Chapter 6: The Search for Objectives Instructor Manual

CHAPTER HIGHLIGHTS
Chapter 6 continues the thrust of Chapter 5 by examining important documents and committee
reports that have appeared since the publication of ARS 1 and ARS 3. As its title indicates, the
chapter is concerned with the question of who financial reporting is prepared for and what
information should accessible by them. ASOBAT was the first formal report to emphasize the
importance of user needs to accounting standard setting, even though the actual development of
the user needs themselves was quite limited.

APB Statement 4 was the APB’s “last hurrah.” The document contained much of the
“conventional wisdom” going back to the basic concepts underlying historical costing discussed
in Chapter 5, as well as material coming from ASOBAT. In some ways it was more complete
than ASOBAT, because it listed users of financial accounting information—classifying them into

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those with direct interests and those with indirect interests.

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In the wake of the demise of the APB, the AICPA commissioned the Wheat Committee and the
Trueblood Committee reports. The former pertained to the organization of the APB’s successor

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and was briefly discussed in Chapter 3. The latter attempted to delineate the major overall
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objectives of accounting in terms of user needs. The objectives have been criticized as being
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non-operational. However, since they were intended to be at the apex of a metatheoretical
structure, that criticism misses the point, in our opinion.
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SATTA, like its predecessor ASOBAT, was an attempt to assess the contemporary state of
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financial accounting theory. Unlike ASOBAT, which attempted to codify some elements of a
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metatheoretical structure, SATTA attempted to show why agreement in terms of selecting among
competing accounting theories (valuation systems such as replacement cost or exit values) could
not be achieved at that particular time. We believe that one of the crucial issues brought up in
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SATTA is the question of how diverse the information needs of the various user groups are.
This is an empirical question that has not yet been resolved. In fact, little, if any, work has been
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done on this extremely important question. It is also interesting to note that SATTA took a very
pessimistic view at almost the same time that the FASB launched the conceptual framework.
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The discussion of user objectives and user diversity, which was given in separate appendices in
previous editions of this book, are now included in the body of the chapter. This information is
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important and supplements the discussion of the various committee reports and documents
covered in the chapter.

QUESTIONS
Q-1 How do objectives differ from postulates?

Objectives are goals to be strived for. As such, they must be normative in nature. They may also
have different degrees of specificity. For example, an objective stating that information should
be relevant to users is very broad and is not operational. Objectives standing below relevance

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would prescribe what information they need. Postulates are general statements that may be
either normative or descriptive (or both). The more descriptive a set of postulates is, the more
likely that it will be too broad to use as a basis for deductive reasoning—as in accounting.
Where postulates are normative, they begin to take on the character of objectives (financial
statements should be based upon a stable measuring unit, for example).

Q-2 Do you think that the funds flow statement is more “factual” and less “interpretative”
than the income statement and balance sheet?

The funds flow statement is more factual than the other statements, but it is not wholly factual.
Under funds provided from operations is income, excluding gains and losses, and also
depreciation. However, income still includes elements such as cost of goods sold, which is
interpretative because several ways of measuring this item can be used. The distinctions
between factual versus interpretative concern the allocation problem.

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Q-3 Do you think that the standards mentioned in ASOBAT are really standards? Why or

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why not?

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If we reserve the term “standards” as rules or guidelines for practice, ASOBAT’s standards lie
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above standards in the sense that we presently use the term. They would lie below ASOBAT’s
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objectives. The FASB, in fact, used three of these standards in the conceptual framework but
called them qualitative characteristics. The fourth standard, quantifiability, is a general term
pertaining to measurement which apparently has been dropped because it is somewhat general
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and other standards (verifiability) certainly pertain to measurement.

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Q-4 Why is the problem of heterogeneous users so critical in the development of accounting
theory?

If different user groups have different accounting information needs, a very thorny problem
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exists. There is a cost associated with preparing and disseminating accounting information. On
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the other hand, users do not directly pay for the information they need. Hence, a market-oriented
solution to the problem is not possible. Consequently, a rule-making body is faced with the
problem of benefiting one group at the expense of another. The problems faced by accounting
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policy makers would be significantly easier to deal with if all groups needed much of the same
information. Determining what that information is and how to present it would then be the rule-
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making organization’s principal tasks. More research is obviously needed on this issue.

Q-5 APB Statement 4 defines assets in the following terms: “Assets are economic resources
of an enterprise that are recognized and measured in conformity with generally accepted
accounting principles. Assets also include certain deferred charges that are not resources
but that are recognized and measured in conformity with generally accepted accounting
principles.” Do you think this is a useful definition? Why or why not?

This definition from APB Statement 4 is not very useful. The definition has a cart-before-the-
horse problem because the definition should help in determining GAAP but it says that if GAAP
calls it an asset then it is an asset. In addition it says that deferred charges are assets even if they

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are not resources (resources would be a substitute word for assets). Hence some “assets” are
really not “assets.” Some examples would be unamortized organization costs and deferred tax
debits (determined under APB Opinion No. 11 which is geared to a revenue-expense approach
rather than an asset-liability approach).

Q-6 How do the research orientations of accounting in Chapter 2 compare with SATTA’s
organization of research?

The orientations are different, but there is some overlap. Both list information economics as a
separate category. In SATTA, the “classical” approaches were basically deductive and
normative in nature with little, if any, emphasis upon user needs. Aside from information
economics, current research was classified by whether it emphasized decision models or decision
makers. The former case is normative and deductive in approach and is likewise the same
category used in Chapter 1. The latter, which is empirical and attempts to be descriptive, is

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further broken down into individual users and aggregate market behavior. Many of the studies of
individual users involve behavioral research, which was a separate category in Chapter 1.

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Similarly, aggregate market behavior largely corresponds with our category of capital market
research. Agency theory had not yet burst onto the scene when SATTA was written.

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The statement of Herbert Miller (footnote 33) is closest to which theoretical approach
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delineated in SATTA?

Miller, Herbert E. (1974). “Discussion of Opportunities and Implications of the Report on

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Objectives of Financial Statements,” Studies on Financial Accounting Objectives, 1974

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(Supplement to Journal of Accounting Research), pp. 18–20. Unquestionably, the Miller view is
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quite close to the decision model category of decision-usefulness discussed in SATTA.

Q-8 How has the definition of accounting been modified in recent years?
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The decision-usefulness aspect of accounting was brought into the definition by ASOBAT, as
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opposed to previous definitions that emphasized the input side rather than the output side. The
same definitional thrust was maintained in APB Statement 4.
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Q-9 What potential conflicts are present in terms of different user needs?
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The problem here is, in a very real sense, the opposite of the problem concerning the conflict
among objectives. On one side are actual shareholders versus potential shareholders. The
former would certainly desire “good news,” whereas “bad news” might benefit the latter to the
extent of keeping the security price lower than it might otherwise be. This situation assumes
some degree of market inefficiency. Labor unions might desire income to be as high as possible
in order to support wage demands. On the other hand, suppliers might desire conservative
information as a “margin of safety.” Management might desire a high income in order to look
good or to maintain flexibility in terms of bond covenants. Management of firms that might be
subject to antitrust pressure might, on the other hand, desire lower reported income to minimize
governmental pressure. These are some of the possibilities. Many others probably exist.

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Nevertheless, we wonder if the problem is as serious as some seem to think it is. Certainly,
empirical work is needed to attempt to shed more light on the problem.

Q-10 Why has Ijiri advocated the need for a conceptual framework to implement
accountability?

We still need to know who the users of the accounting information would be: that is, how far the
net should be cast in terms of covering user groups. Should we, for example provide information
about environmental concerns and, if so, who should pay for the information? Similarly, the
rights among various groups must be clearly staked out. For example, major credit providers
might want very conservatively stated income statements to minimize dividend declarations and
management bonuses. Thus, the rights of the various groups must be carefully established.
While we agree that this is not easy, we do not think that the task is one of Everest-type
proportions.

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Q-11 The Trueblood Committee Report advocated the use of financial forecasts. Why do you

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think that adoption of this suggestion has been very unenthusiastically received by
preparers and auditors?

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Both preparers and auditors fear the risks involved, even though safe harbors have been
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provided. We suspect that management is also concerned with disclosing important information
for potential use by its competitors.
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Q-12 Under an accountability orientation, Ijiri makes a strong case for the use of historical
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costing including the possibility of general price-level adjustments. Why do you think he
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has made this choice?

To quote Ijiri himself from his “Theory of Accounting Measurement” (Studies in Accounting
Research #10, American Accounting Association, 1975, p. 35):
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“. . . to protect both the accountor and the accountee from the abusive use of performance
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measures, the measurement used must be highly standardized and verifiable so that there is little
room for dispute over a performance measure that is generated by an accounting system.”
Thus, historical cost would fit the bill better than replacement cost or entry value systems. Ijiri
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would adjust historical costs by general price-level adjustment, which would still be highly
verifiable.
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Q-13 Past viewpoints expressed that financial statement preparers are also the largest class of
users of financial statements. Hence, the preparer has a “unique ability” to recognize user
needs that the FASB does not really appreciate. Critique this viewpoint.

They do indeed have a “unique ability” and they are important users. However, agency theory issues can
easily get in the way relative to external statements: (1) an optimistic view if management wants to
maximize bonuses or generally impress users or (2) a pessimistic view if the firm is very large and subject
to governmental pressure. The enterprise could easily use one set of financial statements for published
purposes and another for internal purposes.

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Q-14 Why would “fairness” in financial reporting be difficult to implement?

We all have a tendency to think that what benefits us is “fair” and what does not benefit us is
“unfair.” This is not, however, an insuperable problem, although it would certainly require care
and caution on the part of a standard-setting agency.

Q-15 What is the relationship between “stewardship” and “accountability”? Discuss.

Accountability is related to but broader than stewardship. Both are concerned with good internal
controls. Accountability is much more concerned with how well management has done. Thus,
stewardship would be less interested in measures assessing management’s performance, such as
earnings-per-share and return on investment, than would accountability.

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Q-16 Do you think that the income tax return mandated by the federal government is an

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example of user heterogeneity? Why or why not?

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Perhaps preparer heterogeneity would be a better term but the idea is definitely there. This is one
reason why the federal income tax return is so complicated. One small example would be social

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security income which pertains to an older group of taxpayers. It is taxed at a lower rate than
other forms of income. Another example involves home owning. Owners have interest and
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property tax deductions. Renters cannot deduct their rent payments.
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Q-17 If a division manager of a firm were fired due to poor operating results, would this be an
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example of stewardship?
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Stewardship refers to the providing of information to the organizations owners and creditors that
show how the organizations’s resources were used during a financial reporting period. So, the
provision of the information is the stewardship function, not the firing.
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CASES, PROBLEMS, AND WRITING ASSIGNMENTS

1. A crucial question brought up in this chapter concerns the issue of whether the
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admittedly heterogeneous users of financial statements have highly diverse information

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needs in terms of their underlying objectives. State as carefully as you can (1) why the
user groups have largely diverse information needs, and (2) why the user groups may
have relatively similar information needs. Do you think user diversity or different user
objectives presents the greater problem for accounting standard-setters?

Different user groups do indeed have somewhat different user needs. Shareholders, for example,
would want financial information which would tell something about the long-term growth and
potential earnings increases – hopefully leading to security price increases – in the stock.
Bondholders would be less interested in the overall growth of the stock but would be more
interested in the overall safety and ability of the firm to pay interest and principal on the bonds.
While these information needs are slightly different, they are not so different that a well

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developed set of financial statements should be able to cover both of these sets of needs. The
same general statement applies to the other user groups mentioned in the chapter. Some
problems apply more to different objectives more than to different user groups. For example, in
Chapter 16 there is a conflict between cash flow predictions and accountability relative to
measuring service costs of pensions. It is possible that shareholders might prefer the former
measure and bondholders the latter but that is not entirely clear. Problems of this type may have
to be dealt with on a case-by-case basis but this is not entirely clear.

2. Using the different valuation methods discussed in Appendix 1-A, what possible
different user preferences do you see among the various user groups?

Historical cost and possibly general price level adjustment might be the most understandable
methods (which cuts across user groups). Management itself might prefer exit valuation since it
shows liquidity available to management for assessing the possibility of liquidating assets for the

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purpose of getting into different assets or businesses. Entry value might be preferred by

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shareholders since it might be useful for predicting future cash flows because current value

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(replacement cost) of assets being used up helps to give more of an economic income perspective

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than historical costing. While there are some potential differences between user groups, the

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biggest preference or choice might be based upon the qualitative characteristics of the conceptual
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framework which appeared earlier in ASOBAT: relevance versus reliability (one aspect of which
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is verifiability).
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CRITICAL THINKING AND ANALYSIS

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1. Do you see an evolutionary process involving the documents and reports presented in this
chapter? Explain.
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There is a certain evolutionary pattern that is present. After the failure of ARS 1 and ARS 3,
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ASOBAT picked up the user orientation approach which was followed in APB Statement 4, the
Trueblood Report, and eventually the FASB’s conceptual framework. Close up, several of
ASOBAT’s standards for accounting information (relevance, verifiability, and freedom from
bias) appear in the conceptual framework (freedom from bias is complementary to the
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conceptual framework’s qualitative characteristic of neutrality). APB Statement 4, as noted

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above, continued ABOBAT’s user orientation. It also picked up “basic features” of accounting
which largely came from Moonitz’s ARS 1. The Trueblood Report kept the emphasis on users
and objectives and was something of a “state of the art” position when it was drafted.

The one exception to all this is SATTA. SATTA was imply a disagreement among academics
on an appropriate value system. SATTA appeared at a time when the dominant research thrust
in academe had swung from deductive to inductive. The irony of SATTA represented a
breakdown of theoretical agreement among academics at a time when the FASB would
commence with its conceptual framework project.

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2. If different user groups do have different objectives, how might the situation be handled?

This is a tough question. Can financial reporting be all things to all people? If it can, will the
costs be acceptable to those bearing them? Perhaps technology can help. XBRL, for example,
may provide greater transparency of financial data, allowing users to view the data from multiple
perspectives and levels of detail. On the other hand, if financial reporting cannot be all things to
all people, then the user group(s) should be clearly defined and financial reporting oriented
towards meeting the needs of this more narrowly defined group.

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