IPA 2012
Fair value and the missing correspondence between accounting and auditing
By Kim Jeppesen and Dennis van Liempd
Comments by Anna Samsonova, Manchester Business School (UK)
I enjoyed reading the paper, and think that there is a need for a paper like this
because a debate about the impact of fair value accounting on the work of an auditor,
despite a few recent additions to such a debate, is still very much in its early stages.
The paper looks at the evolution of accounting thought and practice, leading to the
institutionalisation of fair value accounting that has been actively promoted by both
national and global accounting regulatory institutions in recent years. The paper then
contrasts the above changes against the respective changes in audit practice. The paper
draws mainly on the secondary sources of data, e.g. research articles and manuscripts, and
its empirical focus is on the Anglo-American world of accountancy, i.e. developments in
Britain and the U.S. In this regard, the authors take a conceptual approach by analysing the
ontological and epistemological underpinnings of such developments which they divide in
three cycles.
According to the authors, the first, “positivist”, cycle covers the early days of
accounting development when the accounting’s main objective was to keep record of
economic transactions for external use and report on the accountability of stewards. The
job of an auditor, therefore, was to check, first, the truthfulness of the stewards, and later,
the “truth” of the written accounts as blueprints of external economic reality. The second,
“neo-positivist”, cycle was characterised by a growing “politicization” of the processes of
accounting rule-making, with the accounting standard-setting bodies opting for the
development of a system of accounting principles (criteria) as a way to respond to the
challenge of reconciling the conflicting economic interests of the preparers of financial
statements and also convincing the users that the accounting standards represent the best
possible solution. As a result, “the validity claim of truth (correspondence with the external
reality) was deemphasized, and the auditors’ report was reworded, making accounting
principles the criteria for measuring reporting fairness” (p. 10). And finally, the third, most
significant for the purpose of this paper, cycle started with the institutionalization of the
principles of fair value accounting, which can be seen as a departure from the neopositivistic view of the notions of validity and reliability toward such notions being seen as
socially constructed realities (i.e. accounting reports as subjective representations built
around the management’s assumptions about what they see as most reliable characteristics
of economic reality). Hence, the job of today’s auditors increasingly has to do with providing
an attestation of the accounts based on these subjective representations.
The principal argument of the paper is that, while the conceptual basis for the above
changes in accounting have been clearly articulated in the public domain and also widely
debated by the accounting scholars over the years, the impact of such changes on audit
practice has been minimal. Here, the authors, with reference to some recent accounts (such
as Power (2010)), argue that auditing thought has not been able to adequately address what
looks like a fundamental transformation of accounting practice and basic accounting
constructs (i.e. valuation) in that auditors seem to have responded to this new accounting
reality with the old “neo-positivistic” approach of checking correspondence with facts. This
has led to the current status quo, which the authors call a “mismatch” between the key
philosophical assumptions of accounting and auditing. At the end, the paper calls for an
alternative, more qualitative, audit approach where auditors would act as parties in a public
dialogue about the social construction of fair value estimates rather than “distant” private
experts.
Below, I have summarised my comments on the paper that the authors hopefully
will find useful.
The paper’s contribution
While the topic of the paper is very interesting and relevant, I think the authors need
to do more to show what the paper’s specific contribution is and what it is that they are
saying that hasn’t been said before. This is especially important because the paper mainly
relies on prior research as a basis for analysis and so, as the authors mentioned themselves
early in the paper, there is a risk of the paper being seen as restating some of the things that
have already been argued before. The way that the authors may address this is, firstly, by
making the introduction tighter, finishing off with a clear statement about the paper’s
specific objective, and secondly, by doing some more work on the analysis, specifically with
regards to providing some evidence for the conclusions drawn from literature review, and
on theorising the paper’s observations (see below).
Need for further empirical illustration and theorisation
The paper’s intent is on demonstrating a mismatch between the contemporary
philosophical assumptions that underpin accounting and audit practice, as a result of the
spread of fair value accounting. My impression is that the paper focuses mainly on the
accounting developments, and hence, needs to do more to demonstrate and explain why
audit developments have so far lagged behind. Authors show the existence of the
“mismatch” mainly with reference to the practical side of audit (i.e. difficulties of verifying
the “socially constructed” accounts of fair value estimates). They also argue that it is the
accounting, not audit, standard-setters that are more influential in determining audit
criteria. While I agree with this argument, I think there is still a need to show what auditors
themselves have done in an attempt to respond to the changing accounting world, such as
by looking at the changes in the auditing standards as “narratives” about the socially
constructed accounts of an appropriate audit practice. Doing this may require (1) extending
the sources of empirical data to include the analysis of audit rules, policy documents, and
regulatory debates and (2) looking beyond the Anglo-American context and more at a global
(IAASB) level where much of the capacity for audit rule-making is now concentrated.
For example, the clarified ISA 540 (which authors do briefly mention at the end of
the paper) shows that the standard-setters’ response to the spread of fair value has so far
been to increase the prescriptiveness of the audit rules - the number of requirements
regarding fair value estimates and other disclosures increased from 4 in the old standard to
16 in the new. Arguably, this has been an attempt to “de-risk” the high level of uncertainty
associated with auditing fair value estimates (splitting one task into a number of smaller
tasks and checking correspondence with a set of formal criteria specified for each of them),
and effectively to reinforce what authors call the “neo-positivist” (= outdated) view of
auditing as a set of formalised procedures (boxes to tick). Above may be one example of the
sort of analysis that could be employed to illustrate the existence of the mismatch.
Also, it would be good to hear the authors’ view as to why such a mismatch exists in
the first place. For example, who drives the change in audit thinking and audit innovation?
Or has the politicisation (or what Perry and Nolke (2006)i called “financialization”) of
accounting regulation been prominent to the same extent as the politicisation of audit rulemaking?
Also, the authors can do more to theorise the paper’s findings/conclusions. If
auditing fair value estimates is like attesting the socially constructed accounts of reality,
then who are the actors contracting such accounts – managers, auditors, standard-setters,
users? Can then the existence of a mismatch be characterised as a failure of audit rulemakers and/or practitioners to provide a solution that would reconcile the differences in the
actors’ subjective representations? The authors do ponder on these and other issues, but I
think the discussion may be tighter and better linked to the paper’s chosen conceptual
framework.
More analysis of the proposed solution
At the end, the paper calls for a more qualitative approach to auditing that is based
on a dialogue between the auditor and the auditee to determine the logic behind the social
construction of the fair value estimates based on the model of the “ideal speech situation”
where (1) each party is allowed to participate in the discussion; (2) to offer any proposal; (3)
to question any proposal; (4) no party is coerced by forces inside or outside the discussion.
I think this is one of the most interesting bits of the paper (i.e. its contribution) and
should be developed further. Just a few things I wondered about here: (a) What kind of
impact can the above solution have on auditors’ (perceived and actual) ability to remain
independent? (b) What should the auditor’s “ideal” response be in case his or her proposal
is questioned/contested (as per point 2 of the model above)? (c) Can the nature of the
existing auditor liability regimes play a role on the effectiveness of the solution?
And lastly, I think it is important to remember that any development should be put in
context and in an appropriate timeframe. Given that audit developments are often a
response to the changes in accounting thought/practice, the current status quo should be
seen as an episode in a longer story (cycle) of evolution and reform.
i
See Perry, J., and Nolke, A. (2006) ’The political economy of International Acounting Standards. Review of
International Political Economy 13(4): 559-586.