. In the implementation of the ERP system, LG engaged Oracle Consulting to put in place a single centralized system intended to replace dependency on the location specific system. Consequently, a single centralized system was proposed for implementation.

The system brought forth various benefits to the company as listed below:

Increased employee productivity and morale.

Transparency in employee and recruitment appraisal processes.

Cost savings because of having a single system.

Automation modules allowed full production control as per demand.


ERP systems place a critical role in organizations depicting high costs and variable time frames. Successful implementations of ERPs rely on a careful selection of vendors and solutions to be implemented. In addition, an understanding of the existing gaps facilitates the realization of the desired goals. In the case of LG Electronics, an engagement of Oracle facilitated the implementation of a centralized system meant to smoothen processes within the company. As a result, LG managed to realize the benefits of ERP through a thorough and extensive implementation process.



Bradford, M., Earp, J. B., & Grabski, S. (2014). Centralized end-to-end identity and access management and ERP systems: A multi-case analysis using the Technology Organization Environment framework. International Journal of Accounting Information Systems, 15(2), 149-165.

Schniederjans, D., & Yadav, S. (2013). Successful ERP implementation: an integrative model. Business Process Management Journal, 19(2), 364-398.




Conservatism in Accounting Valuation Paper advanced higher history essay help

Conservatism in Accounting Valuation

Accounting is used to determine the financial health of a business or individual. As such, it is carefully regulated and those who practice it for compensation are required to have education and certification. There are various rules, laws, and principles that govern the business of accounting and that are commonly used in order to ensure that those who work as accountants are handling others’ money and financial information correctly. Because there are only a few accepted methods of accounting, it is possible to learn them all and determine which one of them would be best for a client. That way, an accountant can help his or her client save the most money on taxes and create an accounting system that can be more easily used and dealt with by accountants for the company in the future. Among the principles that are often seen in the accounting profession is the conservatism principle, which will be the focus of the information presented in the following pages.

1.1 Conservatism Principle

In short, the conservatism principle says that, when an accountant has the opportunity to choose between two specific solutions, he or she should select the choice that will be the least likely to overstate the individual or company’s income and assets (Ball, Kothari, & Robin, 1999). Furthermore, the principle indicates that expected gains should not be counted as gains, but expected losses should be counted as losses. Based on this, when stock closes it is valued at the market price or the cost price, whichever is less (Ball, Kothari, & Robin, 1999). Doubtful or bad debts have their own provisions, but each debt that is expected to occur is counted in order to underestimate how much money the company may have earned or will see as its bottom line. When the recognition of gains is delayed and expected losses are acknowledged promptly, it is much easier for the company or individual to see where there are problems – and that will often allow the company to realize a final number better than what was anticipated by the accounting system they have in place and by the accountants who work for that company.

1.2 Widely used

Conservatism has been adopted in accounting because of the benefits it provides to agents that use, prepare, and/or regulate financial reporting (American, 1939). When a financial manager or accountant provides information to a client, and then the client sees later that his or her company or portfolio has actually performed better than expected, that is obviously good news. By using conservatism, it is easy to be realistic about the debts that are being incurred and the income that is coming in without overestimating income and ending up with figures that paint an inaccurate picture of the company’s or individual’s actual financial concerns. Accountants must be open and honest with their methods, and must follow accepted practices. Despite that, however, there are ways in which they can use those practices to underestimate or overestimate the income and assets of a client (Chadwick, 2000).

Overestimating can be troublesome and can lead to problems with the bottom line (Ahmed, et al., 2001). Underestimating is a better option, because it requires clients to operate in a more conservative financial manner and that means they will usually have more savings to enjoy instead of having more debt and less money than they anticipated. All of the approved and commonly-used ways of handling accounting are legal and acceptable, but that does not mean that they are all as valuable or that they all work as well as some of their counterparts. When accountants debate with their clients which method to use, conservatism is the most commonly suggested method because of the benefits that it is able to provide to the client (Ahmed, et al., 2001). A good accountant can discuss those benefits and show his or her client the value behind the method he or she proposes, so that everyone is on the same page financially.

The use of conservatism is long and highly significant, with evidence of the practice dating back over 500 years (Ahmed, et al., 2001). It has also been rated as the most significant and influential practice in accounting. Recent research has provided insight into the fact that accounting valuation has actually become even more conservative recently, which is surprising since there are so many who are very vocal in their opposition of the practice. Because the practice is resilient to criticism and has been widely used for such a long period of time, there are indications that critics are missing many of the benefits that others are seeing when it comes to this style of accountancy.

In order to determine why this is the case, however, what those benefits actually are must be determined. If conservatism is simply avoided, the concern is that doing so could have a detrimental effect on accounting in general, and that it would be problematic for anyone who was used to conservatism in their accounting practices.

2. Overview of Conservatism

In order to clearly understand conservatism, it is important to address the four perspectives that are included within it. That way, it is easier to see the issues that are being faced by the accountants who choose to use conservatism and one can better determine the merits of that option. As such, there will be four perspectives of conservatism discussed here, encompassing contracting, litigation, income tax, and regulatory issues. By addressing them all, a more complete picture of how conservatism works in accounting and how it is able to include all aspects of the accounting profession can be seen. If only some of the principles are addressed, that can make it more difficult to show the value of conservatism when it comes to accountancy and can also make it more difficult for accountants to justify the use of that particular style when they provide services to others.

2.1 Four Conservatism Perspectives

As has been mentioned, there are four perspectives included in conservatism. Each one of them will be addressed here and discussed thoroughly, to form a better and more complete picture of the principle.

A. Contracting perspective

The majority of contracts that are seen between parties to an accounting firm use numbers that help to reduce the agency costs that are specifically associated with that firm (Brooks & Buckmaster, 1976). That can include contracts that are seen between the firm and the holders of debt, employment contracts, contracts for management compensation, and cost plus sales contracts. Any of the parties to a contract generally expect (and often demand) the measures of performance as well as net asset values are provided in a manner that is timely. Being timely helps to avoid outcomes that can otherwise be dysfunctional.

In contracts, earnings are used in order to restrict the dividend payments to the shareholders and keep a minimum level of assets within the firm so that there is backing for the level of outstanding debt that firm has (Bliss, 1924). Whether earnings decrease or increase, reporting that information in a manner that is timely helps to ensure that shareholders are provided with the right information. It can also help the firm manage its debt correctly, because creditors will be more aware of the level of debt the firm has based on its earning power and assets – which can affect issues such as credit ratings and the percentage of interest the firm will be asked to pay on any new or refinanced debt.

When a company estimates what its earnings will be in the future, there is no way to verify that information. It may end up being correct, or it may be far off in either direction due to something unexpected that takes place in the future. Since that is the case, it is highly possible for a company that is not using conservatism in accounting valuation to end up in financial trouble. By making sure conservatism is used, no verification is necessary because there is no speculation. Everything that is claimed as income and assets has already been acquired, and anyone wanting to verify that can easily do so.

B. Litigation Perspective

The idea of litigation under the Securities Act generally encourages the idea of conservatism (Antle & Lambert, 1988). The reason behind that statement is that litigation is far more likely to be seen by the overstatement of assets and earnings instead of the understatement of that information. Since the costs of litigation are expected to be much higher with overstatement than with understatement, it is wise for firms to err on the side of caution and significantly lower their litigation risk and the costs which are associated with that risk. The lowering of that risk is a good incentive for auditors and management to understate both the net assets and the earnings that are held by the company.

Unlike the contracting perspective, which dates back hundreds of years, the litigation perspective only goes back to 1966 in the United States (Antle & Lambert, 1988). That was the year that significant changes were made in the Securities Act and the rules for bringing class action lawsuits were adjusted and modified. Because of those changes, it became more important from a litigation standpoint to ensure that conservatism was used in accounting valuation. Because there are empirical differences between the contracting and litigation perspectives, there have been many discussions regarding them in the past and that will likely continue well into the future. Each accounting firm must do what it feels is in the best interest of both itself and its clients, but the avoidance of lawsuits is a highly significant issue to consider when a company is planning to focus on a particular accountancy option.

C. Income Tax Perspective

Because income taxes are so closely tied to earnings, it only stands to reason that there would be an accounting valuation issue as it relates to conservatism where income tax is concerned (Ball & Watts, 1972). Income taxes often influence how earnings are calculated. Depreciation, for example, must be recorded as an expense now, due to changes requested by the U.S. Treasury. If it is recorded that way in any and all reported financial statements, that makes it possible for it to also qualify as tax deductible. Now that the depreciation laws are so well established they no longer influence taxable income – but the accounting laws still have a strong effect on how the taxable income of any company or individual is reported (Ball & Watts, 1972).

There have been many court decisions over the years that have also served as precedents for the ways in which income reporting and other accounting issues have been handled. As long as a firm is showing a profit and has taxable income and positive interest rates, there is an incentive to defer income so that the present value of taxes can be reduced. This leads to the understatement of assets in many cases, so that taxes will be lower and the company will not have to pay out as much to the IRS. This may sound illegal, but it is not. The income will be properly reported when it is received and is not hidden. It is simply not reported on anything as a speculation and is kept off of the books until it is actually acquired. In this sense, the income tax perspective shares much with the contracting perspective, as both are interested in minimizing current assets for various reasons.

D. Regulatory Perspective

Regulators and those who set standards have reason to be conservative, because they know that overvalued assets and overstated income (and the losses that those things frequently produce) are more easily seen by others than foregone gains due to the fact that everything was understated and undervalued (Beaver, 1993). That does not mean that understating things will never be noticed, but only that it is less observable – and viewed as far less of a problem. It is one thing for a company to make more than the market was expecting, but it is quite another thing entirely for that company to make less than the market had planned.

Making more indicates that the company was actually doing better than anyone would expect. Making less indicates that the company was not performing well, but that it was trying to convey a good performance until it was no longer able to do so (Beaver, 1993). There have been several cases of companies doing this illegally in the past, but there are more legal ways for something like that to occur, also. Avoiding that is by far the best choice for companies, all of which should be focused on handling their earnings in a conservative manner.

Accounting overvaluation was even blamed for what took place in the Stock Market in 1929 (Beaver, 1993). Since history has shown how badly that turned out, there are more and more regulatory bodies that are leaning toward the idea of remaining conservative with virtually any and all accounting practices.

2.2 Empirical Approach

In order to address the empirical approach to this issue, it is very important to understand that there are two different types of conservatism: unconditional (balance sheet) conservatism, and conditional (earnings) conservatism. These are very different in how they are used, and those who work in accounting must be clear on the differences so that both approaches can be used properly. Without using a specific kind of accounting approach correctly, a company can easily have a problem where its assets are concerned.

In unconditional conservatism, there is a greater focus on the expense of the costs of most intangibles (Benston, 1969; Carhart, et al., 2002). For example, this could include the costs for research and development, intellectual property, and other things that are generally not seen and are not part (in a sense) of the finished product or service. Intangibles are not things that the company can touch, but they are certainly very real and they have to be clearly and properly addressed in order to be used by the company as a savings device where accountancy is concerned.

When looking at the balance sheet, is the company really including all of the costs? Are intangible costs being included, and are they being priced fairly and equitably? If they are not, they certainly need to be. Research and development, as well as other intangibles, are expenses that are seen by the vast majority of companies – and those companies will want and need to show those as real expenses when and as they occur (Basu, 1995; Basu, 1997). If they have paid money out for something, or if they have acquired a debt in relation to something intangible, showing that right away is vital to proper conservatism in accounting.

With conditional conservatism, there is less of a focus on the balance sheet and the costs, and more of a focus on the earnings side of the issue (Basu, 1997). Conditional conservatism can help to balance out the asymmetry that is often seen in recognition of earnings and that is also often present with unrealized gains and losses. Impairment of assets would be one example of this. If assets are not functioning correctly and cannot be used (i.e. broken, malfunctioning, or obsolete equipment), they can quickly change from providing gains to providing losses for the company who must repair or replace them.

By having timeliness in both gains and losses, a company is better able to show how its financial bottom line really looks to Wall Street and to potential investors and creditors (Ball, Kothari, & Robin, 2000). The goal is to be honest about finances, but also to paint the company in the best possible, legal light. There are ways to do that, and conservatism is one of those ways. By keeping accounting both timely and conservative, any company can have a bottom line that speaks to what it really has to offer to others and that will not decrease significantly because of unexpected losses or gains that are not realized.

It is never a good practice to show income or assets that have not actually been acquired, or to show ownership of something on which the company still has a debt load. To do so fails to provide an accurate portrayal of the company’s financial strength.

2.3 Theoretical Approaches

There are several theoretical approaches that are seen with conservatism in accounting valuation. One of those is the signaling model. In that model, investors in the market use the signals that are picked up based on the decisions that the manager makes (Ball, Kothari, & Robin, 2000). From those decisions, the investors are able to infer more private information about the firm. That can lead them to predict the future value of the firm more easily. There are still no real easy ways to make predictions about how a firm will perform, however, because there may be other influences that are not seen or noticed by investors.

Still, the signaling model is relatively reliable and is one of the best ways to gain information and make decisions when one does not work in the inner circles of a company or have any kind of inside information as to what the company might do in the future. The signals that are given off by the managers in the decisions they make can be very telling for someone who is good at deducing those kinds of things, but it takes practice and analysis in order to discover what the managers are really doing based on the decisions that they are making.

Sometimes, they appear to make decisions that do not seem to be in the best interests of the company. When that is the case, investors may need to sit back and wait to see what the manager will do next. It is possible that the decision was part of a greater (and often very effective) plan that the investors cannot see from their viewpoint, so speculation may have to wait until more information is available.

2.4 Measuring conservatism

There are several different ways in which conservatism can be measured, and they all have value to the accounting profession. Five of those different measures will be addressed here, so differences in them can be seen.

A. asymmetric timeliness of earnings

Earning asymmetrically is part of measuring conservatism (Ball, Kothari, & Robin, 2000). In some accounting models, earnings become overstated because the earnings are placed on the company’s balance sheet as an estimate, before they are actually earned. That is a relatively common practice, especially with large companies on Wall Street. Still, if the earnings that are actually seen when they are acquired are significantly lower than what the company projected, that can spell real trouble for that company y. Failing to meet earnings is one of the biggest problems that companies can have, and one of the best ways to overcome that problem is to focus only on the earnings that have actually been received and not use the estimated earnings as a measure of how much money a company has made. The earnings are not factual until they have been collected by the company, so keeping them symmetrical based on when they are received is the best way to avoid overestimation of earnings.

B. asymmetric accruals-to-cash-flow measure

The income that has been accrued is not necessarily equal to the cash flow. Conservatism reduces the earnings that are reported cumulatively over time, so it has been suggested by some researchers that the magnitude of these accumulated accruals – or even signs of them – are among the ways in which conservatism can be measured (Dechow, Hutton, & Sloan, 1999). For example, if the company was in a completely steady state where no growth was being seen, and there was no conservatism taking place, earnings would converge into cash flows and the periodic accruals would converge all the way to zero. Negative accruals over a long period of time shows a pattern of conservatism, while the rate of those accruals shows how conservatism has shifted in degrees over time. Of course, there are other ways to show conservatism, and it does not have to be a method that involves accruals and cash flow.

C. market-to-book ratio measure

Some researchers use market to book (or book to market) ratios in which to measure conservatism (Dechow, Hutton, & Sloan, 1999). These researchers look at cross sectional data and pooled time series. Using that information, they can regress the market to book ratios for each year individually and look at dummy variables and stock returns for the current year and the five years previous to the current one. The differences between the firm’s market value and book value of equity are considered, and the lower the coefficient the more the firm is thought to be conservative. Of course, the coefficient measures only the relative conservatism and cannot be used to measure aggregate conservatism (Beneish & Press, 1993). It can, however, show the extent to which the conservatism across firms actually varies. Conservatism can be varied, because some firms are more conservative than others, but market to book ratio is a good way to measure that level of conservatism and see how one firm compares to another.

D. hidden reserve measure

Do companies hide their reserves? Legally, they must declare all of their income and assets (Beneish & Press, 1993). However, that does not mean that there are not any ways in which reserves can be built up or protected. One of the ways to do that is through conservatism, because the accounting firm can use this method in order to make sure the company is not showing income and assets that they have not yet acquired. When companies avoid listing anticipated earnings, they set their expected earnings much lower. That means that Wall Street and investors also set that company’s expected earnings lower. Since that is the case, the company may end up with a higher level of earnings than what it was actually showing. That can allow it to “hide” its reserves, or surplus income and assets, because they were not expected of it in the first place – and that can mean that the company has more to its name than most people think, even though it is not hiding anything for tax purposes.

E. negative accruals measure

Negative accruals are another way that conservatism can be spotted in a company or an accounting firm (Beneish & Press, 1993). When the company does not appear to be accruing anything, and instead appears to be losing money or going backward financially, it is possible that the company is actually being too conservative with its accounting. The odds are high that it is actually making some money, or it would not still be in business, but its balance sheet or income tax statements may show that it is not making money because there are too many expenses and debts being recorded and not enough areas of income (Beneish & Press, 1993). The company may look that way on paper because it does not want to overestimate its earnings, but may have enough income to survive and may beat investor estimates of its earnings.

3. Effects of conservatism

How does conservatism affect accountancy and the assets and debts that are seen by companies and firms? There are three ways in which conservatism affects accounting – earning quality, capital markets, and contracting efficiency (Ahmed, Morton, & Schaefer, 2000). All three of these issues will be addressed here, because it is important to realize how far-reaching the effects of conservatism may actually be when it comes to accountancy and what accountants can provide to companies who wish to use conservatism as the method of accounting that is right for their company. Not all companies choose that method, but it has been proven to be effective and to have mostly positive effects on a company’s bottom line.

3.1 Earning quality

The earning quality of a company is significant when it comes to investors and how they feel about the value of the company in which they are considering investing their funds (Ahmed, Morton, & Schaefer, 2000). If a company is meeting or exceeding its Wall Street expected earnings, then it would appear that the company is doing well. The cash flow is good, the number of assets is high, and the company is performing as well as to be expected. Sometimes, companies actually perform better than Wall Street expects, which can allow that company to enjoy a higher number of investors as well as a lower interest rate when it borrows money. There are other perks, as well, and they mostly depend on the company and what that company wants to do with its income, assets, and debt levels.

If a company is not meeting Wall Street expectations, that company can have trouble getting credit at a lower rate and can also struggle with getting investors for new projects and advancements. Companies in that predicament may actually be doing quite well, but if they set their estimated earnings too high and then fail to meet them, they can appear as though they are performing poorly (Ahmed, Morton, & Schaefer, 2000). Certainly, that is not a good thing for any company to have to deal with, so the best thing that a company can do is try to avoid allowing that to happen. One of the best ways to avoid that is to make sure that the company underestimates its earnings. Then the company will not fall short of the estimate – and that underestimation of earnings can be done through conservatism in accounting. There are other ways to help a company appear better on paper, but conservatism in one of the easiest and most common ways to do so – and it is often also very effective.

3.2 Capital markets

Capital markets are also affected by the conservatism seen in accounting valuation (Beaver & Ryan, 2000). When a company underestimates its earnings and shows lower asset levels, it is not valued as highly because it does not appear to have as much capital. However, when it then exceeds its reporting, it is seen to be more valuable because it looks as though it performed better than expected. This is a game, but it is legal, accepted, and done quite often. Unfortunately, there are some problems with using it that the advocates of conservatism fail to realize. One of these is the damage that is being done to the information environment. Although conservatism in accounting is completely legal, it is also deceitful in that it does not portray information about the company in a light that is completely realistic and honest. Companies are made to look bad so that they can then be made to look good by doing “more” than what was expected of them – except it is not actually more, it is just made to appear that way.

Another concern about the effects of conservatism on accounting is that the forecasts that are given by analysts are called into question when companies use accounting methods that hide some of what they expect to earn. In many cases, these companies are very good at estimating their actual earnings, but they end up underestimating those earnings because they want to exceed the expectations of others so that they can be viewed more favorably in the marketplace. This also lowers the cost of capital for them, because they are able to get better deals and lower interest rates based on the strength that they have in their financial information (Beaver & Ryan, 2000). Giving credit where credit is due makes perfect sense, but only in the context of that credit really being due – and not just looking as though it is due based on practices that make businesses appear to be doing better than they are in fact.

3.3 Contracting efficiency

It can be more difficult for companies to reach outcomes that are mutually beneficial if both companies are not able to put all of their cards on the table (Beatty, Ramesh, & Weber, 2002). That is true no matter who the contracting parties are, and is often seen when it comes to company negotiations where one company vastly outweighs the other one in financial issues, income, clout, or anything else. When one company uses conservatism and the other does not where accounting practices are concerned, it can be highly difficult to determine the true value of both of those companies and what they can bring to the table where negotiations are considered (Beatty, Ramesh, & Weber, 2002). In other words, how can companies really tell how equal they are when their accounting practices are completely different? It is not an easy thing to determine the quality of both of the companies as they relate to one another, and that can be frustrating for any company that is negotiating with another company.

4. Conservatism in U.S.. GAAP vs. IFRS

There are some differences in conservatism rules and regulations that have to be considered, as well. Mostly, however, the main difference is that GAAP has been seen getting more conservative over time, where IFRS has not (Ball, Robin, & Wu, 2002). Evidence of conservatism is much stronger in GAAP, and over the last thirty years or so that has been more obvious. The IFRS is not as conservative and has never been, so that is something that is very important to consider when companies look at working with other companies that may not be required to follow the same kinds of accounting rules (Ball, Robin, & Wu, 2002). There is nothing wrong with doing business with these companies, but understanding how they handle their accounting and if there are any specific issues that should be considered is important.

5. Conclusion and Implication

As can be seen, there is a lot of information to take in when it comes to conservatism in accounting valuation. This paper mostly touched on the surface because there was not space to go into detail on each one of the issues that are being seen in accounting today where conservatism is concerned. However, enough information has been provided to show that conservatism has been changing over time, and that it is getting more pronounced – especially within the United States. International standards are not as strict or conservative, so companies doing business across countries, cultures, and borders should be aware of that before they make decisions about whether to buy out or merge with a company that is located (and pays taxes) in another country.

One of the main implications for conservatism in accounting valuation is the way in which that type of accounting practice focuses on the underestimation of earnings and assets. The method behind that is quite legal, in that it simply shows all of the debts and expected debts, while showing only earned income and not expected income. By doing that, the accounting firm is underestimating the level of income the company will probably have, but that is good in some ways because it makes the company exceed expectations overall. Still, there are valid concerns about making things seem less than they are where expected earnings are addressed. Companies that do not appear to have good earnings may not be able to get credit easily, and they may have to pay more for interest and other debt markers. When they exceed their earnings, they can then more easily get better interest rates and more credit more easily. That is one of the big factors where conservatism is concerned.

Overall, conservatism is becoming more common in the United States, and that is a trend that has been seen for approximately the last thirty years. Conservatism in accounting has been around for much longer, but has not been as obviously used until recently. Some of the regulations that changed in the last thirty years have made things more secure for companies, and have also made it easier for them to consider conservatism in order to avoid some financial problems. Litigation was a particularly problematic issue for companies that were focused on overstating or overestimating their earnings, and companies that do not want to have to worry about that are much more likely to practice being conservative so that they do not need to have as many worries about whether they can be sued because they failed to meet the expectations that they had set forth.

In the future, it remains likely that there will be further conservatism measures taken for companies in the U.S., but unlikely that will transfer to the rest of the world. United States companies must be aware of what they can and cannot do when it comes to accounting rules and regulations, and they rely on their accountants to handle that for them. Still, the more they understand about accounting rules the better off they will be, because even the best accountants can make mistakes. As the rules change and conservatism becomes more the norm despite its critics, individuals and companies that use accounting firms should learn about the changes in the rules and how they will be affected by those changes, so that they are better able to handle any issues or concerns that come their way. Overall, conservatism in accounting makes sense for the majority of companies in the largest number of cases. However, there are always exceptions to the rule and it is a good idea to check with an accounting firm to determine the best type of accounting method for a business.


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Normative vs. Positive Accounting Theories university history essay help: university history essay help

Normative vs. Positive Accounting Theory

In the past few decades, accounting theory has slowly evolved; as a result, various research methodologies have been utilized to study the development of accounting theory. As accounting theory has developed, debates have emerged regarding the manner in which financial theory should be developed and applied in the accounting profession. This has been essentially a normative, philosophical exercise, imposing a view of how actuarial practice should progress (Thomas & Smith, 1997). In recent years, the differences in application between normative vs. positive accounting theories have become the subject of much debate, raising the awareness of those involved in the accounting profession. The underlying basis of normative theory is that it assists in standardizing the practice and thus facilitates the teaching of practice in a more coherent manner. The underlying basis of positive theory is intellectual justification; models are derived from observed behavior.

This paper discusses all aspects of accounting theory and the history of regulation in the accounting profession that has been implemented as a result of notable financial accounting scandals. It will analyze and synthesize the normative and positive accounting theories, beginning with the historical background of each theory and a discussion of the suggested changes and problem areas revealed in the debate. It will analyze the GAAP in relation to the conceptual framework and will conclude with recommendations toward an appropriate course of action.

Historical Development of Normative and Positive Accounting Theories

Normative and positive accounting theories grew out of economic theory, as tools for understanding relationships in the economy. Economic theory can be used to explain the behavior of market actors, but it cannot determine which public policies are desirable and which are not. Economic and accounting theories have been traced very far back by researchers searching for a correlation between the cultural significance of accounting and the discipline’s substantial impact on society. According to research by Mattessich (1995), the origins of accounting go back to prehistoric times and actually precede the invention of writing. Mattesich (1995) explains that hollow clay tokens were transferred in and out of a clay envelope. This practice originated over 8,000 years ago and evinces a form of double-entry recording (Mattessich, 1995). Other researcher’s attribute the origins of accounting to the 1914 work of John Dewey’s “pragmatic” educational philosophy that led to both the laboratory method and the case method used to study accounting (Mitchell, 2005). Comparable to present day “practice sets,” the accounting laboratory contained bookkeeping machines, records, minute books, “model” sets of books and collateral records, stock certificate books, transfer books, organization charts, statistical data and other documents.

In 1916, academicians formed their own group called the Accounting Academicians, concurrently with the American Economic Association. Practitioners belonged to the American Association of Public Accountants; while academicians felt more comfortable with other faculty; this organization later became known as the American Accounting Association (Mitchell, 2005). Positive accounting theory has been traced back to the research conducted by Watts and Zimmerman (1978), which provided the theoretical basis for a number of social disclosure studies. Research by Watts and Zimmerman (1978) concluded that individuals acted to maximize their own utility, and that managers have greater incentives to choose accounting standards which report lower earnings, thereby increasing cash flows, firm value, and their welfare. Watts and Zimmerman’s research was based on three main hypotheses: 1) Managers of firms with bonus plans are more likely to choose accounting procedures that shift reported earnings from future periods to the current period, 2) the larger a firm’s debut/equity ratio, the more likely the firm’s manager is to select accounting procedures that shift reported earnings from future periods to the current period, and 3) the larger the firm, the more likely the manager is to choose accounting procedures that defer reported earnings from current o future periods (Milne, 2001). In 1989, researchers Belkaoui and Karpik tested watts and Zimmerman’s arguments through the use of an index of social disclosure. Belkaoui and Karpik’s (1989) research remained consistent with that of Watts and Zimmerman, arguing that levels of social spending are a way for self-interested managers to reduce current period income; however this proposition was not tested in heir research. Many other researchers built off the work of these and other researchers of the prior decades.

Current GAAP Discussion

Research by Gaffikin (2007), indicates that for most of the twentieth century the accounting profession sought to maintain a regime of self-regulation. Accounting professional bodies worked hard to avoid the imposition of regulation on the discipline (Gaffikin, 2007). The Generally Accepted Accounting Principles (GAAP) were developed, followed by an attempt at a conceptual framework that would serve as the basis of an accounting theory. A review of the literature indicates that the search for GAAP and a theoretical framework has been a struggle for the discipline and its Members, a result of widely differing viewpoints on the necessity and form of regulation. The financial accounting scandals in the prior decades have spurred the need for reform and strictly adhered-to accounting regulations. Public interest and awareness resulting from the notable and widespread scandals demanded such regulations, and the GAAP was amended and implemented.

A review of the literature indicates that much as been written about the Generally Accepted Accounting principles (GAAP). For example, the current GAAP is more “rules-based” standards with specific application guidance than the earlier versions. According to Deloitte (2007), the significance of the differences of the current GAAP varies with respect to individual entities depending on factors such as the nature of the entity’s operations, the industry in which it operates, and the accounting policy choices it has made. Under first time adoption in the current GAAP, there is not a specific standard, and the practice is generally full retrospective application unless the transitional provisions in a specific standard require otherwise. The current GAAP permits the use of historical volatility or industry index measurement for non-public entities when it is not practicable to estimate expected volatility (Deloitte, 2007). Under the current GAAP, for share-based payments with graded vesting features, an accounting policy choice exists for awards with a service condition only to either: a) amortize the entire grant on a straight line basis over the longest vesting period, or b) recognize a charge similar to IFRSs (Deloitte, 2007).

Other example of the current GAAP in practice are that a liability for a planned post-acquisition restructuring can be recognized if the restructuring relates to the acquired business and certain conditions are met. For purchased in-process R&D, the current GAAP determines the fair market value of in-process R&D and expense immediately unless it has an alternative future use. For combinations of entities under common control, the current GAAP requires the pooling of interests method (Deloitte, 20070. For comparative prior year financial statements, there is no specific requirement under the current GAAP to present comparatives. Generally at least one year of comparative financial information is presented (Deloitte, 2007). Public companies are subject to SEC rules and regulations, which generally require two years of comparative financial information for income statement, statements of equity and cash flows (Deloitte, 2007). There are many other differences and requirements underneath current GAAP.

Positive Accounting Theory vs. Normative Accounting Theory distinction is made by many people between positive accounting theory and normative accounting theory, leading to a debate between the two theories. In discussing market failure and regulation a similar distinction is made by some; there are analyses of regulation which are derived from positive economics and some from normative assumptions (Gaffikin, 2007). Normative accounting theories are described as long-term values of economic parameters that cannot be confirmed or refuted by data. They cannot be confirmed by data because the long-term refers to a time so far ahead that it is impractical to conduct any objective tests. Normative theory involves prescribing a “right” approach. Positive theory, on the other hand, is not concerned with prescribing a “right” approach (Thomas and Smith, 1997). Positive theory involves observing the environment in which actuarial decisions are made and seek to model that environment and generate hypotheses which could be tested against data. Positive theory considers factors such as risks faced by the actuary, such as legal liability, professional censure, or the loss of the client. Positive accounting theory aims to provide explanations of practice, through observation and the generation of hypothesis. On the other hand, normative accounting theory aims to provide prescriptions for practice, through the codification of practice and premises to prescriptions. The methods of both theories are different; positive accounting theory places emphasis on testing, whereas normative accounting theory is concerned with little testing. The uses of positive accounting theory is that it leads to better understanding and better predictions. The uses of normative accounting theory are the standardization of practice, training for practice, and the market for excuses.

Changes and Problems Revealed in the Debate

Normative accounting theory has been categorized as being stimulated by the demand for excuses. Thomas and Smith (1997) state that normative accounting theory follows where the political or regulatory agenda leads. The examples cited by Thomas and Smith (1997) are the political concern with discrimination in insurance pricing, leading to numerous papers on underwriting; and proposals to change accounting standards for pension costs, leading to a flurry of effort to defend traditional actuarial approaches, or argue for alternative approaches. Another example cited by Thomas and Smith (1997) is that normative accounting theory are stimulated by the emergence of “orphan estates,” as a political and media issue, leading to efforts to justify distributions more favorable to shareholders. A second consequence of normative theories’ role as excises is that whether a theory proves true or false in the long-term may not be a particularly relevant factor in whether its originators prosper or not (Thomas & Smith, 1997).

Positive accounting theory appears to have the better position in the debate. This is because the first step in economics involves identifying the qualitative nature of a policy’s consequences. Positive analysis allows for the assessment of the expected, objective outcomes. According to principles of economics, the distinguishing feature of positive analysis is that it deals with propositions that can be tested with respect to both their underlying logic and the empirical evidence. In other words, it deals with what is, or what might be, without deciding whether something is right or wrong, good or bad. Positive accounting theory supports logical research because it draws on accepted rules of logic and evidence, of both a qualitative and quantitative nature. Research indicates that a normative accounting theory is comparable to a value judgment that is not scientific, and cannot be proved right or wrong by facts, evidence, or logic. These value judgments stem from the value system of each individual making the judgment. Since individuals value judgments differ, they cannot be applied universally across the board. This is a significant problem within the realm of normative accounting theory.

Also revealed in the debate between positive and normative accounting theories is that some researchers have sought to combine the two theories. These researchers have analyzed the existence of one theory without the other, and have found that they operate together. Majone (1996) concludes that positive and normative theories of regulation should be viewed as complementary rather that mutually exclusive. However, neither include an explanation for the institutional framework of regulation; institutions were regarded as “black boxes” from which regulation emerged (Gaffikin, 2007). Such research has indicated that regulation needs the benefits that a combination of both theories has to offer the profession.

GAAP Analyzation and History in relation to Conceptual Framework.

Historically, the general approach of the GAAP was more of a principles-based standard with limited application guidance. This has changed to become more rules-based standards with specific application guidance. Historically, the use of volatility or industry index measurement for non-public entities when it is not practicable to estimate expected volatility was not permitted, but currently is permitted under the new GAAP principles. For the modification of a ward by change in performance condition, historically the GAAP would determine the expense based on the grant date fair value. The current GAAP determines the expense based on fair value at the modification date. Historically, under the GAAP, the definition of a discontinued operation continuing involvement was not addressed. In the current GAAP, the disposing entity should have no continuing cash flows representative of significant continuing involvement (Deloitte, 2007). Finally, for rights and obligations under insurance contracts, the historical GAAP addressed recognition and measurement in only a limited way, or an interim standard pending completion of a project. Under the current GAAP, several comprehensive industry accounting guidelines have been published.

The majority of the literature on the topic indicates that over the years there have been many arguments and debates over the necessity for regulation. For example, those who believe in the efficacy of markets argue that regulation is not necessary as market forces will operate to best serve society and optimize the allocation of resources (Gaffikin, 2007). However, there are many who point out that markets do not always operate in the best interests of societies so some form of intervention in the form of regulation is necessary. An analyzation of the conceptual framework indicates that the history of the accounting profession brought about the need for the GAAP. The GAAP emerged as a natural response to the scandals occurring in the profession and the need for regulation.

The conceptual framework as it relates to the GAAP indicates that there are a number of reasons for regulation. Regulation is considered desirable where there are “windfall profits” – where through some fortuitous event a firm is able to make above “normal” profits (Gaffikin, 2007). For example, the suppliers of equipment to aid search and recovery where there has been a natural disaster can be considered. As a result of the urgent need and the immediate demand, suppliers may attempt to charge higher than normal prices and thus generate above normal profits. Similarly, in the past many costs that are related to certain productive activities were excluded such that the “true” cost was not recognized (Gaffikin, 2007). The regulations were mandated by notable scandals that occurred in the early part of the 1990s.

Although several accounting scandals rocked the business industry in the past decade; however, the fall of global business giant Enron in 2001 is the most notable. That same year, Fortune Magazine had selected Enron as the most innovative company in America, six times in a row, and in just 15 years, Enron grew from nowhere to be America’s seventh largest company, employing 21,000 staff in more than 40 countries. As a result of this widespread success, Enron was hailed as a new-economy company that would act as a business model for others to follow. However, also in 2001, Enron filed for bankruptcy, and it was revealed that the firms’ success was really attributed to the fraudulent manipulation and unethical management of financial data. Enron engaged in a number of practices that led to their eventual downfall, including the manner in which they modified and traded commodities. This led to the need to manipulate financial data to appear profitable and continue operations. The Enron scandal encompassed a myriad of complex transactions involving mysterious partnerships that allowed Enron to book huge corporate profits and payments to insiders, while simultaneously ignoring any associated financial liabilities.

Enron benefited from this expansion because the greater volume of transactions, the greater Enron’s profits would be. However, the financial problems for Enron began when the company started trading for its own accounts. This involved the often simultaneous purchase and sale of the same or equivalent security, in order to profit from price discrepancies. This practice resulted in debt and complicated accounting for Enron, who had no risk control strategies in place. The 2000s marked an era of accounting and financial frauds that occurred as a result of monitoring failures at different levels, including directors, prominent accounting and law firms, shareholders, and securities analysts that escaped detection. These scandals changed the business world forever, and new reforms have been implemented as a result.

Recommendations for Course of Action

In the analyzation for recommendations or for future courses of action, the basic principles underlying theories in general must be taken into consideration. There is not a checklist that determines whether a theory is a good or bad one. According to the research, a theory is considered to be valid and useful if it successfully explains and predicts the phenomena that it is intended to explain and predict. Depending on how well a theory matches the data, the theory is maintained, refined or sometimes even discarded (perhaps in favor of a competing explanation) (Gaffikin, 2007). Gaffikin (2007) concludes that the continual process of testing theories against real-world data is critical to the advancement of any science, not just economics. In testing a theory, it is important to note that imperfection tends to be the norm (Gaffikin, 2007). Positive accounting theory offers a means of focusing academic attention on the study of actuarial practice as it is, rather than normative models of how it should be. Since there does not appear to be one superior method over another to test whether positive or normative accounting theory is better, a combination of the two must be implemented. This way the stronger aspects of both theories can be applied together. For example, a better understanding gained from positive theory could be used to training others for the practice or to standardize the practice.

A future course of action would also combine ethics into both positive and normative accounting theories. Ethics is generally a term used to describe a set of values that describe what is right or wrong, good or bad. From a professional and scientific point-of-view, the ethics of business and the moral code of our society are inseparable, sometimes indistinguishable. Ethics is a branch of philosophy that is concerned with the principles and standards of human conduct. Values and beliefs are cultivated strictly on ethics, which is the philosophy and science for determining what values to hold and when to hold them. Morality and ethics are closely linked in the operation of a business. One of the most important characteristics of moral judgments is that they express values. Moral judgments are made about those actions that involve choice. It is only when people have possible alternatives to their actions that we conclude those actions are either morally good or morally bad.

Additionally, explanations of practice from positive accounting theory could be applied the lack of testing in normative accounting theory. Thus, a combination of the two theories would serve the accounting profession well.


As discussed above, a review of the literature regarding the debate between the application of positive accounting theory and normative accounting theory to the profession indicates that the debate is far from over. Future courses of action would include ethics in both theories, and finally, more research is needed within the realm of combining both theories for the accounting profession to continue to prosper and grow.


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Mattessich, R. (1995). Critique of Accounting: Examination of the Foundations and Normative Structure of an Applied Discipline. Westport, CT: Quorum Books.

Milne, M. (2001). Positive Accounting Theory, Political Costs and social

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Thomas, G. & Smith, a. (1997). Positive Theory and Actuarial Practice. Internet Source.

Strength of the EU in the world economy ap art history homework help

studied appeared a business accounting publications. A partial list publications article selected: The Accounting Review, Barrons, Wall Street Journal, Business Week, Fortune, Barrons, and Wall Street Journal.

GAAP article review:

Crovitz, Gordon L. (2008, September 8).Closing the information GAAP. The Wall Street

Journal. Retrieved November 22, 2010 at

GAAP article review:

Crovitz, Gordon L. (2008, September 8).Closing the information GAAP. The Wall Street

Journal. Retrieved November 22, 2010 at

The Wall Street Journal is famous for its pro-business, conservative editorials. So perhaps it is no surprise that in 2008, Journal editorial writer Gordon L. Crovitz praised the Securities and Exchange Commission (SEC)’s decision to mandate a shift to international accounting standards, in a phasing out of GAAP (Generally Accepted Accounting Principles) by 2016 for all U.S. firms. The Journal writer said that this was reflective of the “remarkably quickening pace of acceptance of a true lingua franca for accounting,” (Crovitz 2008). GAAP has stood as the bible of U.S. accountants for 75 years, but the Journal says GAAP has grown rapidly outdated because of the cumbersome and unwieldy number of regulations it contains. Now International Financial Reporting Standards (IFRS), whose regulatory board is based in London, will replace GAAP.

To be a fully-involved participant in the world economic community, the U.S. must embrace widely-practiced international accounting standards, and no longer be mired in the past. The adoption of IFSC will eliminate waste and inefficiency, now that multinationals will no longer have to prepare multiple accounting books for different regulatory agencies to review. The adoption of IFRS guidelines “would also make U.S. exchanges more competitive for listings by eliminating accounting differences” (Crovitz 2008). This will, Crovitz suggests, increase the influx of international cash to U.S. firms, which is particularly important given the increased strength of the European Union in the world economy.

The Journal, of course, does not dwell on the fact that smaller companies who are not large multinationals and have never used IFSC rules will be financially hurt by this shift, as they will have to pay for the costs of adopting an entirely new accounting system. Despite its highly-touted flexibility, IFSC rules may prove onerous for some firms: the IFSC only allows the first-in; first-out inventory accounting system (FIFO) and some U.S. firms use the last-in, first-out inventory accounting system LIFO. In fact, because of its tax advantage for businesses, many firms have shifted to LIFO (Gibson 2002). Yet, despite the international guidelines’ insistence upon FIFO, most firms tend to appear more rather than less profitable when using IFSC, which again seems to underline the possibility of ‘flexible’ accounting practices under the less detailed IFSC system.

Critics charge that IFSC regulations are less specific, and are thus more open to financial ‘smoke and mirrors’ of the type seen in the recent accounting scandals at WorldCom and Enron. Crovitz points out that GAAP’s nine-inch, three-volume list of guidelines did not prevent such scandals and some have suggested that IFSC’s emphasis on principles vs. exact policy is a superior means of ethical enforcement. “There are hundreds of pages of GAAP covering how to account for derivatives, but this didn’t stop opaque pricing mismatches, which helped create the credit crunch. GAAP rules allowed trillions of dollars in securitized financial assets and liabilities to stay off the books of U.S. financial firms, while the international standard, by focusing on the true underlying economics, kept these on the books for firms-based elsewhere” (Crovitz 2008). A single set of standards, stresses Crovitz, would thus increase transparency overall and GAAP has not shown itself to be superior in ferreting out fraud, as it supporters claim.

Crovitz admits there will be difficulties in the shift to the new system. While the major accounting firms support the transition to the international standard, critics allege these amounts to an effective ‘full time employment’ insurance policy for accountants, given the headaches that will ensue making the shift. The mandated transition period is extremely long, but that may make things worse, rather than better for investors and organizations, given that some entities within the same industry may be deploying different standards at the same time: “The transition will also be tough on investors. Under the SEC proposal, larger companies in the same industry would switch to the international standard before smaller companies do. Investors for the transition period would have to compare similar companies using different accounting” (Crovitz 2008). Investors have already complained about the difficulties about managing and assessing risk in the complicated economic environment, and the long transition period could only worsen such confusion during a critical juncture of the nation’s economic history.

The change will be seismic on the accounting industry: textbooks will have to be rewritten; forensic as well as corporate accountants will have to adopt new methods. Crovitz praises a new system “based on principles could create new defenses for company boards and accountants who try to do the right thing, if they fully disclose why they thought that a particular accounting treatment made sense” (Crovitz 2008). But an opponent might note that the fact that a company did not act in a spirit of good intentions is difficult to prove, thus giving companies new ammunition who commit fraud, in the Brave New World of IFSC vague accounting guidelines. From a corporate perspective, Crovitz says such ambiguity is welcome, but an investor may be less sanguine.


Crovitz, Gordon L. (2008, September 8).Closing the information GAAP. The Wall Street

Journal. Retrieved November 22, 2010 at

Gibson, Scott. (2008, October). LIFO vs. FIFO: A return to the basics. RMA Journal. Retrieved November 22, 2010 at