William G. Shenkir
NEW YORK UNIVERSITY (VISITING PROFESSOR)
A PERSPECTIVE ON THE MEASUREMENT OF EARNINGS AND FASB POLICYMAKING
An issue in the measurement of earnings is: Should the determi-nation of financial position—that is, the measurement of assets and liabilities—determine income? That can be called a balance sheet or asset and liability perspective. Or should the measurement of income—that is, the process of matching costs and revenues—determine the balances that are necessarily carried forward in the balance sheet? That can be called an income statement or revenue and expense perspective, In stating the issue in that way, it is extremely important to recognize that the issue is not whether the balance sheet or income statement is the more important statement to users.
The question of statement importance is not relevant to the debate. Rather the issue is whether the focus of income determination should be based on a systematic matching of costs and revenues or on a measurement of the change in net assets. According to the income statement approach, matching costs and revenues is the center of attention in accounting, and the identification of assets and liabilities is partly dependent on the matching process. If it becomes necessary to defer certain items to avoid “distorting” income, then it is generally sanctioned by that perspective. Under the balance sheet perspective, the focus is on the measurement of assets and liabilities; revenues and expenses are dependent on those measurements.
At a policymaking level, critical questions in the resolution of specific accounting issues may vary depending on which perspective is preeminent. For example, under an asset and liability perspective, questions of priority include:
Is the item (under discussion) an asset?
Is an asset impaired?
Is a liability incurred?
Under a revenue and expense perspective, questions such as the following are important:
Is revenue realized?
Is the cost appropriately related to revenue of the period? (Or when does the cost become an expense?)
A major difference between the two perspectives concerns the attitude of each towards income smoothing. The revenue and ex-pense perspective, with emphasis on matching costs and revenues, lends itself more readily to spreading or deferral methods of accounting which may be achieved and rationalized more easily under the guise that they achieve “proper matching” and prevent distortion of income. On the other hand, the asset and liability perspective, with its focus on the measurement of the change in net assets, makes it more difficult to rationalize spreading or deferral methods of accounting.
The asset and liability perspective is generally implicit in the con-clusions reached by the Financial Accounting Standards Board (FASB) in Accounting for Research and Development Costs (FASB Statement No. 2), Accounting for Contingencies (FASB Statement NO. 5), Accounting for the Translation of Foreign Currency Transactions and Foreign Currency Financial Statements (FASB Statement No. 8), and Accounting for Certain Marketable Securities (FASB Statement No. 12). In each of those Statements, the primary focus is on the measurement of assets and/or liabilities; matching costs and revenues is de-emphasized. Also, a common thread run-ing through Statements Nos. 2, 5, and 8 is that “the Board rejected the implication that a function of accounting is to minimize the reporting of fluctuations.”2 The Board deviated slightly from the asset and liability perspective in its conclusions on accounting for marketable securities. In that situation, it concluded that “a decline in market value below cost should in all cases be reflected in the balance sheet and when such securities are classified as current assets, the decline in market value below cost should enter into the determination of net income.” However, changes in the carrying amount of noncurrent marketable securities are to be reflected in the equity section of the balance sheet rather than included in income.
The Board’s asset and liability perspective to the measurement of earnings has brought rather strong reactions from the business cornmunity.4 The conclusions reached in FASB Statement Nos. 5, 8, and 12, were, in effect, recently reaffirmed by the Board when it considered requests to reopen the deliberations on those Statements and concluded that at present there was no basis for such action.
Whether the FASB can continue to resist the pressures opposing its perspective on the measurement of earnings remains to be seen.
Certainly, at this point in its fife, the FASB may be viewed as meeting the charge it was given to be a “bold and exciting new concept in self-regulation by the private sector.”
FOOTNOTES
1The discussion of the two approaches in this paper is based on a previous paper by the author. (William G. Shenkir, “Current Efforts to Develop a Conceptual Framework for Financial Accounting and Reporting,” A Paper Presented at a Symposium Sponsored by the Arthur Andersen Faculty Fellow, the Pennsylvania State University, Pittsburgh, PA., April 29-30, 1976, Unpublished, pp. 13-16.) Also see: Robert T. Sprouse, “The Balance Sheet-Embodiment of the Most Fundamental Elements of Accounting Theory,” in Williard E. Stone (editor), Foundations of Accounting Theory (Gainesville, Fla.: University of Florida Press, 1971), pp. 90-104.
2Statement of Financial Accounting Standards No. 8, “Accounting for the Translation of Foreign Currency Transactions and Foreign Currency Financial Statements,” October 1975, para. 198. Also see: Statement of Financial Accounting Standards No. 2, “Accounting for Research and Development Costs,” October 1974, para. 54; and Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies,” March 1975, paras. 64-65.
3Statement of Financial Accounting Standards No. 12, “Accounting for Certain Marketable Securities,” December 1975, paras. 29(b) and 30.
4″Focus on Balance Sheet Reform, Business Week, June 7, 1976, pp. 52-60.
5FASB Status Report, July 7, 1976, p. 1; and FASB Status Report, April 28, 1976, p. 1.
(Vol. 3, No. 3, p. 3, 1976)
