Historical Cost and Conservatism Are Joint Adaptations That Help Identify Opportunity Cost

Braun (The ecological rationality of historical costs and conservatism. Accounting, Economics and Law: A Convivium, this issue) argues that the traditional accounting principles underlying the revenue-expense approach such as Historical Cost and Conservatism are ecologically rational in that they help organizations survive better in uncertain economic environments. More importantly, Braun argues that the revenue-expense approach generates new private information, which informs markets and makes them more effective (Hayek, 1945, The use of knowledge in society. The American Economic Review, 35(4), 519–530), as opposed to merely reflecting back market data under the asset-liability approach (e.g. Sunder, 2011, IFRS monopoly: The Pied Piper of financial reporting. Accounting and Business Research, 41(3), 291–306). We try to explicate the nature of the new private information generated jointly by Historical Cost and Conservatism, and how this information facilitates the survival of individual entrepreneurs and organizations in market competition

Sprouse\u27s what-you-may-call-its: Fundamental insight or monumental mistake?

We critically evaluate Sprouse\u27s 1966 Journal of Accountancy article, which prodded the FASB towards a balance-sheet approach. We highlight three errors in this article. First, Sprouse confuses necessary and sufficient conditions by arguing that good accounting systems must satisfy the balance-sheet equation. Second, Sprouse\u27s insinuation that financial analysts rely on balance-sheet analysis is contradicted by contemporary and current security-analysis textbooks, analysts\u27 written reports, and interviews with analysts. Third, and most crucially, Sprouse does not recognize that the primary role of accounting systems is to help managers discover and exploit profitable exchange opportunities, without which firms cannot survive

Financial Reporting and Moral Sentiments

Dating back at least to Adam Smith (1790), philosophers and researchers expect that people will behave differently when they know their actions are observable to others. We hypothesize that financial reporting reveals managers’ actions and leads them to take different actions that are better aligned with investor interests. We posit that the reason why is the activation of our internal mental self-evaluation that Smith refers to as an “Impartial Spectator.” We test this hypothesis with an experiment in which we manipulate the availability of a financial report that makes managerial actions transparent. Our evidence shows that financial reporting leads a manager to choose reinvestment and resource sharing actions that are better aligned with investor interests, even in a sparse experimental setting where the investor can impose no cost or confer no reward on the manager. This same effect holds in a setting where the investor can shut down the firm at any point and take a sizable portion of the assets. Our evidence is important because it suggests that part of financial reporting’s economic value comes from its enabling moral evaluation by the manager in addition to its traditional contracting function

Recordkeeping Alters Economic History by Promoting Reciprocity

We experimentally demonstrate a causal link between recordkeeping and reciprocal exchange. Recordkeeping improves memory of past interactions in a complex exchange environment, which promotes reputation formation and decision coordination. Economies with recordkeeping exhibit a beneficially altered economic history where the risks of exchanging with strangers are substantially lessened. Our findings are consistent with prior assertions that complex and extensive reciprocity requires sophisticated memory to store information on past transactions. We offer insights on this research by scientifically demonstrating that reciprocity can be facilitated by information storage external to the brain. This is consistent with the archaeological record, which suggests that prehistoric transaction records and the invention of writing for recordkeeping were linked to increased complexity in human interaction