From instrumentalism to realism in accounting

Journal of Economic & Financial Studies 03, 03 (2015): 53-57 content available in open access Journal of Economic & Financial Studies journal homepage: http://journalofeconomics.org From instrumentalism to realism in accounting Mihaela Enachi a*, Ioan I. Andone b a Ph.D. Teaching Assistant, Faculty of Economic Sciences, Vasile Alecsandri University of Bacau, Romania. E-mail: [email protected] b Ph.D. Professor, Faculty of Economics and Business Administration, Alexandru Ioan Cuza University of Iasi, Romania. E-mail: [email protected] * Corresponding author s email address: [email protected] H I G H L I G H T S: 1. 2. 3. This paper focuses on the relativity of the values that characterize the events in the life of an organization and tries to provide solutions for bringing accounting closer to reality. The study consists mainly in literature review but also takes into consideration the content of some current accounting regulations in order to identify the limits that accounting presents in its attempt to capture the truth and the factors responsible for these limits. The main conclusion is that the quality of the professional judgments exercised in designing and implementing a system for accounting representation of reality is essential in increasing the reliability of the information included in financial reports, as the final product of accounting. Article History Received: 23-04-2015 Accepted: 25-05-2015 Available online: 27-05-2015 Keywords: Accounting practices; economic substance; faithful representation; professional judgment; regulatory framework; relevance. JEL Classification: M40, M41, M48. 1.0 ABSTRACT How, by their nature, the humans cannot have perfect knowledge, the only absolute thing is relativity, this being present in all their actions. In accounting, given its subject matter, it can talk of the relativity of the values that characterize the events in the life of an organization, this being caused by a wide variety of factors. In a previous article (Enachi, 2012) was identified a particular paradigm with visible effects in accounting practice, more precisely, it was talked about the transition from instrumentalism to realism in accounting. This paper supports the previous assertions and after explaining the accounting implications of the two fundamentally different approaches tries to provide solutions for bringing accounting closer to reality. A literature review is conducted to identify the limits that accounting presents in its attempt to capture the truth and the factors responsible for these limits. The main conclusion is that the quality of the professional judgments exercised in creating and implementing a system for accounting representation of reality, although partially controlled, is essential in increasing the reliability of the information provided by accounting. This is an open access article under Creative Commons Attribution 4.0 License, 2015. Introduction Any activity that includes some sort of human involvement makes judgment inevitable (Kam, 1973, p. 52) and even there are many factors that it depends on, there must be a proper basis for the exercise of judgment which to tend toward the formation of good judgments (Byrne, 1952, p. 657). The professional judgment of preparers and auditors is greatly influenced by economic, legal and ethical incentives and a comprehensive framework for making principled judgments in the presence of these incentives would be highly useful for professionals (Stuebs and Thomas, 2009, p. 35). As previously mentioned (Enachi, 2012, p. 69), the shift from instrumentalism to realism in accounting should http://journaloffinance.net Page 53 Enachi and Andone, (2015). JEFS, 03 (03): 53–57 not be understood as a total renunciation to an approach in the favor of the other, but as a prioritization of the realistic side in the process of identification, recognition, evaluation and recording of the elements that undergo changes due to different events. Thus, the need for a tool which to allow organizations to capture and present similarly the economic truth can not be denied, but a special attention must be paid to the manner in which this tool is designed and used, of course, without neglecting the constant search for solutions in order to assure a more appropriate reflection of reality. Otherwise, as Kam (1973, p. 55) asserts, the accounting does not encourage diversity, but actually attempts, as much as possible, to control judgment in order to control errors. So, considering the extent to which professional judgments can be controlled, the question this work wants to provide an answer is: what can be done to reflect in accounting as appropriate as possible the economic reality? In what follows, it was tried to point out the accounting implications of the two fundamentally different approaches: instrumentalism and realism. The purpose of this research, which consists mainly in literature review but also takes into consideration the content of some current accounting regulations, is to identify the factors that influence the reliability of the information provided by accounting and to offer solutions for ensuring a stronger connection between accounting and economic truth. 2.0 The instrumentalist approach in accounting The instrumentalism, also called experimentalism, is a philosophy advanced by John Dewey holding that what is most important in a thing or idea is its value as an instrument of action and that the truth of an idea lies in its usefulness ( Instrumentalism , 2006, p. 945). Unlike realism, which focuses on discovering the truth and may be characterized by the belief that an invariant representation of reality exists independently of the observer, instrumentalism aims to solve problems and generate solutions, being often characterized by the belief that reality is a product of cognitive and social constructions (Lau, 2005, p. 345). As a practical activity, accounting is designed to meet a series of internal and external needs of organizations, being called, depending on its role: an instrument for describing and modeling the enterprise (Colasse, 1993/1995, p. 414), a measuring, information and social intermediation instrument (Patz, as cited in Munteanu, 2002, p. 17), a power instrument (Minu, 2002, p. 19), a management, verification, test and communication instrument (Boghean, 2005, p. 49) etc. Unlike these authors, Amernic and Craig (2009, p. 882) consider that if accounting is likened to an instrument, conceptually and ideologically, then the many entailments accompanying such a metaphor are in play and the most foundational of these entailments (the presumption that accounting can represent some pre-existing, objective corporate financial reality) has strong potential to create mischief in both accounting academe and accounting practice and should be recognized as such. Whatever the events to register in accounting, they are seen through the links between elements that can be classified into the following categories: assets, liabilities, equity, income and expenses. These structures which accounting operates, although extremely useful, are reducing reality to a product of arid constructions, usually unable to capture the essence of events, whose knowledge is very important in trying to proper interpret the values reflected in accounting (Enachi, 2012, p. 69). Even if it proves that the decisions taken by users on the basis of information provided by accounting are correct, to stop at the usefulness of information understood in terms of strict compliance with some regulatory requirements, regardless of what is behind various operations or deliberately neglecting all or part of their visible effects, means to present a partial truth. It is important to have a regulatory framework for accounting, but need to be careful in preparing and using it, in other words, to give a special consideration to the judgment used in designing and applying regulations. The use of judgment in preparing regulations sometimes leads to the presence of errors in these referentials, inconsistencies, unclear or inappropriate specifications that leave room to interpretation. In addition, the existence of a regulatory framework for accounting which is different from one jurisdiction to another (being at the same time more or less influenced by fiscality in its application) can determine the different reporting of similar realities, and the frequency of changes that undergo in the content of regulations can affect the comparability of information, sometimes without making the information closer to the truth. Moreover, the regulations contain, in some cases, explicit specifications concerning the possibility of organizations to depart from the requirements that would conflict with the objective of financial reports, using, in this way, the professional judgment which inherent subjectivity not only can affect the comparability of information in time and space, but also doesn t guarantee that information offered by accounting is closer to reality. http://journaloffinance.net Page 54 From instrumentalism to realism in accounting The application of regulations makes necessary the use of professional judgment in choosing between different accounting policies and management decisions, which allow organizations to present, within certain limits, a financial position and performance consistent with their objectives rather than reality. Moreover, it is important to mention that not only in the selection of accounting practices, but almost in every phase of the application of regulations can talk of subjectivism, especially when determining the values used in recording events, these being affected by different estimates, the exchange rate for situations that require currency conversion, taking or not into consideration the inflation etc. It can be, also, specified, in this second situation that leads to relativity that errors and frauds can be made, but some of them can be detected if using modern tools. In the same context, must be mentioned that the examination made by professional accountants, in order to appreciate the compliance with regulations, can lead to an increased confidence in a more or less faithful image of the financial position, performance and changes in financial position of an organization. Otherwise, it is known that these professionals provide a high, but not absolute, level of assurance that financial reports don t contain misstatements. Grady (1968, p. 184) presents a series of factors which combined impact makes it questionable whether the certified public accountant can obtain a fair trial. In the next sections are presented some opinions concerning the connection between accounting and economic truth and are provided solutions for bringing accounting closer to reality. 3.0 The presentation of economic truth From the ontological point of view, realism admits that reality exists independently of human representations (Searle, 1993, p. 60) or, in other words, independently of any observer s perceptions (Shapiro, 1997, p. 167). It does not say how things are, but only that there is a way that they are (Searle, 1995, p. 155). The epistemological realism recognizes that the world is knowable Menzel, , p. ; Pohoaţă, , p. or partially knowable and understandable by perception, thinking and an intersubjective science (Vollmer, 2004, p. 200), that the phenomena can be named and closer to be known through words Pohoaţă, , p. . No science, whatever its subject matter, can capture reality in its entirety. However, the goal of every science should be that of transposing the reality as objective as possible. So, if necessary, a science could use new means in order to achieve this goal. As was anticipated, the accounting can not register the whole reality and, therefore, it selects the facts according to some economic, juridical, fiscal or human references (Augustin, as cited in Ionaşcu, , p. . Thus, the , accounting is only a reduction (i.e., selection) and a schematization (i.e., formalization) of reality Ionaşcu, p. 132) or only an interpretation of reality (Lassègue, as cited in Ionaşcu, , p. . Absolute epistemological objectivity is not possible because all accounting judgments are made from a point of view, subject to various measurer and measurement biases, motivated by personal factors, and within a certain historical context (Shapiro, 1997, p. 167). As a language, whose principal function is communication, accounting is useful only to the extent that people who use it generally agree on definitions of words and accept certain assumptions even that these have no inherent truth or exactitude and, so, can change over time (Anonymous, 1979, p. 78). According to Hines (1988, p. 259), accounting practices communicate reality, but in so doing, such practices play a part in creating, shaping and changing, that is, in constructing reality. Maali and Jaara (2014, p. 157), sharing a similar thought, assert that many accounting objects, such as profit, unlike physical objects, are socially constructed, they do not have an independent existence. In this context, it is considered relevant the question raised by Lo (2007, p. 6) if accounting frameworks could be not only far different from, but superior to, the one we are comfortable with. On the connection between accounting representation of events and economic reality stopped, along time, a number of authors which proposed measures through which it can bring improvements to accounting practice. For example, Couchman (1940, p. 257) argues that the application of realism cannot be accomplished by simple rule and circumstances must dictate in all cases the method which best serves the attainment of realism. Bullock (1974, p. 19), referring to a particular situation, draws attention to the fact that accounting should reflect, or at least respect, the economics of reported transactions. Risk (1982, p. 276) considers that before one can achieve realism in accounting, one must have a clear picture of the physical events. Adelson and Cho (2002, p. 6) assert that accounting standards need to focus on the real economic substance of financial transactions. Tweedie (2003, p. 719) presents the basic pillars of a financial infrastructure which allows markets to operate effectively over a sustained period and mentions the need to ensure that, taking into account the growing complexity and speed of http://journaloffinance.net Page 55 Enachi and Andone, (2015). JEFS, 03 (03): 53–57 change in the marketplace, this infrastructure remains relevant. Maali and Jaara (2014, p. 155) sustain that utilizing interpretive view to the world in accounting research is better able to capture the economic reality that is socially constructed and much affected by our account of it. Accounting aims to register the events that cause changes in assets, liabilities, equity, expenses and income by expressing them in monetary units. As not all the changes can be measured with reliability (this being a criterion for recognition in financial reports which must be admitted that is not devoid of subjectivity) some of them will not be reflected in the main component of the financial reports. Moreover, some events may have multiple consequences from the accounting point of view and reflecting only the prominent facet or that side accountants used to present affects the reliability of the information. Each of the aforementioned problems can be partially solved by providing additional information in the reports prepared at the end of the financial year. However, it should not be understood that this is the only way to solve such problems, permanently looking for solutions to improve accounting practice. In order to faithfully present the economic reality, accounting must not limit itself to recording events on the basis of different documents, but to always seek cause-effect explanations in trying to find the truth. To speak of realism in accounting is imperative to exercise the professional judgment in order to identify the economic substance of the events that generate changes because no perfect system for representing the reality exists (Enachi, 2012, p. 70). 4.0 Conclusions and recommendations The regulation of accounting makes possible ensuring that similar judgments are exercised when recording events in the life of an organization. However, the content of the regulations issued should be clear and should avoid creating confusion among professionals or offering unwanted freedoms. The opinions found in the literature lead to the conclusion that it is important that professionals have a clear picture of events involving the organization and have access to methods which to allow capturing the economic substance of events and which to remain relevant over time. Also, must be mentioned that, in order to achieve their goal, these methods should offer the possibility of taking into consideration, in a certain manner, the circumstances in which some events occur if these aspects could influence the decisions taken by the users of information in financial reports. Assuming the quality of professional judgments and making abstraction of the influence on accounting of certain constructed realities, the following are some measures through which accounting may be closer to the truth: the search for an optimal combination between rules and principles in designing a regulatory framework for accounting which to allow organizations to capture the economic substance of events; the identification of as many as possible relevant events in the life of an organization through constant awareness of their classification in internal events (with significant internal/external/internal and external effect) and external events (with significant internal/internal and external effect); the inclusion in the financial reports of certain non-financial information which could explain or justify the significant changes produced in the structure of different elements, as well as the insertion of certain prospective information, which is based on intentions and/or necessities, in order to better understand the activities of the organizations and their possible future evolution. 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