Adverse Effects of Accounting Uniformity on Practice, Education, and Research

Adverse Effects of Accounting Uniformity on Practice, Education, and Research1
Shyam Sunder
Yale School of Management
Abstract
The pursuit of uniform written standards at the expense of social norms
diminishes the effectiveness of financial reporting in stewardship and governance, and in
better informing security markets. Uniformity discourages thoughtful classroom
discourse, attracts less talent to accounting programs and, ultimately, to the accounting
profession. Uniform standards induce a follow-the-rule-book attitude among accountants
at the expense of developing their professional judgment. Since judgment and personal
responsibility are the hallmarks of a learned profession, the pursuit of uniform written
standards weakens the accountants’ claim to belong in this class, as well as the claim of
accounting degree programs to belong in universities alongside architecture, dentistry,
engineering, law, medicine, and nursing. Uniformity discourages research and debate in
academic and practice forums. Most importantly, uniformity encourages increasingly
detailed rule-making and shuts the door on learning through experimentation, making it
difficult to discover better ways of financial reporting through practice and comparison of
alternatives. Improving financial reporting requires creating a careful balance between
written standards and unwritten social norms.

Keywords: Accounting standards, uniformity, profession, practice, education, research
JEL Codes: M41, M44

1 Emanuel Saxe Distinguished Lecture, Baruch College, New York, October 22, 2007.

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Adverse Effects of Accounting Uniformity on Practice, Education and Research

Samuel Johnson published his dictionary not as the conqueror of the
language but as the person who knew best how unconquerable it really is.
Verlyn Klinkenborg (2005)

The rules of accounting, even more than those of law, are the product of
experience rather than logic.
George O. May (1943)

Common global standards, if read to mean identical, is an illusory and
unobtainable goal. However, seeking to achieve similar objectives and and to
address in an effective way similar problems is a realistic goal.

Richard Breeden (1992), Former Chair, SEC


I am delighted to join you this afternoon to engage in a conversation about the
attempts to achieve uniformity in accounting practice through authoritative written
standards and the effect this pursuit has had on practice, education, and research. It is a
special pleasure to do so in a lecture series in memory of Emanuel Saxe, who contributed
so much to accounting education and worked to build Baruch College into a center of
excellence in accounting education. The list of lecturers who have preceded me at this
podium is a who’s who of accounting thought and scholarship. Indeed, I have often read,
and had my students read, many of the lectures delivered here. I feel honored to join their
ranks.

The pursuit of uniformity in accounting practice through written standards and
their enforcement by authority has been a dominant phenomenon in accounting during
the past half-century. In the recent decade, the convergence of accounting standards and
the harmonization of accounting practice have been the policy of the Financial
Accounting Standards Board (FASB) and the International Accounting Standards Board
Sunder, Adverse Effects of Accounting Uniformity, October 22, 2007
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(IASB). If the current trends continue, the U.S., the E.U., and many other parts of the
world may claim to have reached this long-sought goal of uniformity in the foreseeable
future.
This pursuit of uniform financial reporting through official enforcement of
standards written by organized boards enjoys broad support from government, business,
the accounting profession, and academia. It is widely believed that this will result in
improved financial reporting, better governance and stewardship of business, not-for-
profit, and governmental organizations, better informed and therefore more efficient
financial markets which will direct capital towards its productive deployment.
In this hour, I shall make a contrarian case: pursuit of the goal of uniformity
diminishes the effectiveness of financial reporting in stewardship and governance, and in
better informing security markets. Uniformity discourages thoughtful classroom
discourse, attracts less talent to accounting programs, and ultimately, to the accounting
profession. Uniform standards induce a follow-the-rule-book attitude among accountants
at the expense of developing their professional judgment. Since judgment and personal
responsibility are the hallmarks of a learned profession, the pursuit of uniform written
standards weaken the accountants’ claim to belong in this class, as well as the claim of
accounting degree programs to belong in universities alongside architecture, dentistry,
engineering, law, medicine and nursing. Uniformity discourages research and debate in
academic and practice forums. Most importantly, uniformity encourages increasingly
detailed rule-making and shuts the door on learning through experimentation, making it
difficult to discover better ways of financial reporting through practice and comparison of
alternatives.
Sunder, Adverse Effects of Accounting Uniformity, October 22, 2007
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The enthusiasm for the pursuit for uniformity to the exclusion of social norms
should be tempered by recognition of these unintended consequences of the path
accounting has chosen to take. Perhaps it is not too late to adjust our goals so we can
achieve better financial reporting by balancing written standards, and unwritten social
norms. I shall organize my remarks on theory, practice, education, research, and the
structure of accounting institutions before turning to reforms that might be considered as
candidates to help pave the way for better financial reporting.
1. Uniformity and Classification
Uniformity has long been the holy grail of rule-making in accounting. The
diversity of accounting practices invites criticism. It is an intuitively appealing idea that if
the accountants would treat similar transactions similarly and different transactions
differently, financial statements would be more useful. Unfortunately, it is not true.

The problem is, no two events or transactions are exactly identical, nor are they
totally different. Close examination reveals some similarities as well as some differences
between any two transactions.
Transactions come in infinite variety, and the accountant must classify and
aggregate them into a manageably small number of categories. We can use one of two
principles to classify any set of transactions into a small number of categories:
1. Treat any two transactions that have any differences differently.
2. Treat any two transactions that have any similarities similarly.
By choosing one of these two principles, we must necessarily violate the other.
This gives rise to a fundamental problem in defining and attaining uniformity and
comparability in financial statements.
Sunder, Adverse Effects of Accounting Uniformity, October 22, 2007
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When applying the first criterion, each transaction being different from all others
in some respect, will be treated differently. This will yield an unmanageably thick
accounting rule book, and each rule will be used only once. In effect, there will be no
categorization and no aggregation. Some may call this a system without rules and
uniformity because no two transactions are treated alike. Others can, with equal
justification, refer to the system as the ultimate in uniformity, in the sense that two
transactions must be exactly identical in order to qualify for the same treatment. The
pursuance of uniformity carried far enough leads to complete diversity.
Paradoxically, applying the second criterion does not improve things. If any two
transactions that have anything in common between them must be treated alike, then all
transactions will end up in a few, or even a single, category. In accounting, this is not of
much use either. This problem is common to all systems of rules and laws, as well as to
other schemes of classification.
The point can be graphically illustrated by a simple example of four objects which
differ in, say, size and color—two large, two small, two black and two white (see Panel A
of Figure 1). Applying the first uniformity criterion to size (objects with any differences
should be treated different), we get the classification shown in Panel B. However this
classification would leave those who consider color to be the important criterion
dissatisfied. Applying the first uniformity criterion to color, we get the classification
shown in Panel C, which would leave people who consider size important unhappy. It
would seem that there is a simple solution: apply the first criterion to both size and color,
and we get the classification shown in Panel D.
Sunder, Adverse Effects of Accounting Uniformity, October 22, 2007
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However, D is far from perfect when we look at the second criterion of treating
similar transactions alike. This four-way classification also leaves people wondering why
two objects which are both black are being treated differently, and why two objects
which are both large are being treated differently. In short there is no conceptual way,
even in a simplest theoretical example, of satisfying the uniformity criterion in a world in
which more than one attribute of transactions are important to the users of financial
statements. In practice, things get even more complicated.
The accounting treatment of research and development (R & D) outlays is a case
in point. Until the FASB issued Statement No.2 in 1974, capitalization of these outlays
was left largely to the discretion of management. Practices varied across firms. Demands
for uniformity led the FASB to search for rules that would reduce management discretion
in capitalization decisions and closely approximate the economic nature of these events.
It soon became evident that there was no way of satisfying both these requirements. The
nature and circumstances of research and development outlays, and their results, vary so
greatly, that it is not feasible to lay down rules that will remove management discretion
without also weakening the link between the economic consequences of R & D outlays
and their accounting treatment.
The FAS 2 removed managers’ discretion by requiring that these outlays be
expensed. It achieved uniformity of form, but not substance. The underlying event that is
supposed to be recorded is not the R & D expenditure alone, but also its economic
consequences. Compulsory expensing of R & D outlays, irrespective of its results, creates
a greater divergence between the underlying event and its accounting treatment than
might occur under a discretionary system. Two firms, each having spent $10 million on
Sunder, Adverse Effects of Accounting Uniformity, October 22, 2007
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research, will have identical financial statements, irrespective of the development of a
hot-selling product by one of the firms. Whether Statement No. 2 has led to greater
uniformity of financial statements in this fundamental sense is open to question.
Let me summarize my first main point: There is no conceptual way of defining
the uniformity criterion so it can help guide standard setters, preparers or auditors to
improve financial reporting. Concepts such as uniformity and comparability are
operationally vacuous for accountants’ work.
2. Uniform Standards vs. Social Norms
Norms of a social group can be defined as the common knowledge expectation of
its members about how others behave in various circumstances.2 Wearing a coat and tie
in an office is its social norm if, even in the absence of any formal rules and enforcement
process, and in the presence of available and convenient alternatives, people do in fact
wear a coat and tie and expect others to do the same. In this sense, social norms or
conventions are indistinguishable from the culture of the group (Sunder, 2002c).

Unlike formal rules and regulations, motivation to conform to social norms is
rooted in the anticipation, or even fear, of others’ disapproval of deviations for the norms.
Social norms may be so internalized by individuals that conformity may be seen as a
moral or ethical obligation. When norms become sufficiently internalized, the members
of the group may find it unnecessary to monitor conformity, giving rise to trust. The key
mechanisms that create trust in society are personal relationships and social

2Common knowledge of X, in its technical meaning, is shared knowledge among two or more people so
each knows X, knows that others know X, knows that everyone knows that everyone else knows X, ad
infinitum.
Sunder, Adverse Effects of Accounting Uniformity, October 22, 2007
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embeddedness of market participants rather than the legal rules and the formal
enforcement structures.
It has been so long since accountants began to shift their allegiance and attention
away from norms that the authoritative promulgation of accounting practices is often
assumed to be synonymous with the progress or advancement of accounting. It is easy to
identify the history of accounting principles with organized efforts to produce written
rules because documentary traces of such processes are more easily available for the
historians; social norms, even if they are widely accepted, leave nary a footprint in the
public record. We can see the evidence of norms in fiction3, 4. Unfortunately, accounting
is hardly a favorite subject in English or other literature.
Yet the early predominance of norms is clear from the charge the American
Association of Public Accountants gave to a Special Committee on Accounting
Terminology in April 1909 “to collate and arrange accounting words and phrases and
show in connection with each the varying usages to which they are put. … This
committee will not attempt to determine the correct or even the preferable usage where
more than one is in existence.” (Zeff 1971, p. 112).
In 1918, a reprint of a memorandum on auditing procedures, prepared by the
American Institute of Accountants, and approved by the Federal Trade Commission
(FTC), and originally published in the Federal Reserve Bulletin, was labeled “A
Tentative Proposal Submitted by the Federal Reserve Board for the Consideration of

3 For examples of accounting and commerce in Chaucer and Goethe and other German literature, see
Russell (1986), Gallhofer and Haslan (1991) Jackson (1992), Ganim (1996), Maltby (1997), Parker (1999),
and Evans (2005).
4 Waymire (personal communication) suggests that researchers have rarely ventured to examine the internal
correspondence and discussions of client and audit firms where they might find the “footprints” of social
norms.
Sunder, Adverse Effects of Accounting Uniformity, October 22, 2007
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Banks, Bankers, and Banking Associations; Merchants, Manufacturers, and Associations
of Manufacturers; Auditors, Accountants, and Associations of Accountants.” The intent
was to coordinate the evolution of a norm and not to impose a standard.
In the same year, the American Institute of Accountants appointed a Special
Committee on Interest in Relation to Cost to address a lively controversy on imputed
interest as part of the cost of production. The Committee’s recommendation against
inclusion of imputed interest in cost of production and its approval at the annual meeting
of the Institute, did not become accepted as an accounting norm.
The absence of authoritative standards of accounting did not mean that the world
of accounting had less order in the early twentieth century than in the early twenty-first.
Zeff discusses several active mechanisms the accountants of the day might have used to
identify the norms of their profession. The pages of the Journal of Accountancy and
perhaps CPA Journal served as forums for active, even feisty debates on accounting and
auditing; a function largely abandoned by the accounting journals over the past quarter
century as authoritative standards pushed the norms out. During 1920-29, the Librarian of
the Institute issued 33 “special bulletins” on topics referred to them, albeit without the
authority of the Institute. In 1931 the Institute published a 126-page book, Accounting
Terminology, a compilation of accounting terms and their definitions as a matter of
advice not authority.5
The stock market crash of 1929, and the economic depression that followed, also
precipitated another crash—in the trust in norms of accounting and the formal or informal
mechanisms by which these norms evolved and were sustained. The social contract was

5 In his review of Costing Terminology, Kitchen (1954) provides a masterful argument for resisting the
temptation to issue official definitions, especially in accounting. See also Baxter (1953).
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broken. Politicians responded by introducing securities laws and regulations to replace
the norms as well as private innovation as a response to adverse events6. In the following
seven decades, accounting and audit failures were interpreted as evidence that norms do
not work; norms were gradually shifted to the back burner, and legislated accounting
standards rose to dominate accounting.
The shift is also reflected in the increasingly assertive nomenclature of the three
private sector organizations that wrote accounting rules and how they labelled their
publications: The Committee on Accounting Procedure’s Accounting Research Bulletins
(1939-59), the Accounting Principles Board’s Opinions (1959-73), and the FASB’s
Financial Accounting Standards (1973 to present). The IASB’s International Financial
Reporting Standards are the latest addition to this trend. Have the standards achieved, and
can they achieve, their purported goal?
3. Practice
As a matter of practice, consider four reasons why attempts to create a uniform set
of top down written standards does not necessarily dominate social norms in financial
reporting. I label them as the information, design, gaming and signaling problems.
3.1 The Information Problem
Rule makers face a difficult problem in identifying good rules. This difficulty
may be seen by asking even a simple question, like what is a good rule for determining
interference in a game of football? Rules can affect different members of society in
diverse ways. The direct effect of the rules on people depends on their individual

6 Also see Jamal et al.’s (2005) finding on the evolution of the U.S. web seal market to provide assurance
on privacy practices in e-commerce. Under the stricter regulatory regime of the European Union, no such
marker has developed.
Sunder, Adverse Effects of Accounting Uniformity, October 22, 2007
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