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Open the Andersen archives to find way out of today's mess

As Congress, the Securities and Exchange Commission and the accounting profession ponder what's wrong with accounting standards, they might find guidance in the most unexpected of places -- the archives of Arthur Andersen that remain unshredded. For it was at Arthur Andersen from 1946 to 1962 that a novel approach to accounting was implemented, an approach based partly on "fairness," and not strictly on an adherence to overly complicated rules. Ironically, Andersen's solution from four decades ago may point the way out of the accounting profession's current crisis.

Accounting rules today have become as voluminous and complex as the Internal Revenue Code and its regulations. The Financial Accounting Standards Board is the primary standard-setting authority. The current codification of its 101 statements bulks to more than 2,300 pages, with type sufficiently small to drive most 50-year-old CPAs into premature retirement. The recently issued standard on derivatives consumed 254 pages alone. To provide direction on how to apply its standards, the FASB supplements them with interpretations, technical bulletins and implementation guides. Another board, the Emerging Issues Task Force, addresses questions and issues pronouncements so technical and narrow that they are impenetrable by all but a handful of specialists. The SEC and the American Institute of CPAs add further layers of edicts and interpretations.

Why do we have such a Byzantine collection of accounting rules? Blame it mainly on the SEC itself and on the Big Five accounting firms. The SEC's accounting staff wants detailed and unambiguous rules so as to minimize interminable disagreements with companies and auditors over how to interpret broad standards. The big firms want an intricately woven cloth of regulations so that they can cover their posteriors in the event of litigation.

What results is a detailed rule for almost every conceivable transaction. It takes the FASB two or more years to issue such a detailed standard. It then takes a clever investment banker or accountant about two hours to figure out how to circumvent it. Everyone plays games with the details, and no one looks at the big picture.

Since 1939, the standard opinion that auditors have given on companies' financial statements is that they should "present fairly" the position and results of operations " ... in conformity with generally accepted accounting principles" (GAAP). Yet between 1946 and 1962 Arthur Andersen took a novel tack. Alone among audit firms, it gave two separate opinions -- one on whether the statements were "fairly presented" and the other on whether they were in conformity with GAAP. In other words, Andersen recognized that statements could be "fair" even if they deviated from the rulings of the standard-setting authorities and misleading even if they adhered to them.

During most of that era, Arthur Andersen was headed by Leonard Spacek, a maverick who argued that accounting standards should be suited to informing all stakeholders in a company, not just management, in a "fair," or unbiased, manner. Spacek adhered to the quaint notion that professional accountants should exercise professional judgment. He believed that standard-setting bodies should be responsible for establishing the accounting norms and that the auditing firms should be charged with interpreting and applying the standards in the spirit in which they were intended. Recognizing that "fairness" may be as subjective as a figure skater's "artistic presentation," he proposed that an "accounting court" arbitrate any differences between an audit firm and its client.

The idea that "fairness" rather than adherence to detailed rules should be the governing criterion of sound accounting practice is one that has been recognized in the courts. In 1969, a federal appeals court in the landmark Continental Vending case said that the "critical test" of the falsity of the financial statements was whether they "fairly presented" the company's financial condition, not alone whether the statements were in conformity with GAAP.

The International Accounting Standards Board, based in London, accepts the minimalist view of accounting standards. In fashioning its own GAAP, which it hopes will gain acceptance around the globe, the IASB promises to issue lean standards that are rooted in principle and are much less detailed and lengthy than those in the United States. To the dismay of the IASB and it supporters, the SEC and some U.S. professional and business leaders have questioned the legitimacy of its standards, looking down upon them as being overly broad and thereby overly flexible. Ironically, a commissioner of the European Union recently criticized the U.S. standards, claiming that the Enron case demonstrates that their very specificity renders them susceptible to a regime where form is vaunted over substance.

When it comes to accounting standards and their application, less may be preferable to more, and progress may be found in the past. Andersen's audit of Enron has focused our attention on the inadequacies of current accounting standards. Oddly, Andersen's innovative opinion on "fairness" may show us how to overcome them.

Granof is the Ernst & Young Professor of Accounting at the McCombs School of Business at the University of Texas at Austin. Zeff is the Herbert S. Autrey Professor of Accounting at the Jones School of Management at Rice University.