Shyam Sunder is the recipient of this years Notable Contributions to Accounting Literature Award for his book, Theory of Accounting and Control (South-Western Publishing, Cincinnati, 1997).

The literature award, the winner of which is selected each year by a joint committee of the AICPA and the American Association of Accountants (AAA), was presented to Sunder at the annual meeting of the AAA in New Orleans.

The book is a synthesis of the different areas of accounting theory. It also offers a wide variety of readers (undergraduate and graduate students, faculty and business people) a method to examine how principles of accounting operate within an organization.

An underlying premise of the book is that an organization is a system of contracts. Accounting is a process for implementing and enforcing those contracts. It is the structure that holds an organization together and the mechanism that makes sure it functions.

Sunder, who also won the award in 1982 for an article he co-authored with Nicholas Dopuch (FASBs Statement on Objectives and Elements of Financial Reporting: A Review), is the Richard M. Cyert Professor of Management and Economics at Carnegie Mellon University.

Of Rubles and Dollars

When the Soviet Union collapsed and a slew of newly independent republics began looking for financing to operate a capitalist economy, a foreign banker was heard to comment, Governments come and go. Money remains. If money is a universal constant, it may explain why, as their country moves into a global capitalist economy, Russian accountants have much in common with their counterparts in the United States.

From Moscow to Washington
In September, the Maryland Association of CPAs played host to a delegation of 11 Russian accountants eager to find out what the U.S. professions concerns and interests were and to compare notes with their overseas counterparts. The visit included a trip to the AICPAs Washington office where the staff explained the CPAs role in the U.S. economy and listened to how accountants operate in Russia.

All the visitors worked for what was translated as audit companies, equivalent to CPA firms. They seemed bewildered that the U.S. has 54 licensing jurisdictions: Russian accountants all are certified through a central ministry of finance. However, Russian firms must be licensed for some of the industries for which they act as auditors. Investment companies are fairly new in Russia and only a few firms have licenses to audit them, giving this small group a virtual monopoly.

The delegation members, like many U.S. CPAs today, wanted to know more about IASC standards and their application. One visitor explained that there was a lot of interest in adopting the GAAP of various Western European countries, which can differ from both U.S. and IASC standards. Griping about the tax authorities is a common thread there as well as here. We are not popular with the government tax authorities, said one accountant through an interpreter. They feel we work too hard to help people avoid paying their fair share. They want everyone to pay more than they should. Late-payment fines are very high, they explained, and are a key government profit center.

Marketing, of course, is another capitalist reality. We have to spend lots of time and energy looking for new clients, said one accountant. Its especially hard for a new firm.

100 years of CPE
M. Christine Stewart, president of the Maryland society and head of her own consulting firm, told the Journal that the U.S. profession has been moving to its present role as business advisers for much of the century. Her Russian guests were studying hard to bring their profession up to speed much more quickly. As the Russians met with CPAs around the state, they were stunned by the hourly rates many CPAs command, which are very high compared with Russian standards, said Stewart. Nevertheless, the Russians are not entering this economy with decades of existing perceptions about what the profession has been. They seem very eager to make the move to provide complete business advisory services. They readily bought into our Vision Process.

The Center for Citizen Initiatives, a private organization receiving support from the U.S. State Department, sponsored the trip through its Productivity Enhancement Program, which provides training to Russian business people.

A Truly Public Accountant

Between the activities of the Independence Standards Board and American Express buyouts, the CPA may well ask, what is independence? For Martha O. Haynie, CPA, its being directly answerable to the public. In office since 1989, she is the only elected county comptroller in Florida, with more power than most county comptrollers: She has the authority to audit all the countys departments, including those of the other county officers, such as the county property appraisers and the tax collector. This power allows the comptrollers office to protect the public in new ways.

Thorny audits
Haynies early audits covered countywide procurement practices. We found some pretty sloppy and expensive practices, such as contracts signed on an emergency basis that were extended for years. The county ended up rewriting purchasing regulations. Another audit, of the countys land acquisition practices, found the county was overpaying for some land. In fact, according to the audit, the county commissioners had delegated too much of their authority.

Haynie often walks a fine line between politics and standards. Weve had to be very careful. Officials sometimes want to use my audits to make a political point, which is inappropriate. Consistency is also an issue: Haynie has to be careful not to appear to be going after anyone. She and her staff do risk analyses to decide which agencies to audit. They cant shy away from auditing the sheriffs office just because the sheriff is popular. To maintain the appearance as well as the fact of independence, Haynie generally allows the audit director under her to select which entities to audit.

Tax collections and mistaken identity
The comptroller is also responsible for collection of the tourist development taxessentially a bed tax imposed on tourists and collected by hotelsthat raises nearly $100 million a year. Haynie had to get involved when some hotels claimed rollaway beds were not subject to the taxagain, a political issue. Tourism is our number one industry and you dont necessarily want to make these people mad. But a rollaway bed is a bed.

Haynie also oversees the countys investments. When Orange County, California, found itself teetering on bankruptcy because of poor investment decisions, she spent a lot of time saying, No, thats not us. Nevertheless, she ended up chairing a statewide task force on investment policies. As a result, the state legislature passed a law, modeled on Orange County, Florida, regulations, requiring written investment policies and public annual reports.

Never underestimate the value
The CPAs audit and financial management skillsas well as reputationhave helped Haynie. When I first ran for comptroller, people connected with the fact that I was a CPA, said Haynie. All her senior finance staff and senior auditors are CPAs as well. Its raised the publics confidence. People see the designation and seem confident that Im qualified and doing the job right.

Largest Firms Grow

As a group, the 100 largest independent public accounting firms experienced revenue growth for the third straight year. In 1998, the firms (ranked by net revenue for the most recent fiscal year), generated $24.8 billion in net revenue, 20.7% more than in 1997. Ninety of the 100 firms had revenue growth: 58 of them grew by double-digit margins.

Over the summer, the SEC quietly held a series of meetings with members of the FEI, FASB and Big Five firms, among others, prompted by recent accounting problemsmany of them widely publicizedat companies such as Livent, Cendant and Sunbeam. Although at the time the SEC would not comment on what transpired, in a September 28 speech at the New York University Center of Law and Business, SEC Chairman Arthur Levitt made it very clear how he felt. In brief, the SEC expects the accounting profession to get out of the gimmick business.

This isnt the first time the SEC has traveled this road. Not long ago, Levitts dissatisfaction with the state of auditor independence led to the creation of the Independence Standards Board to address the issue. No doubt the profession will be taking his new statement very seriously.

Earnings managementthe partys over
Levitt blasted a process that has become a game of nods and winks among corporate managers, auditors and analysts. Continued Levitt, In the zeal to satisfy consensus earnings estimates and project a smooth earnings path, wishful thinking may be winning the day over faithful representation.Integrity may be losing out to illusion. While reiterating his pride in the strength of U.S. capital markets, Levitt stressed that continued good fortune depended on clear, unambiguous financial statements. If a company fails to provide meaningful disclosure to investors about where it has been, where it is and where it is going, a damaging pattern ensues. The bond between shareholders and the company is shakenthe trust that is the bedrock of our capital markets is severely tested.

Under a category titled hocus-pocus, Levitt discussed five key illusions he felt were poisoning the financial reporting process.

Big bath charges. Companies may overstate one-time charges associated with restructuring. Such charges help companies clean up their balance sheeta big bath. The theory is that Wall Street will ignore a one-time loss and focus on future earnings. Levitt agrees that financial reporting needs to reflect restructuring charges. But this should not lead to flushing all the associated costsand maybe a little extrathrough the financial statements.

Creative acquisition accounting. Levitt criticized a process he called merger magic that occurs when some business acquirers use stock as an acquisition currency. They classify an ever-growing portion of the acquisition price as in-process research and development, soyou guessed itthe amount can be written off in a one-time chargeremoving any future earnings drag.

Miscellaneous cookie-jar reserves. Some companies use unrealistic assumptions to estimate liabilities for sales returns, loan losses or warranty costs, for example. In doing so, they stash accruals in cookie jars during the good times and reach into them when needed in the bad times. Levitt discussed one company that took a large one-time loss to earnings to reimburse franchisees for equipment which had yet to be bought. At the same time, the company announced future earnings would grow by 15% a year.

Materiality. Levitt agreed that some items may be so insignificant they are not worth measuring precisely. But some companies misuse the concept of materiality. They intentionally record errors within a defined percentage ceiling. According to Levitt, the companies then say the effect on the bottom line is too small to matter. If thats the case, why do they work so hard to create these errors? Maybe because the effect can matter. Missing an earnings projection by a penny, for example, can result in a loss of millions in market capitalization, he pointed out.

Revenue recognition. Think about a bottle of fine wine, said Levitt. You wouldnt pop the cork on that bottle before it was ready. However, he said some companies were essentially doing that, recognizing revenue before the sale was complete when the customer still had the option to void or delay the sale.

Call to action
Levitt did not just point out the problemshe outlined solutions. He asked that regulators and standard setters improve the transparency of financial statements and called for nothing less than a fundamental cultural change on the part of corporate management as well as the whole financial community. Specifically, he introduced a nine-point plan:

• The SEC staff will require well-detailed disclosures about the impact of changes in accounting assumptions. Companies should include a supplement to the financial statement showing beginning and ending balances, for example.

• Through the AICPA, the SEC will challenge the accounting profession to clarify rules for auditing of purchased research and development. The AICPA also should increase guidance on restructurings, large acquisition write-offs and revenue recognition.

• The concept of materiality will no longer be an excuse for deliberate misstatement of performance. Levitt brought up a Fortune 500 company that used a materiality ceiling of 6% of earnings to justify an accounting error. Materiality is not a bright-line cutoff of 3% or 5%. It requires consideration of all relevant factors that could impact an investors decision.

• SEC staff will immediately consider interpretive guidance on revenue recognition. It will look at software revenue-recognition standards to see if that guidance is applicable to other industries. (See "Recognize the Software, Recognize the Pitfalls" , JofA, May98, and "Software Revenue Recognition Updated" , JofA, Nov.97, for details on recent changes in this area.)

• Standard setters will have to take quick action where current standards are inadequate. The FASB should promptly resolve key projects in process.

• SEC review and enforcement teams will assist in this effort by focusing on companies with red flags that indicate they are managing earnings. Included will be companies with restructuring liability reserves and major write-offs, for example.

• Auditors must rededicate themselves to the reliability of the financial reporting process. The integrity of that information must take priority over a desire for cost efficiencies. Junior auditors must have proper supervision, and corporate audit committees must take responsibility on behalf of their companies.

• The New York Stock Exchange and the National Association of Securities Dealers are sponsoring a blue-ribbon panel to recommend changes for audit committees and function as the ultimate guardian of investor interests and corporate accountability.

• Corporate management and Wall Street must re-examine the current environment. While the temptations are great, and the pressures strong, illusions in numbers are only thatephemeral, and ultimately self-destructive. To Wall Street, I say, look beyond the latest quarter. Punish those who rely on deception, rather than the practice of openness and transparency.

The view from the Institute
In a press release dated the same day as Levitts speech, the AICPA threw itself behind the chairman. We share Chairman Levitts commitment to investor protection and will continue to ensure that auditors fulfill their responsibilities. The Institute announced several new initiatives to support the SECs thrust:

• The Institute is issuing a new publicationa tool-kitcontaining comprehensive guidance to help all involved in the financial reporting process understand the importance of accurate revenue recognition. It will reinforce best practices and summarize current standards.

• The ASB will examine the audit risk model to see if it needs updating. In fact, the ASB has already moved in that direction with its report, Horizons for the Auditing Standards Board: Strategic Initiatives Toward the Twenty-First Century. (See New Dawn for Auditing, JofA, May98, page 23, for details on this report.)

• The AICPA will prepare a periodic publication for audit committee members to keep them up to date in accounting, financial disclosure, corporate governance and market regulation.

Much of the AICPAs recent focus has been on expanding the CPAs role into consulting services and assurance services that focus on nonfinancial issues. However, the Institute statement concluded with a renewed commitment to the audit, the most traditional of a CPAs services. For the past century, the AICPA has provided guidance, standards and tools to assist auditors in that trusted role. We will continue to demand that auditors fulfill their responsibilities. To that end, we support recommendations that will have as their result the protection of investors.

and others
The profession has not responded widely yet. However, a spokesman for KPMG Peat Marwick said the firm has always been in favor of any movement aimed at strengthening the vitality of U.S. capital markets.

Also, the Journal spoke with John P. McAllister, CPA, PhD, chairman and professor of accounting at the Michael J. Coles College of Business, Kennesaw State University, who did not seem surprised at some of the issues Levitt brought up. Just look at the sheer size of the purchased R&D being written offtheres definitely a problem. He brought up the WorldCom/MCI merger as an example. McAllister pointed out that, in this $37 billion deal, $7 billion was initially to be written off as purchased R&D. After discussions with the SEC, the amount was reduced to $3.1 billiona good indication that the SEC is serious about making changes. McAllister also said that in the same deal $26 billion was allocated to goodwill. If this were added to the initial purchased R&D amount, the total would be close to 90% of the purchase price. He said, Our accounting model dealt well with the assets of the industrial ageland, buildings, equipment. It does not deal nearly so well with the assets critical to todays information-age companies.

The complete text of the Levitt speech is available at www.sec.gov/news/speeches/
spch220.txt . The AICPA press release is on its Web site, www.aicpa.org, under the Press Releases/News Alerts link.

Not all the fiction in Hollywood appears on screensome stories can be found in the studios financial statements. Movie and TV producers have always had some leeway in their accounting. But a proposed SOP, written by AcSEC and approved by FASB, could drastically change the rules and force producers and distributors to curtail some of their more aggressive accounting methods.

Recognition
The Journal spoke with Louis W. Matusiak, Jr., AcSEC member and chairman of the motion pictures task force, about some of the differences between the provisions in the proposed SOP, Accounting by Producers and Distributors of Films, and the current guidance found in FASB Statement no. 53, Financial Reporting by Producers and Distributors of Motion Picture Films. Revenue recognition will be significantly different, he said. Lets say a producer licenses 60 episodes of M ^* A ^* S ^* H . Currently, the producer gets to record the revenue as soon as the episodes are delivered. The ED says the revenue should be recorded ratably over the entire licensing period.

Continued Matusiak, Theres a big, big change for handling advertising costs. Under Statement no. 53, producers capitalized these costs, also called exploitation costs, and wrote them off over the revenue streama process that took more than a decade in some cases. David J. Londoner, another task force member, said in his companys newsletter that many film companies have been capitalizing all their advertising and writing it off against total estimated revenues from the film. As an example, he said that the cost of ads in Toledo could end up being amortized in part against revenues from New Zealand. The proposed SOP says producers can capitalize these costs in the theatrical market onlyas opposed to the TV market, for exampleand must write them off over the theatrical release period or three months, whichever is shorter.

The third big proposed change, according to Matusiak, relates to participations and residualscompensation paid to actors and other creative people that is contingent on the films success. Currently, these costs are accrued and recorded when the film achieves the financial goals that trigger accounting recognition. A lot of the accounting in the ED is based on the premise that the industry can predict early in a films life how well it will do; thus, producers will have to recognize these liabilities up front.

Stricter guidelines
In general, the ED will halt some past abuses. Said Matusiak: Lets say you plan to license a film for Chinese TVas soon as China gets TV. Thus, if you include this revenue in the ultimate gross revenue estimate over which the films costs will be amortized, the asset sits there like a huge intangible. The ED eliminates such practices. Another questionable practice that will be curtailed involves what can be capitalized and amortized as overhead. A producer could have 10 films: 7 lose money, 2 break even and one becomes Forrest Gump. Currently, the producer can take the losses of the 7 losers and capitalize them in the balance sheet. That is, the producer records them as an asset on the balance sheet and amortizes those costs over the income of Forrest Gump. So it looks like the big hit was a loser too.

Matusiak said that many of the studios will be upset with these changes, although some, like Disney, have been using accounting methods similar to those in the new model already. This could significantly affect a lot of the smaller, independent producers who will miss the loss of flexibility.

The EDs exposure period runs until January 18, 1999. The proposed SOP appears on the AICPA Web site, www.aicpa.org. Copies can be ordered by calling 888-777-7077. CPAs outside of Hollywood will be pleased to note the ED includes a brief glossary of film industry terms.

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Short takes, notes and items of interest