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Author: SONY WARSONO, PhD
Email address: firstname.lastname@example.org; email@example.com
Institution: Department of Accounting Faculty of Economics and Business Universitas Gadjah Mada Yogyakarta – Indonesia
History-based Accounting Reform …
HISTORY-BASED ACCOUNTING REFORM: USING MATHEMATICS PERSPECTIVE TO IDENTIFY AND SOLVE SOME MAIN PROBLEMS IN ACCOUNTING EDUCATION AND STANDARDS
Manuscript Type: Perspective Research Issue: Perceived as a pure social science, prominent accounting scholars agree that the current accounting development overemphasizes on rules, and this has wide negative impacts on accounting education and research. Thus, accounting reform is necessary even though it is still unclear the direction of the reform. Research Findings/Insights: The basic thesis of this study is that accounting is an application of mathematics because accounting was documented in the mathematics book and written by Luca Pacioli as a mathematics professor. Firstly, this study shows the inappropriateness of current accounting teaching methods. Specifically, this study shows that the use of debits and credits is purely the application of mathematics. Secondly, this study identifies the limitation of the definition of financial statement elements, and proposes the alternative redefinition of the elements. Thirdly, this study shows that the use of a mathematical perspective helps accounting profession to solve current accounting issues. Finally, this study proposes the development of three pillars, i.e. mathematics, rules, and art, in a balanced manner to do accounting reform. Theoretical/Academic/Policy Implications: This study provides a “new” perspective that the accounting development is based on the history of accounting itself, i.e. accounting as an application of mathematics. Using the mathematical perspective, not only do accounting scholars improve the accounting education but also we innovate accounting research agenda. In addition, this study offers insights to accounting standard boards interested in developing a global uniform of financial accounting standard that effectively work.
History-based Accounting Reform …
HISTORY-BASED ACCOUNTING REFORM: USING MATHEMATICS PERSPECTIVE TO IDENTIFY AND SOLVE SOME MAIN PROBLEMS IN ACCOUNTING EDUCATION AND STANDARDS
INTRODUCTION The 2001 and 2002 accounting scandals were considered the beginning of the wave of the global financial crisis. The wave of the scandals spread widely and resulted in significant damages. Many factors potentially contributed to the scandals (see Ball, 2009). The most recent wave of global financial crisis was the 2007 and 2008 financial crisis sometimes described as the most serious financial crisis since the Great Depression. The crisis was the result of frauds and mistakes committed “by managers who were accountable to no one” (Zingales, 2009:391). Association of Chartered Certified Accountants (ACCA, 2009) as the global body for professional accountants demands the accounting profession to learn from the year long financial crisis because “it is clearly unacceptable that poor quality loans can be sliced, diced and parceled up with an AAA sticker and overvalued on banks’ balance sheets as a consequence.” The magnitude of this worldwide financial crisis calls for a fundamental reassessment of all areas of business and economic scholarship, especially accounting because the main roles of accounting is to provide financial information. The better the accounting as a financial reporting system is, the higher the quality of financial information outcomes will be. It is expected that accounting provides information on what really happens both in micro- and macro-economic activities. In turn, accounting will detect and prevent the global financial crisis. Unfortunately, the accounting development is still far from the expectation. Accounting today is under pressure even from inside. Demski (2007) questions whether accounting is an academic discipline. Fellingham (2007) argues that accounting academicians tend to think in terms of contributions to the current generation of students, instead of to the academy or to future generations of students. Hopwood (2007) argues that accounting researchers increasingly focus on accounting research issues that are insufficiently innovative and increasingly detached from reality. Ball (2008) argues that an understanding of the actual economic role of financial reporting is important from both a positivist scientific perspective and a normative perspective. Recently Basu (2008:426) demanded several scholars to present the topic "What is the most important accounting issue
” (AAA FASC. 2008. like in law and politics. & Riedl. This development has wide and significant negative impacts on accounting education and research (Hopwood. 2009). 2010:117). Holthausen (2009) argues that the objective of IFRS adoption would not be successful unless the underlying institutional and economic factors among countries were similar. Armstrong. Li. prominent accounting scholars agree that the current accounting development overemphasizes on rules. In short. 2009:277). Fellingham. 2010). On the one side. The reform is a main part of the enforcement of corporate governance initiatives. prior research studies find that the adoption of IFRS provides benefits on certain conditions (Daske. 2008). Hail. Over time accounting profession tends to apply a “rule-based” approach which emphasizes compliance over substance to financial reporting rather than a “principle-based” approach which emphasizes substance over compliance (Ball. The current case is the adoption of IFRS (International Financial Reporting Standards). Furthermore. Another committee in the American Accounting Association. This dilemma is not unusual in accounting standard setting. in its development. GAAP or IFRS rather than mandating one global monopoly set of standards. companies to choose use of U. Demski (2007:156) challenges accounting 3 . 2007. 2007. it is unlikely to find one industry. the effectiveness of the IFRS adoption is still debatable. the Financial Accounting Standards Committee favors “allowing U. The objective of the IFRS adoption is that a uniform set of accounting standards will achieve the goals of comparability and consistency of financial reporting that applies throughout the world. rules are fundamental in accounting (Penno.S.History-based Accounting Reform … where we either think we understand it but in fact do not or have failed to consider the issue in anywhere near the depth it deserves?" Perceived as pure social science. 2010. even though these telecommunication and computer industries use different standards but they still achieve the goals of comparability and interconnectivity. for example the telecommunication or computer industries. 2007. Accounting reform is necessary and starts running now. However. 2008. 2009. Ball. Arnold.S. Interestingly. Demski. On the other side. applies a single industry standard around the world. the Financial Reporting Policy Committee of the Financial Accounting and Reporting Section of the American Accounting Association concludes that the adoption of IFRS is “a desirable goal” (AAA FRPC. 2010). As a matter of fact. Barth. Leuz & Verdi.
2009). b) chapter 8 about Algebra. Luca Pacioli was neither an accountant nor bookkeeper. and proposes the solutions to solve two current accounting issues (fifth section). Proportions and Proportionality (Weis & Tinius. 1994. ACCOUNTING AND MATHEMATICS As widely acknowledged. 1978. The final section concludes the discussion. The model was expected to discourage political tampering. 1987). Rabinowitz. Luca Pacioli discussed accounting in his mathematics book Summa de Arithmetica. and d) chapter 10 about Geometry and Trigonometry. 1991). including. 1991. astrologer to Pope Leo X. This paper uses a mathematical perspective. and believes that the change will come from young accounting scholars who learn accounting with fun. Proportioni et Proportionalita (hereafter. Luca Pacioli had been teaching mathematics courses in several universities for more than 20 years (Journal of Accountancy. Hernandez-Esteve. but a university professor of mathematics (Peters & Emery. Weis & Tinius. 2009). Geometry. The use of a mathematical perspective is appropriate and valid because accounting itself was academically documented in the mathematics book by Luca Pacioli as a mathematics professor (discussed in the second section). c) chapter 9 about Business. to propose the accounting reform. and the author of a number of mathematics books 4 . Summa’s English title would be Collected Knowledge of Arithmetic. & McCarthy (2007) mention that there were 10 chapters in the Summa: a) chapter 1 – 7 about Arithmetic. Particularis de Computis et Scripturis translated into Details of Accounting and Recording (Rabinowitz.History-based Accounting Reform … academicians “to do good” and “redefine the game”. Moreover. especially the double entry system. The first time Summa was published. Summa). Geometria. this paper shows the inappropriateness of the present accounting education and proposes the solutions (third section). using the mathematical perspective. 2009). Recently the former Vice-Chairman of the Financial Accounting Standards Board David Mosso (2010) proposed a new accounting model that measured wealth and provided information about entity’s financial health. identifies the limitations of the current financial standards and proposes the solutions (fourth section). Sangster. Stoner. The section of Particularis de Computis et Scripturis appears to be included for the sake of completeness to recognize the importance of arithmetic principles in the application of bookkeeping (Rabinowitz.
Thus. Kieso. passive (Bonner. accounting uses a monetary unit principle to measure the economic activities (Littleton. The traditional teaching of accounting has been criticized in many countries (Duff & McKinstry. procedural (Dempsey & 5 . This study argues that the use of debits and credits in the double entry system is mainly because there is no negative numbers in financial unit. 2008). & Kimmel. & Yee. 1926. 1999. 2000). Rabinowitz. The use of debits and credits in the double entry system is also an application of mathematics. & Bettner.. the use of debits and credits in accounting that conveys financial information is purely an application of mathematics. Haka. Boyce. Most of accounting literature agrees that the double entry system is an application of mathematics. In Mathematics Magazine. and credits meaning the right side (e. 2001). Williams. Rabinowitz. 1991). moving negative numbers (suppose minus 5) from the left side of algebra to the right side will change the numbers into positive ones (plus 5).History-based Accounting Reform … (Sangster et al.g. Kelly. Williams. It was possible that the double entry system had existed hundreds of years before it was published in Summa (Yamey. Pacioli cleverly explained mathematics in a clear and interesting way reflecting the state of mathematics during the early Renaissance (Weis & Tinius. 2007. & Merchant. 2007. Anthony. 1994. 2009). 1924. Interestingly. the study of accounting remains essentially the same (Albrecht & Sack. In the contrary. 1926). 2007). Peters & Emery (1978) believe that mathematicians did not use negative numbers when Pacioli published the Summa. 2009). Littleton. Ellerman (1985) confirms that the double entry system is purely the application of mathematics. Scorgie (1989) demonstrates that the negative numbers were known before the publication of the Summa. Weygandt. REFORMING THE ACCOUNTING EDUCATION Even though accounting has been taught for more than 500 years. Most of modern accounting textbooks define debits meaning the left side. This argument is important to explain the rules of debits and credits discussed in the next section. 2007). Hawkins. While business has experienced dynamic changes. The definition indicates that the use of debits and credits is identical with algebra that has left and right sides. the double entry system is one of few principles that stay unchanged for more than 500 years (Hatfield. Mathematically. discussions about accounting teaching methods are always appealing. As we all know.
2003). This traditional learning of accounting makes accounting textbooks look similar to one another (Sullivan & Benke. experts argue that the mechanism of debits and credits does not make sense (“debits and credits are nothing more than pluses and minuses”. & Reckers. and deepening of our intellectual foundations. 2004). Vallely. 1997) which in turn makes accounting less attractive to students.” (Demski. Those three statements confirm that the teaching of accounting today overemphasizes standards. Maccracken. 2008:428). Pincus. 2007:156). Fordham & Hayes (2009) found that paper color may have significant contribution to student performance in the accounting principles courses. Other researchers suggested the use of information technology to improve the effectiveness of accounting study (Elliott. Ingram. 1996. Romcke. On the one side. and “We have ceded to regulators the care. 6 . may actually hinder the student’s efforts to develop the requisite competence in accounting. Mohamed & Lashine. 2003. Silvester. Our accounting textbooks “typically consist of little other than a recitation of the more important standards …” (Ball. 1993. and relying merely on a one-way direction of knowledge distribution (Williams. 2003. and de-emphasize our contribution to the academy” (Fellingham. Pincus. Saudagaran (1996) and Springer & Borthick (2004) noted that the traditional curriculum of accounting. & Yap. David. 2007:160). 1997. inadequate in equipping the student with the necessary competencies (Mohamed & Lashine. This paper discusses the two following basic issues problematic in accounting education. & Wyatt. “We teach the rules. feeding.History-based Accounting Reform … Stegmann. A great number of experts have been discussing the need of changes in the teaching methods of accounting (Rankin. such as critical thinking. Saunders & Christopher. 2003. 2007). Some critical issues that might be questioned by students are answered based only on the rules. 1998:411). 2001). 1992. 2003). 1997). Goldwater & Fogarty. Hartnett. Albrecht & Sack (2000) argue that the study of accounting needs to be transformed to catch up with changes in technology and globalization. demands the student simply to memorize (Saudagaran. is too narrowly procedural (Patten & Williams. The Rules of Debits and Credits The rules of debits and credits have been much debated by experts. emphasizing memorizing skills.
On the other hand. Next. 2009). 1997). 1997:230). As a result. this debit and credit mechanism actually has an argument which is very clear and easily understandable to the student. the debit and credit mechanism represents a consequence of the accounting equation whose recording is reflected in the double entry system. From the mathematical perspective. 2007). the amount of assets is the difference between 25 and 15 (25 – 15). 25 is recorded to the debit and 15 to the credit (alternative A). the increase of assets is recorded on the debit while the decrease of assets is recorded on the credit (see Figure 2). the assets with the value of 10 can be recorded either on one side. Supposed. the alternative A should be applied because the assets have a positive value and located on the left side of the accounting equation (see Figure 1). The basic accounting equation is 10 = 4 + 6. however.. i.. ---------------------------------------------Insert Figure 1 about here -----------------------------------------------7 . The brief description is as follows. 2008:49). According to the mathematical formulation. or 15 to the debit and 25 to the credit (alternative B). Other textbooks briefly describe these rules by providing mathematical illustrations expected to facilitate the student’s understanding even though the description ends up with an appeal that the student simply memorizes the rules (Walther. Diller-Haas. 1997. a rule of thumb (Williams et al. and is liable to convey a mistaken picture about accounting to the student (Pincus. Nelson. and Equity = 6. Liabilities = 4. Case A. Based on the ordered pairs of the group of differences construction (see Ellerman. or customs “like the custom of driving on the right-hand side…” (Weygant et al.e.History-based Accounting Reform … 1990. and because debits and credits are an indispensable part in the learning process of accounting (Vangermeersch. 1985).. 2004). 1995). In essence. Assets = 10. a number of other experts have tried to maintain the teaching of debits and credits in accounting principles because debits and credits are believed to be “part of the vocabulary in our language” (Wallace. A number of textbooks state that the rules of debits and credits are arbitrary (Anthony et al. and accounting does not recognize the negative number. 2007). The interpretation is that number 15 on the credit deducts number 25 on the debit.
Based on the ordered pairs of the group of differences construction (see Ellerman. and accounting does not recognize the negative number. 1985). ---------------------------------------------Insert Figure 3 about here --------------------------------------------------------------------------------------------Insert Figure 4 about here ------------------------------------------------ Case C. the increase of liabilities is recorded on the credit while the decrease of liabilities is recorded on the debit (see Figure 4). Supposed. however. Liabilities = 4. The basic accounting equation is 10 = 4 + 6. 1985). i. The basic accounting equation is 10 = 4 + 6. and accounting does not recognize the negative number. Assets = 10. Next. the liabilities with the value of 4 can be recorded either on one side. As a result.e. the amount of liabilities is the difference between 18 and 14 (18 – 14). and Equity = 6.History-based Accounting Reform … ---------------------------------------------Insert Figure 2 about here -----------------------------------------------Case B. and Equity = 6.e. According to the mathematical formulation. Supposed. the alternative B should be applied because the liabilities have a positive value and located on the right side of the accounting equation (see Figure 3). i. 18 is recorded to the debit and 14 to the credit (alternative A) or 14 to debit and 18 to the credit (alternative B). Based on the ordered pairs of the group of differences construction (see Ellerman. the equity with the value of 4 can be recorded either on one side. 36 is recorded to the debit and 30 to the credit (alternative A) or 30 to 8 . Assets = 10. the amount of equity is the difference between 36 and 30 (36 – 30). Liabilities = 4. The interpretation is that number 14 on the debit deducts number 18 on the credit. Next.
students can understand and accept the rules more easily than if they have to memorize it. which is used only in accounting. debits and credits can be used to enhance the concreteness of knowledge of accounting. the rules of debits and credits are based on a mechanism which entirely follows the mathematical logics. Tangibilizing the accounting mechanism is important to help 9 . students may find it easier to apply the debit and credit rules to all kinds of algebraic equations. especially mathematics. Third. It is true that the rules of debits and credits tend to be mechanical but the rules are always relevant to be taught in accounting courses because of the following reasons. the use of the mathematical perspective has made irrelevant the assumption that the debit and credit rules are something that should be memorized. In other words. With a good reasoning. the increase of equity is recorded on the credit while the decrease of equity is recorded on the debit (see Figure 6). ---------------------------------------------Insert Figure 5 about here --------------------------------------------------------------------------------------------Insert Figure 6 about here ------------------------------------------------ In summary.” accounting is endowed with debits and credits as a unique knowledge.History-based Accounting Reform … debit and 36 to the credit (alternative B). Second. the debit and credit rules convey a picture to students that accounting is based on established knowledge. According to the mathematical formulation. as computer science with its binary digits (0 and 1) and the science of electricity with its “on” and “off. In our experience. the study of debits and credits tangibilizes the workings of accounting. First. As a result. The interpretation is that number 30 on the debit deducts 36 on the credit. however. the alternative B should be applied because the equity has a positive value and located on the right side of the accounting equation (see Figure 5). not just in relation to accounting equation.
Expenses and revenues are part of the equity. Porter and Norton. whose funds come from liabilities and equity (sources of funds). Libby.e. These rationales are primarily based on the balance-sheet approach so that other accounting variables (i. knowledge of debits and credits encourages students to think systematically and logically. 2005. 2002. the rationale of the Equation 1 is that the resources must be always equal to the sources of funds. the equation was expanded to include expense and revenue elements to represent firm’s economic activities. Libby. Reeve. the expanded accounting equation was written as: Assets = Liability + Equity + Revenues – Expenses (Equation 2a). 2002. Warren. This study argues that the rationale employed to explain the basic accounting equation (Equation 1) is not consistent with those employed to explain the expanded accounting equation 10 . 2007). The rationale of the Equation 2a is that resources must be equal to sources of fund in which revenues and expenses are part of the equity.. 2004. Then. 1997). & Smith. 2001.g. Many textbooks employ Equation 1 to analyze transactions which result in changes in the element of revenues and expenses (e. and to develop the knowledge about accounting dynamics as fast growing science through the implementation of mathematical knowledge. while expenses decrease equity.History-based Accounting Reform … students understand accounting topics related to keeping journals. The Rationale of Accounting Equation In Summa. In other words. 2001.. posting. 2008:454). not just to use information.. Thus. & Elliott.. Williams et al. Weygandt et al. 2008). Lembke. as accounting students are expected to compile or construct information. which are indeed in the heart of accounting as an academic discipline. they must have acquired basic knowledge of data processing to present useful information (Vangermeersch. Anthony et al. Fourth. Fifth. The rationale behind the equation is that assets are resources under the firm’s control. & Fess. Sundem. Several of these textbooks write down the Equation 2a in their books (Horngren. King. revenues and expenses) are “considered secondary and derivative” (Dichev. & Short. Luca Pacioli codified the double entry systems which are based on the basic accounting equation as: Assets = Liabilities + Equity (Equation 1). revenues increase equity.
not subdivisions of equity. Therefore. Secondly. we can interpret that the left side of the Equation 1 and Equation 2b reflect the uses of fund. For the sake of simplicity. Equation 2a can be re-written into Assets + Expenses = Liabilities + Equity + Revenues (Equation 2b). equity.e. In other words. to the other element. Firms use the funds to acquire assets and/or pay expenses with funds taken from the sources of liabilities. 1985) to the effect that there is no appropriate justification for an explanation as to why the element of revenues and expenses should belong to the equity. Besides raising the problem of inconsistency in the rationale of accounting equation. Ingram (1998) employs Equation 2b merely to simplify the understanding of the logics of debits and credits. Learning which employs different rationales to explain two things which in essence are closely related is liable to confuse students. i. i. while the right side reflects the sources of fund. the rationale employed to explain the basic accounting equation is different from that employed to explain the expanded accounting equation even though both equations are similar. Therefore. 11 . Vangermeersch (1997) noted that revenues and expenses are separate elements. Firstly. This mathematical rationale can consistently explain both the basic accounting equation (Equation 1) and the expanded accounting equation (Equation 2b). the attachment of elements. However. Mathematically it is more proper to place elements with the same signs (positive or negative) on the same side because accounting does not recognize negative numbers. and/or revenues.e. two additional reasons make the use of equation 2a unacceptable. revenues and expenses. the placement of revenues and expenses on the same side (Equation 2a) is a compulsion that runs the risk of confusing students. Thus. this paper calls the rationale of equation 2b as mathematical rationale. Subramanyam & Wild (2009) and Anthony et al. (2007) argue that the basic accounting equation can be perceived as sources and uses of fund. by definition equity is limited to a residual interest or net assets (FASB. while calls the rationale of equation 2a as conventional rationale. it is hard to find textbooks which express accounting equation as expressed in Equation 2b although mathematically Equation 2a and equation 2b are both correct.History-based Accounting Reform … (Equation 2a) because the element of expenses on the right side of the equation is not sources of fund. the Equation 2b is preferable to the Equation 2a. Mathematically.
2007). 1985:Par. Picker. 2009). 11) and “the lifeblood of a business enterprise” (FASB. Leo. 1985:Par. the database approach provides information which is more up-to-date. Actually. the definition of the elements of financial statements was based on the perspective of assets (Alfredson. which adopted the balance sheet model of financial reporting (Camfferman & Zeff.” (IASB – FASB. 2008:Asset Definition) “A liability of an entity is a present economic obligation for which the entity is the obligor. Furthermore. Radford & Wise. while expenses represent a sacrifice of assets (FASB. More than just offering consistent rationale. assets and expenses have the same rules of debits and credits because both of them represent the uses of fund. the use of mathematical rationale (Equation 2b) will make it much simpler to explain why the elements of assets and expenses should receive the same treatment in relation to debits and credits even though by definition assets and expenses markedly differ from one another. This happened because the standards considered economic resources or assets as “central to the existence and operations of an individual entity” (FASB.” (IASB – FASB. REFORMING THE ACCOUNTING STANDARDS The International Accounting Standards Committee (IASC) issued the conceptual framework in 1989. The Joint Project IASB/FASB tentatively adopted the following working definitions of asset and liability as follows: “An asset of an entity is a present economic resource to which the entity has a right or other access that others do not have. Pacter. 1985). It was based on FASB. Currently the Joint Project IASB/FASB is redefining the elements of financial statements.History-based Accounting Reform … equity. may result in their being less than optimal. and easier to access than the application-oriented approach because the database approach separate data from their application software (Romney & Steinhart. the IASC was replaced by the International Accounting Standards Board (IASB) in 2001. 15). assets represent sources which provide future benefits. 2007). 2008:Liability Definition) 12 . Analogizing the approaches of data management in the computer system. standardized. More specifically.
Many experts have revealed the 13 . are not adequately defined to the effect that accounting runs the risk of providing financial information which does not correctly represent the reality of business. the elements of financial statements. including revenues – the IASB refers to them as income – and expenses. The Limitation of the Accounting Standards The use of the asset perspective to define the other elements of financial statements may result in an incomplete definition. Unfortunately. namely “the arithmetic difference between assets and liabilities …” (Alfredson et al. especially for revenues and expenses. it is predicted that the Joint Project IASB/FASB’s efforts to define equity and other elements. would still be based on the perspective of assets. unless the Boards “expand their effort to a more thorough reassessment of their conceptual framework” (Dichev. revenues are conventionally defined as asset increases or liability decreases (or a combination of both). The tentative definition of the elements of equity has not been issued. accounting may provide financial information which does not faithfully represent the firm’s real condition. Such a definition of revenues is based purely on the accounting equation. Taking a close look at the definition of assets and liabilities made by the Joint Project IASB/FASB. In turn. increases in revenues (recognition of the occurrence of revenues) on the right side of the accounting equation should be followed by asset increases on the left side of the equation or followed by liability decreases on the right side of the equation (or a combination of both) so that a balance in the accounting equation would be maintained. 2008). and revenues and expenses would be parts of the equity. namely the balance sheet orientation (Dichev.History-based Accounting Reform … Essentially the re-definition of the elements of assets and liabilities by the Joint Project IASB/FASB was still based on the same perspective. 2007:76). Equity is defined as net assets. it is very likely that equity will be defined as net assets. Furthermore. So far the work of the Joint Project IASB/FASB is still continuing.. In this case. The limitation of accounting standards in defining the elements of financial statements and the alternative redefinition of the financial statement elements are discussed below. 2008:454). The accounting standards actually employ mathematics in defining the elements of financial statements.
Here are two types of cases which reveal limitations in the standards of the elements of financial statements..” (FASB. 1985). “Revenues are inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods.” (Mirza et al. such as barter. or other activities that constitute the entity’s ongoing major or central operations. especially related to the definitions of revenues and expenses. rendering services. other than those relating to distributions to equity participants.History-based Accounting Reform … inadequacy of accounting to represent the reality of business (Ball. 1985:Par. we would like to present the definitions of revenues and expenses according to the FASB and IASC as follows.” (Mirza. 1985:Par 80) “Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or the incurrence of liabilities that result in decreases in equity. Cheney.” (FASB. 2008) “Expenses are outflows or other using up of assets or incurrence of liabilities (or a combination of both) from delivering or producing goods. rendering services. 78) “Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity. Such a definition disregards revenue/expense transactions. 14 . 2008. that do not produce directly any change in assets/liabilities. 6. & Holt. Before pointing out the limitations of revenue and expense definitions. namely that the recognition of revenues and expenses must be followed by changes in assets and/or liabilities (see Diagram included in the FASB No. 2008) The above definitions are substantially similar. or carrying out other activities that constitute the entity’s ongoing major or central operations. other than those relating to contributions from equity participants. 2009). Orrell.
and service firm T. Business event A: Merchandising firm Q. which is in the business of selling furniture. purchases a number of firm W’s shares (with the intention to own them). This business event. barter their merchandise. should not recognize this business event as a revenue transaction because there is neither an increase in assets nor decrease in liabilities even though firm Q delivers its services. Business event E: Service firm X. which owns more than 20 percent of the company shares. On the announcement date. which is in the business of TV advertising. however. Business event C: Service firm S. however. which is in the business of selling computers. and merchandising firm R. which is in the accounting consulting business. According to the standards. is conducting barter with merchandising firm Q. Accordingly this business event cannot be classified as a revenue transaction by either firm. According to the standards. which is in the information technology consulting business. firm S should recognize this business event as a revenue transaction because there is an increase in assets in the form of computers. both firms S and T should not recognize this business event as a revenue transaction because there is no increase of assets or decrease of liabilities in each of these firms. is recognized as a transaction by firm S but cannot be recognized as such by firm Q. both merchandising firms Q and R recognize this business event as a revenue transaction. which is in the accounting consulting business. 15 . what results is an increase in equity. Business event D: Service firm V. therefore. Firm V should recognize this business event as a revenue transaction because there is an increase in assets in the form of shared investment. which is in the business of advertisement. which is in the business of selling computers. Business event B: Service firm S. barter their main service. The payment is made directly and fully in the form of advertising services delivered by firm V. According to the standards.History-based Accounting Reform … Illustrative Case. as in this event there is an increase of assets into each firm. firm Y immediately utilizes the revenue dividends. firm W should not recognize this business event as an expense transaction because there is neither a decrease in assets nor an increase in liabilities as a result of this business event. Firm Q. According to the standards. distributes revenue dividends in the form of services to firm Y.
and equity. the use of the balance sheet perspective has rendered as un-coverable a large number of business events significantly related to revenues and expenses. the use of the income statement approach is likely to underestimate the importance of business events related to assets. but also by increases in expenses or decreases in equity. Therefore. 2008. firm X should not recognize this business event as a revenue transaction because there is neither an increase in assets nor a decrease in liabilities. the recognition of revenues can be balanced not only by increases in assets or decreases in liabilities. what results is an increase in dividends distribution. while some accounting scholars suggest the use of income statement approach (see Dichev. In short. liabilities. On the other hand. 16 . Likewise. 2007). firm Y should recognize this business event as an expense transaction because the firm receives advertising services and there is a decrease in assets in the form of shared investment (equity method). Current standards have opted for the balance sheet approach. 2009). The illustrative cases above are simulations of transactions that may happen in business on the basis of the expanded accounting equation. AAA FASC. This occurs because the standards argue that revenues and expenses should make a direct impact on the assets and/or liabilities. First and foremost.History-based Accounting Reform … According to the standards. the recognition of expenses can be balanced by decreases in assets. increases in liabilities. The Redefinition of the Elements of Financial Statements One of the topics currently discussed in earnest by accounting experts is the approach that should be adopted in constructing financial statements (Haka. not just the balance sheet and income statement. increases in equity. Likewise. As demonstrated above. Therefore. the current definitions of the elements of revenues (income) and expenses are incomplete. financial accounting should provide financial information. The inadequacy of the definitions of revenues and expenses is also due to the placement of revenues and expenses under the category of equity. this business event should be recognized as an expense transaction by firm Y but should not be recognized as a transaction by firm X. or increases in revenues. standards determined by the use of one perspective are likely to underestimate the importance of other perspectives. Therefore.
especially for the definitions of the elements of equity. we argue that the approach employed in the definitions of the elements of financial statements should be on the basis of an “infobase” (another word for “database. Raval. the alternative definitions of the elements of financial statements are as follow. First. 2000). That rationale should. Early in the development of the computer. & Wong-on-Wing. This file-oriented system was considered inefficient. Modern data management uses a database approach. With the “infobase” approach. The mechanistic definition is not flexible enough for future development. Using the “infobase” approach. equity. instead of using either the balance sheet or the income statement approach. redundant. 2009). the elements of financial statements are not tied to the financial information which has been produced. Mathematically. highly susceptible to errors. The placement of one element above another is inconsistent with the accounting equation. An analogy can be made between the use of the balance sheet or income statement approach and the file-oriented approach. revenues (income) and expenses. which separates data from the application that produced them. expenses. which tied the data to the application that produced them. Cerullo. The current definition of the elements of financial statements is mechanistic rather than substantive. while the right side of the equation reflects the sources of funds. consistent. be employed in defining each element of financial statements. and integrated (Romney & Steinhart. The conversion process may cause changes to the original data. The database approach makes it possible to produce data which are standardized. we can take a lesson from the approach employed in data management. and revenues are on the same level.” which is already common in the literature of information systems). It is only at the end of the accounting period that these elements are designed to produce financial statements. therefore. and is incapable of providing any information about the subject to be defined. As a consequence. The equation of Assets + Expenses = Liabilities + Equity + Revenues indicates that the left side of the equation reflects the uses of funds. the expanded accounting equations (Equation 2a and Equation 2b) show that the elements of assets. data management employed a fileoriented approach. assets are uses of fund in the form of resources whose economic 17 .History-based Accounting Reform … To solve the problems related to the use of appropriate approaches in the definition of the elements of financial statements. liabilities. etc (Wilkinson. in order to access particular data with other applications the data must be converted first. Therefore.
. accounting has developed a focus on rules (Penno. . 2007).. Third. Fourth. and covers many more business events than the current mechanistic definition allows for. This “infobase”-based definition of elements of financial statements is more abstract. In its historical progress. and sources other than creditors. aircraft technology. financial accounting is a tool to be used to provide financial information. accounting has also developed an emphasis on vocational skills. and to allow for continuous development. 2007).History-based Accounting Reform … value can still be utilized in the future. 2007). All these technologies require established knowledge in order to function effectively. The teaching of accounting. Nevertheless. with little contribution to the academic world (Fellingham. Several topics are still debated up to the 18 . however. The Joint Project IASB/FASB has been developing the Conceptual Framework for Financial Reporting that underlies financial reporting. It is a means of communicating to the users of financial reports information that is useful in making choices among alternative uses of scarce resources” (FASB. MATHEMATICAL PERSPECTIVE TO SOLVE THE CURRENT ISSUES Written documents show that accounting was included in Luca Pacioli’s mathematic book (Sangster et al. 2008:OB2). equity is sources of fund from the company’s owner. 2008). 2007). and art. to give the best possible contribution to humanity. 2009). accounting should be of the same nature as computing. expenses are uses of fund in the form of resources whose economic value has been utilized for the firm’s activities within a particular period.” (FASB. has focused largely on vocational skills (Demski. Thus. As a tool. Fifth. “Financial reporting is not an end in itself. revenues are sources of fund from the firm’s activities within a particular period. Second. namely mathematics. Besides focusing on the development of rules. liabilities are sources of fund from third parties acting as creditors. A large number of rules have been issued to the effect that accounting was well-known as a regulatory enterprise (AAA FASC. 2006:OB6) and “The objective of general purpose financial reporting is to provide financial information . the development of rules cannot completely protect the users of accounting information (Scott. retained earnings (accumulated profits). rules. as a result. This study argues that three major pillars should be developed in a balanced manner to enable accounting to become an academic discipline. etc.
For example. This study argues that this could be the reason for the emergence of conflicts between principals and agents. information that is useful to a wide range of users might have 19 . customers. Below are two Joint Project IASB/FASB’s objectives as mentioned in the Preliminary Reviews of the Conceptual Framework (FASB. In this information era firms need information that is more detailed and comprehensive in order to make informed decisions. However. 2008:OB6). donations or facilities received by the firm. and the public (FASB. 2006) that can be achieved through the development of the accounting equation. suppliers. 2006:OB6). current financial reporting is unable to provide information which is specific about governmental subsidies. lenders. Had the accounting equation consisted of elements that represented specific types of users. the Joint Project IASB/FASB revised the objective of external financial reporting as to provide information that is useful for capital providers including equity investors. and other creditors (FASB. For example. as long as all sources of funds other than liabilities are contained in one element. Stakeholder vs. As the equity contains various sources of funds the quality of information coming from the element may decrease. namely the equity. the Joint Project IASB/FASB originally stated in the Preliminary Views of the Conceptual Framework for Financial Reporting that the potential users of financial reports include equity investors. Likewise. it will be difficult for financial reporting to provide information which is useful to users other than equity investors and creditors (stockholder approach). Later.History-based Accounting Reform … present. as the information about governmental support is mixed up with information about other sources of funds in one big basket called “equity”. Stockholder Approaches The objective of external financial reporting is directed to the needs of a wide range of users (stakeholder approach). creditors. These debated topics usually become problematic when we have to choose between two extreme points which appear utterly irreconcilable but which eventually must be accommodated in order to serve the interests of all parties involved. employees. governments and their agencies and regulatory bodies. current financial reporting is unable to provide a representative picture of the long-term contribution of the management to the company because their performance is periodically moved into the equity.
This also applies to other elements in the accounting equation. the accounting information produced would have acquired the long-awaited characteristics of relevance. when assets cover several accounts that employ some measures. accounting should be treated like technology. and understandability. the assets are unable to fully meet both the characteristics of relevance and faithful representation. logically. Relevance vs. Those technologies are developed systematically. both in the element of balance sheet and income statements. comparable. for instance. In other words. faithful. while the elements of historical-cost assets reflect information which is relevant for faithful representation. accounting can be made analogous to aircrafts. or any other technological products. Likewise. and on the basis of sciences whose validity has been so well established that they are capable of growing even further and giving a vast contribution to the humankind. As a technology. Elements of the value-based assets reflect the provision of information which is relevant for decision-making. computers. namely value-based assets and historical-cost assets. For instance.History-based Accounting Reform … been produced. the use of various measurements in one element may weaken the comparability and understandability of the financial reporting. For example. it will be difficult to fulfill these qualitative requirements. THE TRIANGLE OF ACCOUNTING DEVELOPMENT Accounting is a tool to attain a particular aim (Ingram 1998). namely accrual-based expenses and cash-based expenses. faithful representation. 20 . the elements of assets are divided into two. Had the accounting equation consisted of various elements containing information measured with the same (homogenous) measuring tool. as long as the elements of accounting equation consist of financial information employing various measurements. Reliability The qualitative characteristics of financial reporting information should be relevant. and the elements of expenses are divided into two. Asset + Expenses = Liabilities + Owner’s Capital + Revenues + Management Contribution + Governmental Fund + Residual Sources. comparability. The accounting equation could be developed along the line of. and understandable. However.
By using the mathematical perspective. “we cannot expect regulation to completely protect investors” (Scott 2009. it is expected that a development that gives preeminence to the mathematical pillar would enable accounting to give a significant contribution to mankind. 15). this pillar should be firmly founded upon which accounting may grow. b. 1997). Up to now the development of accounting (GAAP) regulations has been intensively done with the hope that such a development may provide the necessary solutions to existing problems.History-based Accounting Reform … We argue that the development of accounting is affected by three interrelated pillars: a. c. this pillar serves to ensure that the development of accounting could be well understood and accepted by the users. The addition of the revenues and expenses elements would make accounting study dynamic (Vangermeersch. Art/craft. it is expected that accounting study would be more dynamic and capable of inviting the student to develop 21 . The model of accounting development can be illustrated as the following triangle. Mathematics. MATHEMATICS BASIC PRINCIPLES ART/CRAFT The tremendous growth of the business world has likewise increased the complexities of accounting and financial reporting. Nevertheless. this pillar provides a space for the user for developing the kind of accounting that is most suitable to his wants and needs. Generally accepted accounting principles (GAAP). The development of accounting should be done through the development of the three pillars mentioned above. Therefore.
including standards. Subsequently. 22 . developing accounting along the line of the three main pillars. This study also briefly discusses the use of the mathematical perspective to achieve the ideal objectives expected by the Joint Project IASB/FASB. and arts. rules. CONCLUSION The development of financial accounting overemphasizing rules has limited accounting simply to the “rules of the game”. rather than to be content with understanding accounting simply as a rule of play established by the business game. accounting should be able not only to function as a supporting tool to portray the reality of business. by using the mathematical perspective. The use of a mathematical perspective identifies the inappropriateness of current accounting teaching methods and reveals the limitations of the current standard boards in defining elements of financial statements. The use of mathematical perspective in the development of accounting will convey financial information that is useful to prevent. Like in computer and telecommunication technologies. which up to now have been considered within the competence of other fields. Accounting should apply mathematical theorems widely. we should identify and discuss several persistent questions and problems. As a preliminary step. detect.History-based Accounting Reform … accounting knowledge. namely mathematics. and correct global financial crisis. The use of the mathematical perspective can also be an initial step toward the development of new models of determining monetary values in financial statements. should be undertaken in a balanced manner. but also to function as a transformer in the future.
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History-based Accounting Reform … FIGURE 3 The Mathematics of Number – Credit/Right Side Debit/Left Side 10 = 14 Credit/Right Side 4 18 + 6 FIGURE 4 The Rule of Debits and Credits – Liabilities Debit/Left Side 10 = Credit/Right Side 4 + + 6 FIGURE 5 The Mathematics of Number – Credit/Right Side Debit/Left Side 10 = 4 Credit/Right Side + 30 6 36 29 .
History-based Accounting Reform … FIGURE 6 The Rule of Debit and Credit – Equity Debit/Left Side 10 = 4 Credit/Right Side + 6 + 30 .
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