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 Why
Accountants are Important
Letter From
Joseph Kerstein, Chairman
Stan Ross Department of Accountancy
Zicklin School of Business
Baruch College
City University of New York
Despite the many troublesome
issues that confront the accounting profession, Baruch College is
experiencing a rush of students enrolling in our accounting, auditing
and allied technical and academic programs. Enrollment for accounting
majors exceeds 3,000, and this growth testifies to the value of
our education for graduates entering jobs in business, government
and not-for-profit fields.
Following major upheavals
in the financial markets and a return to some economic equilibrium,
business leaders now realize the importance of the attest function
to protect investors. The government and the corporate world have
become more determined to fix cracks in the corporate reporting
and disclosure systems. Indeed, with changes in the CPA exam, the
regulatory environment and accreditation standards, the value of
accounting expertise is being recognized throughout the world. And
nowhere are accounting and auditing skills honed as well as at Baruch,
where an outstanding faculty and noteworthy conferences sponsored
by Baruch and its Center for Financial Integrity help educate a
student body in the complexities and significance of the financial
reporting and attest systems.
We find that the new
150-hour accounting program is providing new challenges and opportunities
for our students by improving their interdisciplinary skill sets.
At Baruch, we stress new areas in accounting programs with more
emphasis on understanding risks of doing business and the need for
clear communications. We also focus on the impact of global business
to help graduates function in a new worldwide environment. In addition,
Baruch is helping to launch a new competition for outstanding accounting
research that can lead to more meaningful disclosure and financial
reporting practices. An article in this issue of Impact describes
the first academic paper competition conference at Baruch late last
year cosponsored by the Zicklin School of Business, the Financial
Executives Research Foundation, and the American Accounting Association.
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Academic
Research for Financial Executives:
Competition Sponsored by Accountancy Department
The Stan Ross Department
of Accountancy and the Center for Financial Integrity hosted a conference
at the Baruch College Vertical Campus last November 7 to recognize
the winners of an academic paper competition sponsored by the department,
the Financial Executives Foundation (FERF) and the American Accounting
Association (AAA). The purpose of this first annual competition
was to reward the writers of the article in the Accounting Review
in 2002 that best advanced the understanding of financial reporting
practices.
As Joseph Kerstein, chairman
of the Stan Ross Department of Accountancy, said, “It is important
that academic research by accountants should be useful for financial
executives and more germane to the understanding of the financial
markets. This can only enhance the role of the accounting profession
within the business and investment communities.”
William L. Felix, Jr.,
president of the AAA, said that his organization is “very
happy to be involved” in a project which encourages accountants
and auditors to spend time doing research that sheds light on accounting
practices and regulations with a major impact on business. Felix
is a PricewaterhouseCoopers auditing fellow and professor of accountancy
at the University of Arizona, Tucson.
Ned Regan, president
of Baruch College, attended a presentation of the $5,000 cash award
to authors, S.P. Kothari, Wayne Guay and John Core, whose article
“The Economic Dilution of Employee Stock Options: Dilute EPS
for Valuation and Financial Reporting” was chosen as the most
relevant for financial executives. S.P. Kothari is a professor of
accounting at the Massachusetts Institute of Technology. Wayne R.
Guay and John E. Core are professors of accounting at The Wharton
School, University of Pennsylvania.
John Elliott, dean of
the Zicklin School of Business, said this conference and award reminded
him of when the Accounting Review featured a section on financial
reporting that helped U.S. companies improve their reporting practices.
He found that the Kothari-Guay-Core paper is both “interesting
and relevant.”
Linda Bamber, a former
Accounting Review editor and accounting professor at the University
of Georgia in Athens, noted multiple ways that accounting research
helps business executives. She said such research defines economic
or financial problems, presents substantial indicators of their
magnitude, analyzes whether current reporting numbers are working,
suggests alternative reporting methods, and provides evidence regarding
the effects of current or proposed reporting methods. “Accounting
principles as defined by the Financial Accounting Standards Board
and the Securities and Exchange Commission have resultant benefits
and costs,” she said, “and academic researchers can
assist standard setters in choosing such rules.”
Raj Aggarwal, a professor
of finance at Kent State Univeristy in Kent, Ohio, and a representative
of FERF, noted that the candidates for the winning paper from among
all 2002 Accounting Review articles were first narrowed down to
a dozen, and then to four finalists. “The award was given
to the paper that met the highest academic and practical standards,”
he said.
Commenting on the winning
paper, Prof. Guay noted that awarded stock options represent 7%
of common shares of a broad cross section of public companies in
1997, the latest year for which the authors obtained data. “In
some cases, the options can range from 20% to 30% of the outstanding
stock of high-growth companies,” he observed. He explained
that the method described in the paper to figure out common stock
dilution differs from the FASB Treasury stock method by converting
options into portions of stock, even if the options haven’t
been exercised. He noted that in examining 731 firms that issued
stock options, the dilutions averaged about 3% of outstanding stock
compared with 1.5% using the FASB’s recommended method. He
also conceded that the paper’s method was likely more costly
and complex than the FASB’s.
Audience members at the
conference asked whether companies, investment bankers or investors
would be interested in another more complicated method of figuring
stock dilution as it affects earnings per share and whether more
research is needed on how many options are forfeited and how much
options are worth when they are actually exercised. Participants
also noted that this issue has other stakeholders, such as company
suppliers, employees, and lenders, who would be interested in how
much issuing options “actually cost” the issuers.
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Four
School Conference:
Joint Research Presentation on Earnings Management
An Accounting Research
Conference was held jointly with three other universities at Baruch
College’s Vertical Campus on May 29, 2003. Bharat Sarath,
deputy chair of the Stan Ross Department of Accountancy, noted that
the goal of the conference was to promote cooperation on research
projects by junior and senior faculty across academic lines. Four
papers were presented covering theoretical and empirical projects
mainly related to earnings management. More than 60 faculty and
students attended the conference sponsored jointly with NYU, Rutgers,
and Columbia.
John Elliott, Dean of
the Zicklin School of Business, opened the meeting by emphasizing
the importance of such joint research and suggested that the conference
should become an annual event. Mehmet Ozbilgin, an assistant professor
of accounting at Baruch College, presented a paper entitled, “Competitive
Intelligence, Financial Disclosures and Operational Strategy.”
His coauthor was Mark Penno of Purdue University. Alex Dontoh of
New York University was the discussant. Steven Lustgarten, a professor
of accountancy at Baruch College, was the discussant for a paper
entitled, “Private Information, Earnings Management and Executive
Stock Options Exercises” presented by Partha Mohanram, an
assistant professor of accountancy at New York University. Coauthor
was Eli Bartov of NYU. The fourth college participating was Columbia
University in New York.
Also presented were papers
entitled, “Related Party Transactions and Earnings Management”
by coauthors Elizabeth A. Gordon and Elaine Henry, both of Rutgers
University, and “Earnings Management and Accounting Income
Aggregation” by coauthors John Jacob of the University of
Colorado and Bjorn Jorgenson of Columbia University.
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Mutual
Fund Investor Protection and Disclosure:
Baruch’s Center for Financial Integrity Explores Issues
How can the investing
public be protected from abuses related to fees and governance involving
the nation’s mutual funds? Baruch’s Center for Financial
Integrity joined the Mutual Fund Directors Forum to present a conference
exploring the subject for fund directors, attorneys, and accountants
at Baruch’s Vertical Campus on September 22, 2003.
Key questions that arose
during the program were: Shouldn’t the directors of mutual
funds, who are usually paid higher salaries than directors of public
companies, be more cognizant of investors rights? Are investors
being given enough representation on mutual fund boards?
The most striking suggestions
came from keynote speaker Arthur Levitt, former chairman of the
Securities and Exchange Commission. “The brokerage system
of selling mutual fund shares is broke and we need to fix it,”
Levitt told the group. He noted that the National Association of
Securities Dealers had just settled with Morgan Stanley over a charge
that the firm improperly offered brokers more than $1 million in
prizes in at least 29 internal contests to boost sales of specific
fund products. “Among the perks were all-expense paid trips
to resorts, seats to sports playoff games, and Britney Spears concert
tickets,” he observed.
Levitt remarked that
mutual fund expenses and sales commissions for the average taxable
investor “eat up 3 percent of equity funds assets each year,
or almost half the long-run real return on stocks in these funds.”
Levitt proposed that the NASD “should close the loopholes
and ban all broker sales contests and quotas, ban the granting of
higher commissions to brokers for selling the firm’s own funds,
and regulate the compensation of branch managers who are paid more
for selling more funds.”
He urged funds, regulators
and lawmakers to “stop the clock on market timing…and
embrace fair-value pricing.” About a dozen funds, including
Vanguard, T. Rowe Price, Fidelity and Putnam, have adopted such
pricing. In fair-value pricing, the fund, for example, corrects
discrepancies between current share prices, particularly on foreign
markets, and expected new prices, adjusting stock values for U.S.
portfolios. This stops traders who time markets from capitalizing
on stale prices of funds holding international securities.
Levitt encouraged fund
directors to pick a lead independent director, who would be given
power to keep an eye on such things as flipping by portfolio managers,
which is excessive and unnecessary securities trading that drives
up costs for shareholders. “The truth is that investors will
always look at performances to judge what fund to buy, “ observed
Levitt. “What they need is the take-home number—that
is, what they can take home after all fees and taxes are taken into
account.” If these measures are followed, “we could
bring about reform without relying entirely on the heavy hand of
regulation.”
“If the mutual
fund industry doesn’t take these important first steps and
investors conclude they aren’t getting what they pay for,
they will leave mutual funds” and find other places to put
their money, Levitt declared.
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From
Baruch to Washington:
Dough Carmichael Becomes Chief Auditor of the PCAOB
The Public Company Accounting
Oversight Board (PCAOB) needed a tough and knowledgeable professional
as its chief auditor to fulfill the mandate of Congress’ Sarbanes-Oxley
legislation requiring more vigorous oversight of corporate accountability.
So it was no surprise
that Douglas R. Carmichael, who helped established and directed
Baruch’s Center for Financial Integrity, was selected last
year for the job. The Wollman Distinguished Professor of Accounting
at Baruch and former vice president for auditing at the American
Institute of Certified Public Accountants, Carmichael had been keeping
a keen eye on the accounting profession’s technical and ethical
standards and its auditing practices for decades. He began teaching
at Baruch in 1983 after leaving the institute. In his new position
with PCAOB, he anticipates that in overseeing the redrawing of the
nation’s auditing standards and in advising board members
he will focus on stronger safeguards to protect the investing public.
As a founder of Baruch’s
Center for Financial Integrity, he is proud of his role in originating
an organization where integrity and quality of financial reporting
are stressed along with technical excellence. “I am particularly
pleased that when the SEC issued a study of principles versus rules-based
standards mandated by Sarbanes-Oxley it quoted liberally from a
roundtable presented by the Center in February 2003,” he says.
Noting the importance
of the Center conference on Sarbanes-Oxley in April 2003, he says
that “we brought the best minds in the nation to Baruch to
discuss the issues and shed light on new directions that should
be taken.” Participants included Lynn Turner, former chief
accountant of the SEC; Harvey Goldschmidt, an SEC commissioner;
and Charles Niemeier, a PCAOB member and former chief accountant
of the SEC’s enforcement division.
Carmichael observes that
the Center’s early roundtables provided marquee names. “We
had Paul Volcker [former Federal Reserve Bank chief] interviewed
by Bethany McLean, a Fortune editor who broke the story about Enron,”
he says. People came to regard us as opinion leaders and that put
Baruch in the forefront of helping protect investors and the public
interest and raise the level of integrity for financial reporting.
Participants at our meeting spoke about improving the effectiveness
of corporate board and audit committee members in the oversight
of such reporting.”
Carmichael points out
that the Center’s main achievements are in areas of major
concern with regards to the public interest. “A lot of what
we do at the PCAOB is similar to what we did at the Center,”
he adds. “I chaired a roundtable at the Center on internal
controls, and we kept contact with investor and analyst groups such
as the Association for Investment Management & Research.”
On leave from Baruch,
Carmichael has this advice for Steve Lilien, the current head of
the Center: “It’s important to continue programs that
reach for the leading edge of professional competence and solutions
to current issues in financial reporting and corporate governance.”
Lilien affirms that the
Center will continue to foster integrity in financial reporting
through research, conferences and other scholarly activities. “We
want to create an academic watchdog for ethics with a strong emphasis
on the financial market and its institutional framework, and to
develop case studies for classroom use board on real life experience
in business and investing,” he says.
Center roundtables and
discussions have focused on financial integrity, international standards
and harmonization, class action suits, consolidation requirements
for special purpose entities, how the Sarbanes-Oxley Act affects
industry, and white collar crime in the post-Enron environment.
“We want to become a key factor in restoring investors’
beliefs that securities regulation ensures accurate, transparent,
consistent and useful information,” says Lilien. “By
providing a top-rate vehicle for bringing together market participants,
we can bring issues relating to enforcing the market’s ethics
and integrity to the forefront.”
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Sec
Accounting — Interesting, Challenging And Rewarding
By Eli Mason, CPA
The year was 1951, I was 30, had established a small but growing
CPA firm with a staff of six and was ready to conquer the world.
I had established contacts with some bankers and attorneys and,
in particular, with two young lawyers, George and Marie. At a luncheon
date, Marie said, “My father who is in the wastepaper business
and some of his friends have accumulated a large bloc of shares
in a company listed on the New York Stock Exchange. They wish to
gain control and have obtained a court order to inspect the company’s
books and records located at their main office in Syracuse, New
York. Would you be interested?” With little hesitation, I
told Marie my bag was packed. The company was United Board and Carton
Corp., with paper manufacturing mills and carton plants in upstate
New York.
With three assistants,
I traveled to Syracuse, spent five days auditing, analyzing, and
digging. On our return, I spent the weekend writing a report on
our findings. A proxy fight ensued, many letters to shareholders
were sent by both sides, and, in June, 1951, the old Board of Directors
resigned, a new Board was elected and in a magic moment I was asked,
“Mr. Mason, would you be interested in becoming our independent
auditor?” I tried to act cool and replied, “Yes, thank
you.”
So, at the age of 30,
I had my first SEC client. I was prepared, because after graduation
from Baruch College, I was employed and trained at a prominent CPA
firm, Klein, Hinds, & Finke. Dr. Joseph J. Klein was senior
partner and a prominent person in the accounting profession, was
a past president of the New York State Society of Certified Public
Accountants, and a professor of accountancy at Baruch College (then
School of Business, CCNY). Several partners of the firm also taught
accountancy as adjuncts at Baruch. KH&F had a number of public
company clients, and I had been assigned to various audit functions.
The firm maintained high standards of performance, and I learned
the function and meaning of the independent audit. In addition,
while a student at Baruch in the late 1930’s, I was fascinated
by newspaper accounts of the McKesson & Robbins financial scandal,
and in 1941 I wrote my first article titled “Audit the Auditor.”
The United Board audit
present presented an immediate technical problem — my firm
was retained in June and the public company had a May 31 fiscal
year. I knew that I needed some help; I dialed the SEC in Washington,
D.C., asked to speak to the chief accountant of the Securities and
Exchange Commission. A pleasant voice came on, “This is Earle
King.” With some trepidation, I began, “Mr. King, I
apologize for bothering you. I am a CPA, my firm has just been retained
to audit a public company and I have a problem.” Earle King
chuckled, “What’s your problem?” I explained about
the fiscal year and he said, “Why don’t you come down
to Washington and we’ll talk about it.” At the time,
which was soon after World War II, the SEC was located in a huge
Quonset hut in Washington, D.C. Earle King could not have been more
gracious and helpful. That event started a series of meetings with
Chief Accountants of the SEC including Andrew Barr, John C. (Sandy)
Burton, Jr., A. Clarence Sampson, and others.
Within a year, an executive
of one of our clients called and inquired whether we would be interested
in conducting the audit for an Initial Public Offering of a company
in which he had financial interest named Photomaker Corp. We conducted
the audit, the IPO was successful and soon after our firm had a
client on the American Stock Exchange.
My next SEC experience
was unexpected. The owner of the office building in which our firm
was a tenant, New Plan Realty Co., had syndicated a number of buildings
in the form of limited partnerships. They decided to organize a
real Estate Investment Trust (REIT) and to exchange the partnership
interests for shares in an Initial Public Offering. The IPO was
successful and our firm soon had a second client on the New York
Stock Exchange.
Over the years, we participated
in various SEC filings, frequently on the recommendation of smaller
investment firms as well as CPA colleagues. Our attitude and belief
was that if you can conduct a proper audit in accordance with the
standards of the profession, you can prepare the audit report for
inclusion in an SEC submission.
At one time, our firm
had two clients on the New York Stock Exchange, three clients on
the American Stock Exchange and several clients on the Over-The-Counter
Market (now NASDAQ). We also were retained by several broker-dealers
and prepared their reports for filing with the NASD.
I had retained a friendly
relationship with Klein, Hinds & Finke and one of their public
company clients was Realty Equities Corp. Shortly before an annual
audit, I received a phone call from the partner in charge of the
engagement stating that the company had a number of recent sales
and purchases of property and that the transactions had not yet
been recorded on the company’s books. There was pressure of
time, the independent accountants could not prepare the necessary
journal entries and would Mason and Company be willing to analyze
the transactions and prepare the necessary entries. We performed
the work, Klein, Hinds & Finke was pleased, Realty Equities
Corp. was pleased, and Mason & Company was pleased with the
fee.
In a recent General Accounting
Office (GAO) study, it reported that 97 accounting firms are the independent
accountants for public companies. Obviously, only the major firms
have the global facilities to audit the GEs and GMs of the world,
but I believe it is important that medium-sized and smaller CPA firms
should not hesitate to become involved in SEC companies if the occasion
arises.
Eli Mason is a past President
of the New York State Society of CPAs, past Chairman of the New
York State Board for Public Accountancy, and past Vice President
of the American Institute of CPAs. He is the recipient of the American
Accounting Association’s Exemplar Award and is President Emeritus
of the Baruch College Fund.
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