Accounting Horizons Vol. 26, No. 1 2012 pp. 125–133
American Accounting Association DOI: 10.2308/acch-50087
Some Conceptual Tensions in Financial Reporting
American Accounting Association’s Financial Accounting Standards Committee (FASC) Yuri Biondi, Jonathan Glover, Karim Jamal (Chair and principal co-author), James A. Ohlson, Stephen H. Penman, Shyam Sunder (invited principal co-author), and Eiko Tsujiyama
SYNOPSIS: We examine four key conceptual tensions that are at the heart of many financial reporting dilemmas: stocks versus flows, ex ante versus ex post, conventions versus economic substance, and top-down design versus bottom-up evolution as sources of accounting ...view middle of the document...
Submitted: May 2011 Accepted: September 2011 Published Online: March 2012
Corresponding author: Karim Jamal Email: email@example.com
which these issues become especially salient. However, it is not intended as a comment on any speciﬁc accounting controversy, proposal, or standard.1 We examine four basic facets of ﬁnancial reporting to guide our exploration of ﬁnancial reporting tensions: (1) stocks versus ﬂows, (2) ex ante versus ex post, (3) conventions versus economic substance, and (4) top-down design versus bottom-up evolution of accounting practice. Tensions along these dimensions underlie many of the ﬁnancial reporting issues debated over the past century. It is useful to reﬂect on these foundational issues in isolation from the debates on speciﬁc standards and ﬁnancial reporting practices. Perhaps the Financial Accounting Standards Committee of the AAA can help stimulate further reﬂection and discussion on these issues by sharing its thoughts and analysis. The following sections are written in that spirit. STOCKS VERSUS FLOWS Stocks and ﬂows are the most obvious and frequent dimension of accounting tensions, often reﬂected in debates about the relative importance of balance sheets and income statements. Stock and ﬂow magnitudes are related by a simple law of conservation: ending stock equals the beginning stock plus the net ﬂow over the interval of time between the two instants when the stocks are measured. This identity forms the basis of double-entry bookkeeping and the ﬁnancial statements—balance sheet, income statement, and the statement of cash ﬂows—and their linkages. If magnitudes of all resources of interest in ﬁnancial reporting were observable and measurable or, at least, were equally so, many of the controversies of ﬁnancial reporting would not arise. However, resources vary in how well we can observe and measure their magnitudes; even the stocks and ﬂows of the same resource are not susceptible to measurement with the same degree of precision (i.e., objectivity and reliability). Further, the measurability may change over time. These variations give rise to many of the familiar challenges in ﬁnancial reporting. Consider a building as an example. At the time of its construction or acquisition in an arms-length transaction, the stock of this resource is measurable with reasonable objectivity. But the rate of ﬂow of services deriving from it is more subjective, even at the outset. With the passage of a few years, even the stock of the remaining services becomes more subjective if such buildings are not traded in a relatively perfect market. On the other hand, a patent that earns periodic royalties presents a case in which periodic ﬂows are measurable with a high degree of objectivity, but given the uncertainty about the quantity and duration of future royalties—the stock magnitude associated with the patent—is more subjective, unless, of course, its value is determinable in a relatively...