Lesson 11
Understanding
Accounting Principles
Task Team of
FUNDAMENTAL ACCOUNTING
Business School, Sun Yat-sen University
Outlines
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Accounting standards: a tool for trusting
Introduction of Accounting Standards
Accounting Standards in China
A Brief of Accounting Theory
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Opening Story
• Enron scandal again!
– Filed 8-K to restate its financial statements in
November 8, 2001;
– Filed bankruptcy protection under Chapter 11 in
December 3, 2001;
– Mr. Berardino, then CEO of Andersen, issued an
announcement: Enron, a wakeup call;
• Accounting standards is the first
to be blamed;
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Opening Story
• The standards involved in Enron case;
– Special purpose entity (SPE);
– FASB on SPE;
• 3% independent interest;
• Assume substantially the risk;
– Enron and Andersen: stick to 3% requirement,
ignoring the risk assessment requirement;
• Accounting Standards or standards
enforcement?
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Accounting and Trust
• How could accounting help to develop trust?
– Translate all business activities into numeric so it
could be summarized, measured and evaluated;
– Managers may report and discharge their
accountability;
• Principal-agent problem;
• Since all common investors are principals;
– Free-rider issues are pervasive;
– How to assure managers to provide financial
report truthfully and reliably?
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Accounting and Trust
• Are financial reports reliable and objective?
– The inherent limitation of financial accounting;
• Monetary measurement: penny wise and pound foolish;
– Where to put Bill Gates on Microsoft’s Financial Statements?
• Historical cost, accrual basis, periodic report:
– Financial reporting are lagged, no matter good news or bad news;
– Be aware: all managers, including accountants, are
REMMs;
• Accounting comes down to the-vehicle-for-bank-robbers;
• All the blames to accounting for its “unique role” in Yinguangxia,
Enron, WorldCom, etc.
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Accounting and Trust
• To assure the reliability of accounting
information, many mechanism are
devised and employed;
– Periodic and timely disclosure;
– Full disclosure;
– Accounting standards:
• Why generally accepted?
– Auditing:
• Additional tool to assure the reliability of
accounting information.
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Accounting Standards:
a Trust Perspective
• REMMs push the lines as hard as possible;
• Executives will abuse accounting numbers
given that these numbers are essential in
their performance evaluation;
– Incentive to manage and manipulate earnings.
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Open discussion
• Revenue recognition criteria:
– Earned process done, considerations
guaranteed;
• How to account for
– Sell and repurchase transactions?
– Sell and lease-back transactions?
• The criteria satisfied;
• But they are financing in substance;
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Accounting Standards:
a Trust Perspective
• In order to solve the disputes on
accounting choices, agreement on the
set of accounting choices is necessary;
– We define this as accounting standards;
– It is also named as GAAP in US;
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Introduction of
Accounting Standards
• Varied terms,
– Accounting norms;
– Accounting principles;
– Accounting standards;
– GAAP;
– International Accounting Standards,
– Financial reporting standards;
– ,,,
• Focus on substance, not form;
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Introduction of
Accounting Standards
• Accounting standards:
– Must be authoritatively supported;
– Otherwise, no binding effect;
• Two ways to gain authoritative support;
– Authoritativeness from Governmental
administration;
• Ministry of Finance acting as standards setter;
– Widely represented to gain authoritativeness;
• This is the case of FASB before 2002;
• PCAOB, a quasi-governmental agency, stepped in after
2002.
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Introduction of
Accounting Standards
• Accounting standards must be effective in
resolving disputes;
– Still two ways to reduce disputes;
• Focus on “scientific” principles to guide;
• Furnish with cooking-book solutions;
• This is the story of principle-based and rulebased.
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Introduction of
Accounting Standards
• Accounting standards in China;
– Accounting Law, 2000;
– Regulations for Business Financial Reporting, State
Council, 2000;
– Business Accounting Standards, Ministry of Finance;
• New standards will be expected;
– Unified Accounting Systems, Ministry of Finance, 2001;
– Temporary explanations;
– A whole new set of Enterprises Accounting Standards,
Ministry of Finance, 2006
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Introduction of
Accounting Standards
• CSRC and its role in regulating public
companies’ accounting practice;
– Two sets of regulations;
• Information disclosure on forms and contents;
• Rules for information disclosure;
– Actually affect public companies’ accounting
practice;
• The change of rules on Non-recurring gains and losses;
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Introduction of
Accounting Standards
• Accounting standards itself is in the state
of keep-changing;
– The early stage of A/S, easy and simple;
• The first batch of A/S only includes 6 items
when approved by AIA and NYSEC in 1933;
– More complicated;
• 154 statements published by FASB as to May
2005;
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Introduction of
Accounting Standards
• Although A/S is in the state of
changing, there are still some stable
contents;
– Accounting assumptions;
– Basic principles;
– Accounting conventions;
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Introduction of
Accounting Standards
• Accounting assumptions;
– Impossibility to prove to be true;
– Indispensable to accounting practice;
– May be treated as prerequisites;
• Business Entity;
• Going-concern;
• Periodic reporting;
• Monetary valuation;
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Introduction of
Accounting Standards
• Basic Accounting Principles;
– Substance over Form;
• Most important one;
• Theoretically, one for all;
• Back to Enron case;
– Accrual Basis
– Revenue Realization;
– Matching
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Introduction of Accounting
Standards
– Actual cost;
• Historical cost;
• Fair Value;
• Why does Historical Cost dominate?
– Prudence
• The definition;
• Why do we need it?
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Class discussion
• Read the materials about Southern Airlines
and Xiamen Airlines;
• Which one is more prudent?
• Please find out the underlying reason;
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Story about Principle-based and Rulebased
• From high quality accounting standards to
principle-based;
– Definition of Principle-based;
• Are IASs principles-based?
– Definition of Rule-based;
• Are US GAAP rule-based?
– Objective-based:
• A right way?
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Accounting Standards Evolution in China
• After 1949, we killed all the market;
– Everything is under central planning;
• We planned everything, including those unplannable;
– No corporate finance;
– No decision making oriented management
accounting;
– Costing not cost controlling;
– No auditing;
– No accounting standards too.
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Accounting Standards Evolution in China
• Capital markets were founded in Shanghai and
Shenzhen in early 1990s;
– Public companies will be responsible for common
investors;
– Accounting standards are necessary again;
– 1992, Business Enterprises Accounting Standards
are issued;
– 1997, the first operational accounting standards
was issued;
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Accounting Standards Evolution in China
• Completely revised since 2001;
• The issuance of Unified Accounting System;
– Abandon fair value accounting;
– Readopt actual cost;
– Put restrictiveness on earnings;
• From earning to capital surplus;
• Internationalization or localization
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Accounting Theory:
a deconstruction view
• Derrida and Deconstruction;
• Accounting theory;
– Traditional normative definition;
• A Classical article for positive definition
– Watts and Zimmerman, 1979,
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Accounting Theory:
A deconstruction view
• Accounting theory is regarded as nothing
different from common goods;
– It is demanded;
– It is supplied;
– Who does?
• Unregulated and regulated society;
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Accounting Theory:
A deconstruction view
• The demand for A/T in unregulated society;
– Pedagogy;
– Information;
– Justification;
• The demand for A/T in regulated society;
– Accounting numbers based regulation and its
impact on the demand for “right” A/T;
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Accounting Theory:
A deconstruction view
• The implication to A/R;
– Generally accepted: an expectation, not reality;
• Cases from China;
– Debate on internationalization of accounting
standards;
– Supplementary auditing;
– High quality accounting standards;
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Summary
• The unique value of accounting:
– Cost-effective trusting mechanism;
– Accounting numbers are the center of the interest
disputes;
– Accounting standards are necessary;
– REMMs determine that A/Ss are relatively
effective;
– The demands lead the making of
accounting theory;
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Case for Open Discussion
• Please find articles and comments on Enron
and WorldCom, answer following questions:
– Which is abusing standards? Which completely
false information?
– Check with FASB website and find out the
standards issued raised in Enron case;
– Based on the discussion of principle-based, do you
think these new standards/regulations are
effective enough? Why?
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The End of Lesson 11
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