2.3 Contingent model of accounting change
The totality of the accounting rules in any one country at any one time represents an accumulation of rules that have been brought in over many years (even centuries, in the French case). In remembering that, it becomes clear why the rules are sometimes inconsistent: they have been put together by different people, at different times, and in the face of different circumstances and priorities. It also makes clear why it would be optimistic to expect close comparability between national sets of rules.
When looking at the standards of the International Accounting Standards Committee (IASC) and its successor the IASB, put together over a continuous period of no more than 30 years, it is evident that these different approaches, different priorities, etc., can occur over a very short time. When the IASB, virtually a full-time professional standard-setting committee, started work in 2001, almost their first act was to decide to revise most of the standards inherited from the IASC, because they were internally inconsistent.
When the IASB published the revised standards in December 2003, Sir David Tweedie said: ‘The improvements project has raised the quality and enhanced the consistency of international accounting standards’ (IASB, 2003). The IASB press release added that the project had removed a number of options contained in IASs, whose existence had caused uncertainty and reduced comparability.
Another example is the Financial Accounting Standards Board (FASB) in the US: when issuing the draft of its standard on Fair Value Measurement in 2004, it recognised that there were 31 standards issued since 1971 by the FASB that mentioned fair value but had inconsistent approaches to how it was defined and how it should be calculated.
One of the factors that influences the accounting rules is the way in which they change. Burchell, Clubb and Hopwood (1985) analysed a particular case of accounting change in the UK. This analyses how, in a particular economic context, various interests concerned with financial reporting arrived at a consensus that an additional financial statement, a statement of value added, should be part of the company reporting package. From this detailed analysis we can draw a more general model about how accounting change often takes place. If you consult a history of financial reporting in Europe, such as Walton (1995), you can find plenty of evidence of this model in operation. This model, known as the contingent model, suggests that there is a cycle in accounting regulation which is as follows:
The cycle is started when something occurs to disturb the perception that financial reporting, and its associated infrastructure of audit and professional regulation, is operating effectively. Often this will be a financial scandal – companies suddenly announcing major write-offs or big losses etc. The Enron case is a classic: the intrusive event has to be on a sufficiently large scale to convince people that action is necessary. Typically this is followed by the search for a consensus. In some countries this would be a formal process of the regulator issuing a discussion paper or some consultative document, suggesting solutions and inviting comment. In the Enron case, the SEC made a proposal for legislation, as did several individual politicians. A consensus was worked out in Congress by merging two different proposals which ended up as the Sarbanes-Oxley Act of 2002, although the FASB has been working separately in its usual due process to create new rules for special purpose entities (off balance sheet financing vehicles).
Under the contingent model, the new rules will simply add to previous ones, and will be absorbed over time, leading to a new equilibrium; however, the new equilibrium may include unintended consequences. Generally, when standards are drawn up, the consensus-seeking process ensures that those potentially affected have the opportunity to point out flaws or other problems. However, people frequently cannot be bothered to review new rule proposals, or the rule change affects people who were not consulted, because no-one realised they would be affected, or people just do not see the possible consequences, or estimate them to be unimportant. It happens, therefore, that unintended consequences frequently arise from rule changes.
An example of this in the Sarbanes-Oxley Act is that the act aimed to tighten the scrutiny of audit firms in the US. (Enron was perceived to have been allowed to get away with fraudulent financial statements because the auditor was weak and internal quality control in the firm was not good enough.) The Act therefore created a new oversight body (Public Company Accounting Oversight Board) with powers, amongst other things, to inspect the working papers of auditors and check their quality control procedures. However, no-one really appreciated that this measure to enhance audit supervision of companies listed in the US would apply to non-US companies listed in the US, and therefore to their non-US auditors. For example, Cadbury Schweppes has only a relatively small percentage of its turnover in the US (the company's segment information provides a figure only for ‘The Americas’), but because it is listed in the US, it is audited by the UK partnership of Deloitte & Touche thereby opening the door to US supervision of the UK firm. (Those who perceive the major international audit firms as multinationals might find this unsurprising, but the firms are actually confederations of independent national partnerships trading under the same name, and normally supervised by national bodies). A US financial reporting scandal had the unintended consequence of opening up US supervision of audit all over the world.
Awareness of the contingent model cycle is useful in terms of understanding future evolution in accounting standards, but the immediate point in discussing it is that all countries experience the cycle, but it swings into action as a result of different events in each country, taking place at different times. So, even if two countries start out with the same basic rules (e.g. based on the French 1807 Commercial Code), very soon they are moved away by events in their own country.