2. The Crisis in Financial Reporting Rick Antle Senior Associate Dean and Professor of Accounting Yale School of Management

3. October 17, 20022 Criticized Parties Government regulators Standards’ setters (FASB & EITF) Management Boards of directors Accounting profession

4. October 17, 20023 Debacle A sudden, disastrous collapse, or defeat; a rout

5. October 17, 20024 Fiasco A complete failure

6. October 17, 20025 Failure Cessation of proper functioning or performance

7. October 17, 20026 “I am not an accountant.”

8. October 17, 20027 Basis of Financial Reporting Economic concepts Accounting conventions Institutional context

9. October 17, 20028 Accounting Identity Assets = Liabilities + Equity Assets – Liabilities = Equity

10. October 17, 20029 How it Works 0 – 0 = 0? 5 – 3 = 2? RECOGNITION CRITERIA!!

11. October 17, 200210 Building Example Original cost: $6 million Accumulated depreciation: $4 million Sales price: $3 million Does selling the building add to shareholders’ wealth?

12. October 17, 200211 I Am Not An Accountant Professes confusion of the aspirations of accounting with the practical results of applying its conventions and techniques.

13. October 17, 200212 Standards’ Setters FASB’s elaborate due process means: Details and loopholes are there because someone wants them there. Just look at the treatment of executive stock options.

14. October 17, 200213 Special Purpose Entity - Problem Risky Corp Wants to borrow $100 to build an office building, which it will occupy Office Corp A special purpose entity. Will issue debt, construct the office building, and lease it to Risky Corp Big Bank Loan Payments (Interest rate?)

15. October 17, 200214 Special Purpose Entity - Consolidated Risky Corp Office Corp Big Bank Loan Payments Lease Payments Use of office building Risky Corp & Subsidiary

16. October 17, 200215 Special Purpose Entity - Off Balance Sheet Risky Corp Office Corp Big Bank Loan Payments Lease Payments Use of office building Outside investors Equity Dividends Loan guarantee

17. October 17, 200216 Dialog One How about $0.1 of equity for Office Corp? Not enough? How about $0.02? Still not enough? Ok, you tell me, how much equity is enough?

18. October 17, 200217 Two Choices Don’t answer questions Pick a cut-off number or a rule for determining a cut-off number Pre-Enron, number was $3. Now I believe it is $10.

19. October 17, 200218 Not Feasible to Refuse to Answer Another dialog: How about $100 of equity? That will do it? Then how about $99? That’s OK, too? Then how about $98?

20. October 17, 200219 Categorizations Use of categories as a basis of aggregation is too handy to abandon. Requires methods for assigning things to categories. Creates the possibility of playing games to manipulate the classification.

21. October 17, 200220 Principles-Based Standards Some think less detailed rules are the answer. I think not. Rules for assigning things to categories fall somewhere in the following box:

22. October 17, 200221 ExplicitImplicit Uniform Varied Logical Possibilities for Classification Rules

23. October 17, 200222 Accounting Profession During the recent past, however, the profession has not always lived up to its duties and responsibilities. …Because of the growing list of substandard audits, the profession is slowly losing its credibility…. We have seen too many recent instances of flawed accounting reports that simply have been chalked up to the overworked explanation that a certain amount of poor financial reporting is inevitable. Judge Sporkin

24. October 17, 200223 Accounting Profession We are not confronted with a liability crisis. We are instead confronted with an identity crisis. We don’t know for what, to whom, and the when of our responsibility. Abraham Briloff

25. October 17, 200224 Profession’s Response Tightened internal control of Big 4 Emergency response teams Pro-active – before the Public Company Accounting Oversight Board requires changes

26. October 17, 200225 You can’t regain credibility by only doing things you are required to do.