Stanley C. Martens

Substance over form in auditing and the auditor's position of public trust

Abstract Auditors are placed by society in a special position of public trust. In their public role auditors are required to base their opinions on the substance rather than the form of the transactions underlying accounting numbers. An argument using the economics of trust (implicit contract theory) is constructed to show why it is required by society that auditors opine on substance. Forces exist, however, that deflect the auditor from fulfilling his or her public role into a “rule-dominated” practice in which substance is neglected. An empirical study confirms that auditors neglect substance and perceive little exposure to litigation in doing so. It is concluded that if auditors continue on their current path, their legitimacy before society will eventually erode to nothing.

An examination of the auditing standards promulgation process involving SAS No. 69

Abstract Our paper examines the development of Statement on Auditing Standards No. 69 . ( AICPA, 1992a ). The Statement arose in part due to a jurisdictional dispute between the Financial Accounting Standards Board (FASB) and the Government Accounting Standards Board (GASB) involving the promulgation of generally accepted accounting principles (GAAP) ( AICPA, 1991a , p. 2). We considered all of the comment letters to the exposure draft (ED) of the Statement in an effort to determine if there are certain biases present in the audit standard-setting process involving the success of achieving an organizationss comments (proposed modifications) being integrated into the final Statement. The results did not support the thesis that an advantage accrues to national public accounting firms or other public accounting firms which have an employee serving on the Board. However. in the case of three influential organizations which are external to the American Institute of Certified Public Accountants (AICPA) and whose domain of control was threatened by the proposed SAS: the FASB, GASB, and the National State Auditors Association (NSAA), the success rate of comment integration was statistically significant.

A new look at auditors' reactions toward substance versus form in financial reporting

A decade ago, we conducted a study (reported inMartens McEnroe, 1992) with the result that auditors neglected substance over form and perceived little exposure to litigation in doing so. The theoretical basis of the previous paper was implicit contract theory. We have had occasion to change our analysis since the previous work; in this paper we focus on the commodification of audits, and trace the neglect of substance over form to that commodification. We present evidence that recent actions by the SEC have altered the perception of auditors that the letter of GAAP (Generally Accepted Accounting Principles) is an aegis against litigation, and that audits which do not opine on substance over form are perfectly marketable commodities. We find, however, that audits which do not opine on substance vs. form are extant, and we cannot conclude that a change in the conditions of production of the audit commodity has occurred or is imminent.

The FASB's cost/benefit constraint in theory and practice

The FASB in its Conceptual Framework has set high principles in the ethics of standard-setting in accounting. This paper concentrates on what the FASB calls the cost/benefit constraint, i.e., the commitment to setting an accounting standard only when the benefits of the standard exceeds the costs of that standard toall stakeholders. This constraint is supposed to take precedence over other concerns, such as neutrality (freedom from bias) of account information.The major conclusion of this paper is that a conflict exists between the FASBs commitment and its practice. There is no evidence that the FASB has always made a costs and benefits judgement with respect to proposed standards. In the cases when such a judgement is made, the FASB discounts social costs; therefore, it is not considering costs to all stakeholders. At the same time the FASB discounts social costs, it seems to have an undue concern for standards that do not increase the volatility of net income. The Conceptual Framework explicitly defines costs as the costs to society as a whole.

Testing the Commitment to the Neutrality of Financial Statement Information

Investigates the commitment of various members of the US financial community to neutrality in financial reports. The research design involves five cases in which “GAAP‐condoned” non‐neutral accounting improves a company′s accounting numbers. The populations selected were accounting academics, public accountants, financial analysts and controllers (or chief financial officers) of major corporations. Finds no significant differences among any of the populations as measured by their reactions to any of the five cases. Also there is no evidence for a strong commitment to neutrality on the part of the respondents. Rather, suggests some slight approval for accounting practices which generate favourable numbers and have no adverse impact on a company′s cash flows.