Inside accounting the sociology of financial reporting and auditing

A Gower Book Inside Accounting For my mother and father Inside Accounting The Sociology of Financial Reporting and Auditing David Leung University of York, UK First published 2011 by Gower Publishing Published 2016 by Routledge Park Square, Milton Park, Abingdon, Oxon OX14 4RN 711 Third Avenue, New York, NY 10017, USA Routledge is an imprint of the Taylor & Francis Group, an informa business Copyright © David Leung 2011 David Leung has asserted his moral right under the Copyright, Designs and Patents Act, 1988, to be identified as the author of this work All rights reserved No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers Notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe British Library Cataloguing in Publication Data Leung, David Inside accounting : the sociology of financial reporting and auditing Accounting Practice Accounting Decision making Accounting Case studies Corporate culture I Title 657-dc22 Library of Congress Cataloging-in-Publication Data Leung, David Inside accounting : the sociology of financial reporting and auditing / David Leung p cm Includes bibliographical references and index ISBN 978-1-4094-2049-1 (hardback) Accounting Social aspects Auditing Social aspects I Title HF5636.L48 2011 657 dc22 2011016172 ISBN: 978-1-4094-2049-1 (hbk) ISBN: 978-1-3155-8870-4 (ebk) Contents List of Abbreviations vii About the Author ix Acknowledgementsxi Prefacexiii Chapter Introduction Chapter Finitism Chapter Fox River 21 Chapter Creating Numbers 29 Chapter Software 53 Chapter The Year-end Accounts 77 Chapter The Audit 93 Chapter Truth and Fairness 111 Chapter Conclusion 127 Bibliography133 Index139 This page has been left blank intentionally List of Abbreviations ACCA BSA CIMA FASB FRS FRS FRS FRS 18 FRSSE IAS IAS 18 IASB IASC SOP SSAP SSAP UITF UITF 40 WIP Association of Chartered Certified Accountants British Sociological Association Chartered Institute of Management Accountants Financial Accounting Standards Board Financial Reporting Standards Financial Reporting Standard 3: ‘Reporting financial performance’ Financial Reporting Standard 5: ‘Reporting the substance of transactions’ Financial Reporting Standard 18: ‘Accounting policies’ Financial Reporting Standard for Smaller Entities International Accounting Standards International Accounting Standard 18: ‘Revenue’ International Accounting Standards Board International Accounting Standards Committee Foundation Standard Operating Procedure Statement of Standard Accounting Practice Statement of Standard Accounting Practice 9: ‘Stocks and longterm contracts’ Urgent Issues Task Force Urgent Issues Task Force Abstract 40: ‘Revenue recognition and service contracts’ Work-in-progress This page has been left blank intentionally About the Author Dr David Leung is a Lecturer in Accounting and Finance at York Management School at the University of York in the UK, where he teaches Critical Perspectives on Accounting and Finance, and Governance and Audit Dr Leung is himself a qualified accountant and worked as a financial controller and consultant in a number of sectors (including biotechnology, printing, financial services, tourism and retail) before joining academia He gained his MBA at Durham University and his MSc by research in Science and Technology Studies, and his PhD in Social Studies of Finance at the University of Edinburgh He is a published author 128 I n s i d e A c c o u n t i n g Second, the learning and application of accounting rules were often contingent on the local circumstances For example, accounting rules were applied in a ‘quick and dirty’ or ‘good enough’ way whenever management made urgent ad hoc requests for specific financial information, the importance of which in turn depended on the current month’s financial results, and were influenced by the technical possibilities and constraints which were unique to the particular software package that was being used for the reporting at the time Barnes, Bloor and Henry (1996: 52–3) argue that ostensive learning is a key process in the sustaining and transmission of classifications in all communities (We may describe an act of ostension as any act whereby a direct association is directly displayed, shown or pointed out between an empirical event or state of affairs and a word or term of a language: Barnes, Bloor and Henry 1996: 49) In the culture of accounting, ostensive learning is used at its most basic level to teach the student the six classifications – expense, asset, income, liability, capital and reserves – and their double entry form, that is, whether they are a debit or a credit item Although accounting standards and conceptual frameworks exist and attempt to explain how items are classed, in the beginning the student is simply shown exemplars and taught the corresponding double entry form As Bloor (1997: 47) argues, at this basic level teaching requires no explanation as it exploits a form of trust that does not require each step to be justified in turn In the case study, the lower level accounting staff and non-accounting staff learned numerous accounting concepts ostensively The researcher, for instance, would show the bookkeeper the double entries for the key item ‘accrued income’ and she would copy the journal template without hesitation or discussion and use it in subsequent months The book-keeper had simply trusted the researcher’s expertise in the learning of an institutional fact Thus, the culture of accounting is passed on in the form of paradigms which are upheld through academic, professional and in-house training (An accounting paradigm may be described as a collective achievement, a specific concrete problem-solution which has gained universal acceptance throughout the accounting community as a valid procedure and as a model of valid procedure for pedagogic use.) Members of the accounting profession pass on their concepts and procedures to non-accountants who in turn also attempt to produce statements that give a ‘true and fair view’ of the financial state of their organization Indeed, I had expected ‘standard’ accounting practices to be in place at the casestudy company at the outset – for example, variance analysis, where actuals are compared to budgets, and planning or forecasting systems As a result of my work experience, accounting training and professional enculturation, I had a strong inclination to classify existing and proposed accounting systems as ‘right’, ‘wrong’, ‘good’, ‘bad’ or ‘best’ practice I displayed a stubborn habit of using loaded terms such as ‘error’, ‘mistake’ and ‘correct’ to describe participants’ accounting decisions, and of course it was also assumed that the objective of the company was to increase efficiency and to make a profit.1 Eventually, everyone involved in accounting activity had recognized the accounting paradigm as the At the end of the project it became clear that the case-study company pursued other objectives besides profit In a heated discussion about the profitability of the contracts, I recalled Paul asking Fernando ‘when did we start wanting to make a profit?’ Indeed, after the project, Michael informed me that Fernando wanted the company to be a success, to make profits – but not too much profit Michael speculated that Fernando wanted to keep the company small so that he can maintain close control, that is, the status quo C o n c l u s i o n 129 sole legitimate representation of, and mode of dealing with, the financial and economic environment From time to time, however, the paradigm is challenged Analogous to Kuhn’s revolutions in scientific research, there are periods of radical innovation which interrupt the current way accounting is done As accounting anomalies accumulate and problems arise there is discontent with current accounting practice A period of crisis begins in which alternative accounting treatments, such as the percentage completion and straightline methods, are mooted In the early stages of these periods of crisis where the paradigm is still firm in the minds of accountants and non-accountants, any attempt to challenge existing practice is met with resistance However, as demonstrated by the replacement of the WIP system, new concepts and procedures are eventually adopted that deal more adequately with the new financial environment Consistent with Wittgenstein’s claim that rules and their very meaning are constituted by a community’s use of the rules, staff in the accounting culture were learning the accounting rule and generating the meaning of the rule from physically doing accounting Whenever there was a lack of action, the learning process seemed to stop and staff continued applying the accounting rules the way they did before, that is, the only way they knew how Similarly, the auditors were learning accounting and auditing rules and generating meanings for those rules by performing tests and carrying out the audit This constant generation of meanings meant that staff and auditors had differing interpretations of how an accounting rule should be applied For example, as discussed in Chapter 8, auditors and nearly all members of staff had their own interpretation of the concept of materiality Even when staff considered the application of an accounting rule to the same case (for example, a particular asset) at the same time, staff’s interpretations (as realized by their methods of applying the accounting rule) were no less diverse As Barnes, Bloor and Henry (1996: 79–80) explain, ‘individuals in different social contexts or with different histories may read what is apparently “the same experience” in different ways’ The interpretations by staff were also shaped by the extent to which they were part of the accounting culture As Barnes, Bloor and Henry (1996: 26) make clear, interpretation involves bringing to bear the resources of a tradition Analogous to how scientists extrapolate from conjecture (Barnes, Bloor and Henry 1996: 25), accountants made sense of accounting matters by drawing from the accounting culture For instance, they seemed to know instinctively if something was ‘right’ or ‘wrong’ with the monthly accounts Their interpretive processes would typically include comparing the results to previous months and to budget, and explaining away any variances in conventional accounting terms As pointed out by Barnes (1982: 26–7), ostensive learning introduces a conventional character into the structure of (accounting) knowledge In contrast, non-accounting staff were not part of this culture and instead based their interpretations on a more general and varied knowledge base of financial matters Non-accounting staff’s interpretations of accounting matters therefore appeared uncertain and incongruent compared to the accountants’ interpretations The case study found that accounting was done under an environment of authority, the source of which stemmed from two groups of people: accounting experts, primarily the group finance director/chief accountant and the internal and external auditors, and non-accounting senior management In a similar fashion to how scientists draw 130 I n s i d e A c c o u n t i n g boundaries between science and non-science in order to present a credible image of specialist expertise and intellectual authority, accounting experts controlled accounting matters by demarcating ‘qualified’ accountants from unqualified accountants and nonaccounting staff This latter group would generally accept the authority and expertise of the accounting experts because a sufficient number of trusted authorities were referred to by the accounting experts, namely the accounting standards setters, the professional bodies which give the accounting experts their ‘qualified’ status, company legislation and the auditors As qualified accountants they framed their discussions and analyses of accounting issues under the profession’s Accounting Standards and auditing requirements, which unqualified accountants and non-accounting staff largely accepted without question Even when qualified accountants did not have organizational authority (such as the researcher), unqualified accountants would still seek the opinion of qualified accountants for their expertise when learning new accounting concepts and deciding upon how best to apply accounting standards This appeal to authority and expertise in the search for ‘truth and fairness’ can be understood if we accept that accounting rule-following is an institution, that is, a collective, performative and self-referring activity Within the accounting community (including the company staff and third party recipients of the financial statements), the application of a rule is deemed ‘correct’ when the community says it is ‘correct’ (unless there is state intervention, in which case the state’s interpretation of what is ‘correct’ will be deemed ‘correct’) and financial statements are ‘true and fair’ because the community says they are ‘true and fair’ Indeed, this self-validating process may be the reason why no one dared to challenge the chief accountant about the ‘true and fair view’ requirement, which he referred to in numerous meetings, and its meaning, and why he never offered an explanation of the term If he was challenged, he would have had to reply that it was an accounting requirement because it was an accounting requirement, and that a ‘true and fair view’ meant just that: a ‘true and fair view’ It is revealing that even the IASB Framework and the UK Companies Act 2006 not define ‘true and fair view’ Nevertheless, the accounting numbers in the case-study company still needed to be approved by the non-accounting senior management before they were issued to internal and external parties, and invariably there would be disagreement with the accountant’s application of a rule or rules In fact it was not uncommon for non-accounting senior management to override accounting staff, particularly lower level accounting staff, whenever the accounting numbers appeared incorrect or were below expectations The non-accounting senior management would put forward their interpretation of an accounting rule and the lower level accounting staff would not object Indeed, the lower level accounting staff would habitually accept management’s accounting amendments just to get the accounts ‘out of the door’ and no doubt to avoid negative consequences However, the situation was not so clear-cut when there was disagreement over the application of an accounting rule between the chief accountant and senior nonaccounting management A power struggle would ensue: the chief accountant would appeal to his profession, legislation and his role in the annual audit, whereas members of the senior non-accounting management would draw on their organizational authority and their day-to-day influence over operational and lower level accounting staff While internal management accounting issues such as how best to use the Synergist software and allocate financial responsibilities to staff were important, the impact of accounting C o n c l u s i o n 131 issues that directly and immediately affected external financial reporting took precedence That is, the chief accountant would allow senior non-accounting management to decide on internal management accounting and minor financial reporting issues, but would increasingly exercise his authority and expertise when the financial statements were required to be stated as ‘true and fair’ He would this, for example, by setting the ‘materiality’ levels which would sort out accounting values to be ignored, scrutinized and/or adjusted The way disagreements were dealt with in accordance with attaining a ‘true and fair view’ therefore depended on whether or not the accounts were to be audited This meant that there was a different kind of ‘truth and fairness’ between the unaudited monthly accounts, which were still issued to external parties, and the audited annual accounts As ‘truth and fairness’ was only established at the year end in the form of a written audit opinion, the chief accountant was less concerned with the unstated ‘truth and fairness’ of the monthly accounts Consequently, the chief accountant was not involved in accounting disputes with senior non-accounting management to any significant extent during the year In fact even the recommendations by the internal auditors during the year did not appear to worry the chief accountant, who was content to leave the issues with senior non-accounting management to resolve Finally, it was revealing to find that even the authorities appealed to authority for ‘correctness’ Mirroring the hierarchical, authority structure in the case-study company, it was the senior members of the audit firm that set the ‘correct’ standard for applying auditing rules Even though the audit tests 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accrued income 30, 103–4 action goal-oriented 120–1 lack of 116 Ahrens, T et al analytical review 106 Arden, M 9, 16 Association of Chartered Certified Accountants (ACCA) 32 audit analytical review 106 book-keeper’s room 95–6 contract testing 101–5 accrued income: contract BB 103–4 contract AA 102–3 cut-off test 101–2 offset journals 104–5 ‘good enough’ 123–4 journals test 105 other tests 107–8 percentage completion method 98–101 stock and fixed assets 96–8 enquiries 98 purchase ordering 97 vouching test 97 taxation 106–7 trail 78–9 truth, fairness and materiality 112–13 auditors 93–5, 115–16, 117 Veronica and Katie 25, 27, 93–4 see also audit authority/power relations 18–19, 53–4, 72, 73, 75, 116–17, 129–31 Barnes, B 9, 10, 11, 13, 14, 19, 127, 129 et al 7, 10, 11–13, 17, 18, 19, 127, 128, 129 Baxter, J et al 3, 23–4 Bloor, D 10, 11, 15, 17–18, 127, 128 see also Barnes, B., et al Bloor, M et al 23 Boedker, C 3, 23–4 bonuses 89–90 book-keeper (Sara) 25, 27, 29–38 passim, 48, 121–2 double-entry book-keeping 54 role of 55–6 room 95–6 see also audit; Excel; Sage; workbook; year-end accounts Chartered Institute of Management Accountants (CIMA) 12 Companies Act (2006), UK 16 compensation issues 22 confidentiality issues 21–2 contracts 29–30, 77–8 long term, definition 38–9 status of 113 see also audit, contract testing cost(s) control implementation 78 labour 44–6, 49, 86–7, 99–101, 113–14 measurement 34–7 proposed changes 36–7 recognition of income and 114–15 and revenue 44 sales and gross profits 33–4 cut-off test 101–2 140 I n s i d e A c c o u n t i n g double-entry book-keeping 54 ethnography 2–3 access 21 reasons for lack of studies 21–4 Excel 69, 74 authority/power relations 72, 73 comparative evaluation 117–20 see also workbook expertise see authority/power relations fairness see truth and fairness finance social studies of 1–2 see also Group Finance Director (Brad); Group Financial Manager (Caroline) Financial Accounting Standards Board (FASB), US 14 Financial Reporting Standard for Smaller Entities (FRSSE) 42–3 finitism central tenets 7–12 exemplars 11–12 institutions 15–17 meaning and learning 8–10 nature of accounting rules 113–15, 127–8 labour cost rate 114 labour hours 113–14 overhead allocation 114 recognition of income and costs 114–15 status of contracts 113 ostentive learning 10–11, 128 fixed assets year-end adjustments 90 see also audit, stock and fixed assets Fox River case study 21–7, 129–31 participants 25–7 see also researcher(s) proposed changes 31, 32–4, 37 researcher’s solutions 45–50 passim software 54–75 passim WIP 39, 40–3 see also year-end accounts Group Financial Manager (Caroline) 25, 26, 35, 38, 122 audit 93, 105, 108 authority 116–17 materiality 112 software 53–4, 55, 56, 57 year-end accounts 79, 83–4, 85–6, 87, 88, 90, 92 Hägg, I and Hedlund, G 3, 22 Hatherly, D et al Hines, R.D 14, 15, 18 Hoffmann, L and Arden, M.H 9, 16 Hopwood, A 2, 23 Hutchins, E income accrued 30, 103–4 deferred 30–1 measurement 29–34 recognition of costs and 114–15 institutions, finitist perspective 15–17 inter-company balances 91 International Accounting Standards Board (IASB) 9, 111 Framework 16, 130 International Reporting Review Panel 15 international accounting standards (IAS) 32 IT knowledge and ability 75 Jönsson, S and Lukka, K 3–4 journals offset 85–6, 104–5 test 105 Kuhn, T.S 13, 14, 129 goal-oriented action 120–1 goals and interests 18–19 ‘good enough’ auditing 123–4 Group Finance Director and Company Secretary (Brad) 24–5, 26, 27, 111–12, 121 labour costs/hours 44–6, 49, 86–7, 99–101, 113–14 lack of action 116 learning from doing 115–17 I n d e x 141 meaning and 8–10 ostentive 10–11, 128 Lee, T 14 purchase invoice 35 purchase ordering 97 purchase orders 34–5 MacKenzie, D 1–2, management meetings 81 Manager (Lincoln) 25, 26 audit 102–3 creating numbers 31, 32–3, 37, 42–8 passim software 62–6, 67, 68, 75, 115, 116, 119, 123 year-end accounts 78, 79, 80, 81–2, 89 Manager (Michael) 25, 26, 116, 117 audit 94, 95, 97, 98, 102, 113, 124 creating numbers 45, 47, 48 software 62, 64, 70, 82–3, 118, 123 year-end accounts 78, 81–2, 89, 90–1 Managing Director (Fernando) 25, 26, 30–50 passim, 111–24 passim software 55–9 passim, 61, 65 see also audit; year-end accounts materiality, truth and fairness 111–13 meaning and learning 8–10 as use and interpretation 17–18, 129 monthly accounts 65, 120, 121 annual and 31–2 deferred income 30–1 monthly profitability report 46–7 researcher(s) 22–4, 25, 123 solutions 44–50 percentage completion method 44–5 profitability report 47–8, 49–50 responsibility accounting 45–6, 48–9 Synergist recommendations 46–7 year-end accounts 80–1 resignation and replacement of Synergist champion 81–3 resources and selectivity 121–4 responsibility accounting 45–6, 48–9, 80 revenue recognition 67–9 see also workbook Nobes, C.W and Parker, R.H 8–10 offset journals 85–6, 104–5 ostentive learning 10–11, 128 overhead allocation 114 percentage completion method 43–4, 98–101, 120 performance evaluation system 46 petty cash 91–2 Power, M.K 2–3 power/authority relations 18–19, 53–4, 72, 73, 75, 116–17, 129–31 profitability report 44–5, 46–8, 49–50, 57–8 profits, gross 33–4 progress report 86–7 Sage 31, 53–9, 74–5, 83, 85, 91–2 comparative evaluation 117–20 materiality 112 and Synergist 47–8, 79 truth and fairness 57–9 sales costs and gross profits 33–4 proposed changes 31–3 Scapens, R.W 23 selectivity, resources and 121–4 Senior Manager (Paul) 25, 26, 29–50 passim software 60–1, 64, 71–2, 73, 76 see also audit; year-end accounts Simon, H.A 19 social studies of finance 1–2 see also ethnography; Fox River case study software see Excel; Sage; Synergist; workbook spreadsheets, limitations of 118–19 standard operating procedures (SOPS) 64–5, 72–3 standard-setters’ theory 12–13 Statement of Standard Accounting Practice (SSAP) 38–9, 42 stock see audit, stock and fixed assets stocktake process 90–1 straight-line method 31–3, 39, 84 142 I n s i d e A c c o u n t i n g and clients’ two-invoice approach 34 Synergist 59–61, 115, 123 champion 62–4, 81–3 comparative evaluation 117–20 data 65–7 recommendations 46–7 revenue recognition 67–9 and Sage 47–8, 79 standard operating procedures (SOPS) 64–5 training and knowledge 63–4 work-in-progress (WIP) 37–44 SSAP 38–9, 42 straight-line method 39 UITF 40 40–4 workbook construction 69–71 implementation 71–2 maintenance 71–2, 73–4, 83–4 reconciliation 74–5 SOP 72–3 updating 85–8 taxation 106–7 technical constraints 117–21 theory and textbooks 12–13 Tomkins, C and Groves, R 2, truth and fairness 8–10, 15–16, 130, 131 accounting process 111–12 audit 112–13 and materiality 111–13 Sage 57–9 turnover calculation 44 two-invoice approach vs straight-line method 34 year-end accounts formulae 87–8 management meetings 81 omission 87 project problems 77–9 requests 79 researcher’s suggestions and responses to 80–1 resignation and replacement of Synergist champion 81–3 workbook updating 85–6 year-end adjustments 88–92 bonus, response to 89–90 bonus accrual and WIP write-off 89 fixed assets 90 inter-company balances 91 petty cash 91–2 stocktake process 90–1 Young, J.J 14 Urgent Issues Task Force (UITF) 40 40–4 vouching test 97 Wittgenstein, L 7, 9, 17, 129 .. .Inside Accounting For my mother and father Inside Accounting The Sociology of Financial Reporting and Auditing David Leung University of York, UK First published 2011... Financial Reporting Standard 3: Reporting financial performance’ Financial Reporting Standard 5: Reporting the substance of transactions’ Financial Reporting Standard 18: Accounting policies’ Financial. .. elements in the social construction of the audit profession The undefined nature of the labels and the vagueness of the descriptions of the associated body of knowledge provide auditors with the power