Accounting And Finance
Abstract and Keywords
This article discusses the evolving relationship between accounting and finance, and how this shapes organizational life. It begins with a brief history of financial accounting, followed by an analysis of the rise and transformation of business finance. These two paths of development of accounting and finance intersect in many different ways; the third section discusses a particularly significant recent example of this, namely the fair value accounting debate. The fourth section reflects on the configurations of accounting and finance expertise at the levels of academic discipline and profession, and how this has varied both across time and across different national jurisdictions. The fifth section addresses the complex relationship between accounting and economics and draws on key themes in the sociology of accounting to suggest that accounting is mobilized to operationalize economic concepts and is implicated in the construction of entities and individuals as economic actors. This constructivist analysis sets the stage for the final section, which compares social studies of accounting with analyses from the emerging field of social studies of finance.
Accounting is defined by the Oxford English Dictionary as the “process or art of keeping and verifying accounts.” Professional Associations such as the American Institute of Certified Public Accountants (AICPA) have gone a little further and suggest that it is “the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are in part at least, of a financial character, and interpreting the results thereof” (AICPA 1953). Significantly, both definitions use the term “art,” suggesting professional skill and esoteric knowledge which is hard-won via an apprenticeship. More generally, accounting is regarded as a technical practice that seeks to represent economic events for a variety of purposes, not least to enable comparisons of performance and financial strength within and between organizations.
Traditionally and pedagogically there is a distinction between forms of accounting for internal and for external purposes, between managerial and financial accounting respectively. In theory, the former deals with matters such as investment appraisal, budgeting, and cost analysis as part of the basic financial controls of an organization, while the latter deals with the periodic published reports which include income statements of profit or loss, and balance sheets which list assets and liabilities at a point in time. In every jurisdiction, these public documents are heavily regulated in their form and content, and are subject to the requirement that they be independently checked by auditors. Taken together, both managerial and financial accounting are at the center of the financial management of an organization, undertaken by specialist finance departments headed by chief financial officers. For the most part, accounting is a largely esoteric and taken-for-granted field of practice, permeated by laws, rules, and norms of best practice, and populated by a range of specialists and experts. Yet this lack of visibility is deceptive and makes accounting an important area of interest for sociologists, not least because it can fail and fail spectacularly.
The collapse of Enron and Worldcom in 2001 and the related demise of the accountancy firm Andersen created a crisis of confidence in accounting and auditing and led to far-reaching legislative reform in the United States—the so-called “Sarbanes–Oxley Act”—and elsewhere. Similarly, the financial crisis of 2008–9 has raised questions about (p. 294) the role of accounting and auditing in failing to provide any clues to the weakness of many balance sheets in the financial system (House of Commons Treasury Committee 2009). Accounting regulators, such as the Financial Accounting Standards Board (FASB) in the United States and the International Accounting Standards Board (IASB), have been heavily criticized for their role in the troubles, and investigations by parliamentary and congressional committees have served to emphasize a key point: accounting becomes, at various points in time, highly political. Its history is littered with scandals, failure, and disappointments, which are the engines of new efforts at reform and improvement. In times of turmoil and public outrage, the conventional image of a neutral, technical practice which simply records economic reality becomes hard to sustain.
As far as sociology is concerned, an interest in accounting as a phenomenon reaches back to Max Weber who recognized the importance of calculation in general and bookkeeping in particular in the making of modern life (Carruthers and Espeland 1991). Indeed, the accounting field can be said to encompass many of the processes and problems that deeply interest sociology scholars. For example, accounting can be defined, somewhat differently from above, as “ . . . all those spatially and historically varying calculative practices—ranging from budgeting to fair value accounting—that allow accountants and others to describe and act on entities, processes, and persons” (Chapman, Cooper, and Miller 2009: 1). This view places the analysis of accounting within the heartland of sociological interest in how forms of social and economic knowledge are produced, how such forms shape what people regard as significant, and how they act and react to them. Different forms of accounting are widely diffused throughout society—across states, public and private organizations, and even families—and have a profound influence on the climate of economic and social life. Accounting representations and metrics are also interventions which shape people, processes, and organizations, not least by virtue of their powerful commensurating function (Espeland and Stevens 1998). In many societies the categories of accounting have assumed a powerful cultural position as filters of knowledge and value that enable enterprises and people to be compared with one another (Bowker and Star 1999). The financial crisis may have disturbed this cultural position considerably but it has not been superseded. Accounting is much more than counting (Power 2004).
This chapter provides a critical discussion of the evolving relationship between accounting and finance, and how this shapes organizational life. The discussion begins with a brief history of financial accounting, followed by an analysis of the rise and transformation of business finance. These two paths of development of accounting and finance intersect in many different ways; the third section discusses a particularly significant recent example of this, namely the fair value accounting debate. The fourth section reflects on the configurations of accounting and finance expertise at the levels of academic discipline and profession, and how this has varied both across time and across different national jurisdictions. The fifth section addresses the complex relationship between accounting and economics and draws on key themes in the sociology of accounting to suggest that accounting is mobilized to operationalize economic concepts (p. 295) and is implicated in the construction of entities and individuals as economic actors. This constructivist analysis sets the stage for the final section, which compares social studies of accounting with analyses from the emerging field of social studies of finance. Sociologists have much to learn from the history of the ever-changing relationship between accounting and finance as it plays out in the field of practices, professionalization projects, and scholarly disciplines.
A brief history of financial accounting
There is evidence to suggest that the earliest examples of writing found in ancient Egypt are accounting records (Edwards 1989: 23–6). The functional need to keep track of monies owed and owing resulted in methods of inscription which were the forerunners of modern accounting. The codification of the double-entry method by Luca Pacioli in 1494, whereby every transaction represents a flow of value with a double aspect, formalized a practice at the heart of existing mercantile habits and it remains a central part of elementary accounting courses today. For example, if a merchant puts money into his business there is an increase in capital and an equal increase in cash. If he spends some of that cash on a horse, there is definitely a decrease in cash and an increase in either an expense or an asset (depending on a view about the “useful life” of the horse). And so it goes on, for every transaction there are always these two components of “debit” and “credit,” which must be equal even when the resulting stream of transactions can be extensive and complex. It was for reasons of this almost aesthetic necessity of balance that Goeth's Werner praised double entry as one of the “finest inventions of the human mind” (Jackson 1994).
Yet accounting as both practice and discipline has come to be more than a substitution for imperfect human memory in book-keeping. Conventions of information display using specific categorizations arose to organize and condense the product of the double-entry method; assets came to be distinguished in terms of whether they have a long-term role in the business or not, and the changes in the merchants’ capital accounts came to be summarized as a statement of profit and loss. Importantly, demands for periodic reporting meant that for a continuing business, unlike a finite voyage, there would always be bits and pieces of unexpired balances to account for at the year's end. Unsurprisingly, the growing complexity of accounting reflected developments in the economy and in the form of business enterprise; during the nineteenth century basic financial accounting requirements became part of the new law for joint stock companies, and accountants were prepared to do the dirty work of insolvency practice which lawyers preferred not to do—thus opening the door to a new profession (Edwards 1989: 262). Further decisive changes came with growth of the corporate economy in the first half of the twentieth century. In Britain and other industrializing countries, the emergence of an agency relationship between distant providers of capital (shareholders) and managers positioned accounting in a new institutional space for which it was probably (p. 296) not well prepared. It was no longer to be the extended memory of the merchant and his debtors, but a mechanism of accountability for professional managers to providers of capital.
The course of the history sketched above was not a smooth one and at critical points accounting practice was forced to adapt in response to scandal, such as the use of accounts for deceptive purposes. The collapse of the City of Glasgow Bank in 1878 and the Royal Mail case of 1931 were important catalysts for change. The latter gave rise to a legal and accounting framework that persists today. Prior to this case the culture of corporate regulation assumed that directors generally act in the best interest of shareholders and that businesses are fundamentally an extension of partnership. These assumptions were swept away and accounting moved to the center stage of a new style of corporate governance in which shareholders acquired rights and directors’ duties became more explicit. Yet for all these and many subsequent reforms, the history of financial accounting is punctuated by a number of seemingly essentially contestable issues.
The first concerns, surprisingly perhaps, the basic purpose of financial accounting itself. In many jurisdictions, the legal framework evolved with the principle of creditor protection at its heart. The primary aim of law was to ensure that dividends could not be paid or activities undertaken which would place their debt at risk. Even with the growth of distant shareholders this view persisted; financial accounts were essentially designed to display the proper stewardship of resources according to “prudent” rules. However, another view of the purpose of accounts began to emerge in the 1930s and became more fully articulated in North America after World War II: financial accounting was to provide relevant information useful for existing and potential investors as decision-makers. Though such a view has never been enshrined in the law in any jurisdiction, this information view of accounting rapidly gained currency, although the older view has never been entirely superseded. As a result, an enduring critical issue for financial reporting is its very purpose, which remains contested.
A second critical theme concerns the nature of the accounting entity. When business control and influence was limited to clearly defined legal entities, accounting for these entities was relatively unproblematic. But the advent of mergers and the creation of groups have generated almost insurmountable difficulties for accounting. What is the boundary of the reporting entity as a group and how should we account for it? How can these boundaries be clearly determined when the nature of control relationships between organizations is often fuzzy? If organizations can take advantage of financing arrangements that nevertheless fall outside the group boundary for reporting purposes, then surely financial statements mislead investors about risk? Despite the salience of these questions, successive efforts to develop regulations to deal with the entity issue remain problematic and a clear consensus seems far off. It is as if the accounting entity is an essentially contestable construct.
The third and perhaps most significant critical theme is that of measurement and the problem of consensus about the appropriate metric. A longstanding convention has been the use of historical cost. Under this convention, when an asset is purchased it is (p. 297) recorded at cost and depreciates over its useful life. Revenues and periodic costs are recorded at their historical transaction value to produce a historical cost profit (or loss). It is widely agreed that this measurement method is easy to apply and reliable in the sense that it can easily be checked by an independent auditor or taxation inspector. Yet despite this apparent ease of use, the measurement convention has been subject to continuous challenge. For example, the historical cost of a building often bears no relationship at all to its real value. And in times of inflation, historical cost tends to exaggerate profits and thereby understate the real capital required to stay in business.
Many piecemeal solutions to these and other specific measurement and valuation issues were developed by regulators, and for many years historical cost was the default convention. For practitioners, historical cost was acceptable for all its imperfections because the most important thing was for the income statement to be credible in terms of approximating the cash realization of profit; the balance sheet could be regarded merely as a schedule of unexpired expenses, financial assets, and liabilities—it was not and was not intended to be a statement of value. However, as the difference between accounting net asset values and observed market values grew, this pragmatic view became harder to sustain. It became apparent that financial statements were just a jumble of incommensurable measurement conventions, something that threatened accounting's ability to be a technology of commensuration itself (Espeland and Stevens 1998).
These three critical themes describe a kind of financial accounting paradigm under more or less continuous internal and external pressure. This stewardship conception of financial reporting, which measures the activities of legal entities using mainly historical cost methods, had no intellectual foundation and simply reflected “what accountants do” as the accumulated habits of many centuries. Inevitably, there were demands from academics and thinking practitioners for a rational framework for financial accounting. While the first efforts by some accountants to think conceptually about accounting can be traced to the early part of the twentieth century and before, it became a major policy project in the United States from the 1960s onwards. This was a project led by the FASB to create a rational foundation for the production of financial reporting rules. Subsequently referred to as the “asset-liability approach” because it focuses on the balance sheet and ultimately on valuation issues, the Conceptual Framework acquired institutional momentum, was replicated elsewhere, and provided the platform for a different rationalization of accounting, namely an information conception of financial reporting which measures the activities of economic entities using more “relevant” methods than historical cost.
The apparent transition from one paradigm to another should not be overstated. Scholars argue that there is no single optimal method of accounting despite the many efforts to find one—it all depends on the specific institutional context which defines the purpose of accounting. The search for the framework is both a mistake and a kind of accounting colonialism from this point of view. Indeed, many of the difficulties noted above were not problematic in countries such as Germany with its tradition of creditor protection via accounting conservatism. And in the case of “insider” economies, as Italy has been described, financial accounting is much less important than private sources of (p. 298) information. Only as firms in these and other countries have sought funding in international capital markets, have they recognized the pressures to adopt more “informative” accounting practices. Indeed, the expansion of capital markets has been one of the most significant forces for both change in, and diffusion of, the financial accounting model. And at the very heart of this change process is the rise of financial economics as both an academic discipline and as a practice with global reach.
From financial management to financial economics
The field of business finance, which contains managerial and financial accounting, grew up around investment appraisal techniques and the application of decision sciences to management issues (such as inventory optimization). Yet as Miller (1991) has shown, the introduction of the basic discounting techniques which we take for granted today was initially resisted. It was a rocky path to their normalization, both in practice and pedagogy. And despite this normalization, empirical evidence has always suggested that real decision-makers often use many other investment appraisal methods (such as payback) that are not strictly rational from the point of view of discounted cash flow (DCF) approaches. Notwithstanding these issues, business finance emerged as a body of knowledge and as a cluster of techniques of which accounting was an important part. Indeed, even until the late 1980s the categories of “business finance,” “financial management,” and “accounting” could still be used interchangeably.
Whitley (1986) analyzes how this assembly of practices as part of business finance described above came to be transformed into a subbranch of economics—financial economics. The backdrop to these developments was the rise of what Mirowski (2002) has called the “cyborg” sciences—machine-like knowledge of human behavior—in the 1950s and 1960s. From this period onwards, as the landscape of the social sciences became more analytical, finance as a discipline began to shift away from the rich description and documentation of business practices. Advanced statistical techniques and the methods of an emerging body of analytical economics focusing on asset pricing in idealized settings of perfect markets were imported. According to Whitley, the new analytical emphasis in finance was low in uncertainty for its proponents largely because of its ideal-typical character. The central epistemological problem for the new finance was one of correspondence rules, namely how its analytical insights might be linked to an empirical domain to generate testable propositions. Yet, as others have noted, theory also began to acquire high status in the field of economics, thereby marginalizing these issues of correspondence. Econometric complications in operationalizing analytical models and their relatively simple axioms of behavior meant that, initially at least, empirical scholars often found themselves in a subservient status group. In short, there emerged a “growing distance of the academic finance knowledge base from the complexities of practice and (p. 299) practical institutions” (Hopwood 2009: 549). As a result, a gap between accounting and finance began to emerge—institutional, pedagogic, and theoretical.
Whitley (1986) argues that the development of portfolio theory in the early 1950s was a critical element of this transformation process. It formalized the benefits of investment diversification, which in turn informed the development of the capital asset pricing model (CAPM) in the 1960s. CAPM, for all its flaws, also formalized an idea of immense practical import for asset management, namely the idea that asset prices depend on the sensitivity of expected returns to market variance (β). Despite the unreality of the model and the difficulties of testing it empirically, Whitley suggests that CAPM provided an important combination of analytical cohesion and empirical ambiguity. In the absence of any analytical competition, the significance of CAPM and the concept of β expanded rapidly and a trajectory of change was set in motion.
This change process was not only driven “from above” by theoretical innovation. It was also driven by employers in the growing financial industry who demanded knowledge and pedagogy adequate for operating in capital markets. Whitley argues that the growth of investment intermediaries, pension fund managers, corporate treasury departments, and portfolio managers created an intensified institutional focus on asset management. In turn this focus provided the conditions of possibility for the growth of teaching and research in the elements of financial economics. Over time, the “unreality” of core elements of financial knowledge, such as the tendency to assume perfect markets, and the problem of correspondence, melted away. The analytical end of financial economics acquired legitimacy for practitioners and became both a lens through which practice could be imagined and organized, and a rite of passage for its proponents.
The transfer of knowledge from finance theory to investment practitioner, then, was largely a transfer of technical procedures and skills through the educational system and a direct transfer of a particular measuring instrument for particular purposes. It was not, I suggest, the transfer of a true theory which transformed and directed practical activities. (Whitley 1986: 185)
For Whitley, the circuits connecting analytical financial economics to practice had more to do with its role as a reputational system and less to do with the direct applicability of its analytical core. The point is consistent with Abbott's (1988) broader argument that purely “academic” knowledge has always played a significant role for professions, providing the rational theorizations needed by practice. We saw above how the accounting conceptual framework provides a kind of rational organization for financial accounting rules. Elements of financial economics played a similar role for the practice of finance.
The rise of an increasingly discrete academic field of finance intersected with financial accounting and the representation of business entities in important ways. Espeland and Hirsch (1990) demonstrate the reciprocal and constitutive relationships between merger activity, the creation of conglomerates, and financial accounting. It is no surprise that the early accounting scandals in the 1960s and 1970s were “group accounting” problems and centered on the entity issue mentioned above. The regulatory problem was how to make the substance of connectedness and control visible in financial statements even (p. 300) where formal legal relationships were weak or nonexistent. This was also a time when there was a shift in the conception of the firm—a paradigm change perhaps—from the manufacturing conception of the firm as set of highly specific assets and capabilities to the finance conception of the firm as a bundle of tradable assets, including firms themselves as products in financial markets evaluated by the metrics of shareholder value.
The increasing emphasis on earnings and short-run returns is the product of a “complex conceptual transformation” which parallels Whitley's analysis: real firms came to be conceived more like their economic theories, namely as a bundle of assets or portfolio of capabilities (Davies 2009). The abstract theories of finance changed the conception of the organization. They began life as stylized descriptions but over time became internalized by organizational agents and, via pedagogic repetition in MBA classes and other modes of reproduction, these descriptions became part of the organization (Strathern 2000: 312). Espeland and Hirsch (1990) go on to suggest that the emergence of firms as products, the expansion of merger activity, and the economic interests at stake on all sides fueled what was called “creative accounting.” Accounting rules were exploited strategically to inflate earnings or overstate asset value (for example, with the aim of sustaining the share price to avoid being a takeover target), thereby creating a crisis of financial accounting's capacity to represent the economic reality of firms. This crisis was addressed initially by the creation of institutional mechanisms for setting accounting standards in the 1970s. It is no surprise that one of the first such standards in the UK sought to address the problem of the “group” accounting entity in cases where ownership interests were substantial but not controlling. In this early effort at accounting regulation, and on many subsequent occasions, the goal was to redesign financial accounting to overcome creative misrepresentation (Robson and Young 2009). Increasingly, financial accounting rules aspired to look beyond the legal boundaries of the enterprise and to follow the “economic reality” of control relationships and their associated risks (Hopwood 1990).
In summary, a distinctive historical narrative of the relationship between finance and accounting can be told, one which sees the pair in an increasingly entangled relationship, with accounting regulators engaged in a process of continual and often unsuccessful catch-up with a transactional world that came to be dominated by both the theory and practice of financial economics. Financial accounting practice began life humbly as double-entry bookkeeping but became more elaborate over time, acquiring many conventional and legal attributes. Nevertheless, for all the institutional power of accounting in framing a basis for comparing one organization with another, its ability to represent networks, strategic alliances, and other contractual organizational forms has always been in question. Financial accounting might even be described as a “permanently failing” practice in this respect, because business models and their risks are increasingly recalcitrant to accounting representation. The growth of detailed disclosure and narrative, something that has increased the size of annual financial reports considerably, is also a symptom of the limitations of an income statement and balance sheet to capture important characteristics of organizations—a fact never more evident than in the financial crisis of 2008. It is against this background that the debate about fair value accounting (p. 301) is relevant and provides a case study of a specific attempt by regulators to align accounting and finance.
Financial accounting and finance1
As noted above, the measurement of economic activity is the very essence of accounting. Yet measurement is not a singular or simple thing, and methods may vary according to the purpose of measurement and the intentions of the measurer. For many years, the external financial statements of most large organizations in developed economies were prepared using a plurality of measurement methods. As discussed earlier, the common and simplest method was that of an entry (historical) cost basis, but other “current” values were used which reflect different possible intentions: to replace, to use, or to sell. Students of accounting know that each measurement method has advantages and disadvantages—if there were a single “right” method, it would have revealed itself by now. So a mixture of methods was tolerated for many years by practitioners and regulators alike.
The emergence of fair value measurement changed all this. The debate about fair value accounting was prominent before the financial crisis of 2008 but acquired renewed controversy during it (Laux and Leuz 2009; Plantin, Sapra, and Shin 2004). This highly technical dispute about valuation methods and their scope reveals a complex conjunction between financial economics and financial accounting practice. Despite very heated opposition from practitioners, policymakers, politicians, banks, and academics, and despite the necessity of compromise and concession during the financial crisis, “fair value” measurement not only managed to establish itself in the easy context of liquid financial assets but was promoted as being expandable to other asset classes and liabilities as well (Barth and Landsman 1995). How and why could this happen? And how could a minority of fair value enthusiasts be so influential? Indeed, what is fair value?
Defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date” (IASB 2009), fair value is as much an idea as a specific measurement method. And the idea draws implicitly and explicitly from key elements of financial economics, not least assumptions about what asset prices should be. Both Bromwich (2007) and Ronen (2008) suggest that fair values are somewhat imaginative constructs and only coincidentally correspond to observable prices. For its advocates, particularly specific members of the IASB, the idea of fair value motivates a global change process to align financial accounting more closely with observable security prices in financial markets, and to correct the apparent incoherence of mixed measurement systems. A simple genealogy of fair value can be sketched, consisting of four overlapping institutional conditions which enabled these proponents of fair value to achieve considerable success in the face of opposition.
First, the expansion of fair values was made possible and legitimized by the background cultural authority of financial economics as described in the previous section. It (p. 302) is not only the direct application of elements of financial economics to financial reporting issues which is important in the debate, but also its role as a wider value system available to a minority of fair value advocates. Second, the specific problem of accounting for, and representing the risks of, derivatives (e.g., options, swaps, convertible bonds) challenged the credibility of accounting but also acted as a catalyst for the increased significance of fair value—which had existed as a broad concept for many years (FASB 1998; IASB 2004). Whereas the FASB sought initially to limit the scope of the use of fair values, other bodies located derivatives accounting within a wider context of accounting for financial instruments. A potential for the extended applicability of fair value was created.
Third, successive accounting conceptual frameworks created a heightened focus on asset-liability measurement and the economic, rather than legal, meaning of the balance sheet. Fair value could be promoted in terms of making the balance sheet more meaningful and useful. Indeed, the promotion of fair value measurement represents a program to shift financial accounting from its predominantly legal regulatory framework grounded in specific jurisdictions to a global level where the norms of financial economics circulate freely. Fourth, the rise of fair value has been important to the construction of a new “technical” professional identity for accounting standards setters as experts in a system of global governance. From this “occupational” point of view, fair value is not just a technical issue but also a matter of the political economy of standard setting at the heart of which is the authority of IASB (Perry and Nolke 2006). However, standard-setting bodies like IASB are not homogeneous or necessarily consensual in their views. On the contrary, the fair value debate can be construed as a contest within accounting policymaking between measurement idealists and pragmatists (Power 2010; Walton 2004; Whittington 2008). The idealists succeeded, at least for a significant period, because of the apparent simplicity and coherence of their view.
These four factors mutually reinforce each other and help to explain the institutionalization of fair value accounting against opposition. Considerable heat was generated by technical issues of hedging and the apparent mismatch between accounting and business models for managing risk in financial institutions. In particular, while CAPM and other valuation methods existed for the asset side of the balance sheet, the liability side did not have its CAPM or liquid market equivalent. This mismatch matters because it is the liability side of the balance sheet which has proven to be most technically challenging for the application of fair values. Yet despite the heat generated by this discussion, the fair value method gained in policy weight at the expense of other current value methods. Supporters could appeal to the cultural authority of finance, and there was no unified opposition. However, these pressures for change behind fair value accounting seem to have been generated more by the visions and dreams of a small subset of accounting policymakers than by recognizable market forces and external demands for change (Bignon, Biondi, and Ragot 2009; Power 2010). Overall, the rise of fair value measurement over the last two decades represents a long-term shift in the accounting paradigm and its underlying assumptions about accounting reliability. This is a shift from the early pragmatic world of accounting grounded in transactions, and the principle of the cash (p. 303) realizability of recorded profits, to one founded on valuation models with their basis in financial economics.
The rise of fair value as a measurement basis for external reporting faltered during and after the financial crisis. Nevertheless, the pressures for change described above represent a financialization of the financial accounting model itself—the consequence of a historically specific conjunction with financial economics. The implications could be far-reaching; accountants have for several decades controlled the processes of valuation which support financial statements, even where these valuations are performed by other experts, such as land valuers and lease specialists. Yet financial economics and its proponents within the accounting standards-setting process have called for a new expertise base for accounting. In addition, the emergence of a specialist valuations standards body, the International Valuation Standards Committee (IVSC), poses an occupational threat to the monopoly of accountants over questions of valuation and hence of recognition in financial statements (IVSC 2010). Accountants are also under pressure to know more financial economics.
How these specific pressures for change will play out is unknown at the time of writing this chapter, but they define a potentially interesting sociological research topic at the shifting interface of accounting and finance. This interface and its frictions are not entirely new; they were visible in the UK “brand accounting” debate in the early 1990s (Napier and Power 1992; Power 1992). Then the accounting authorities sought to prohibit the valuation of brands as assets in the balance sheet, arguing that the valuation method was “unreliable” and that markets for brands as separable assets were nonexistent or illiquid. Yet in opposition some companies, advised by valuation firms, valued their acquired brands as separable assets on the balance sheet, and the auditors acquiesced in this accounting treatment.
Multiple competing explanations for the behavior of brand-valuing firms exist, but one issue deserves attention. The valuation method came to have increased institutional credibility because it was used for balance sheet purposes. And, as the valuation method became more credible, so the “market” for brands became more liquid—at least temporarily. In short, we can postulate a “credibility production” process which somehow links together price discovery technologies, their application to elements of financial statements, and the liquidity of the market for the valued asset—in this case brands. Such a hypothesis gives accounting statements as standardized and regulated artifacts a potentially interesting role in the microsociology of valuation, by which models with their foundations in financial economics need the legitimizing relationship to accounting to become operational, and to “kick-start” expectations and hence market liquidity. The underlying mechanism needs much more investigation and depends on the role of standardized accounting in creating networks of belief in valuation methods, which in turn generate transactional confidence and hence liquidity. Accordingly, both the older brand-accounting debate and the more recent dispute over fair value point to the sociological importance of unraveling the complex linkages between accounting, as an administrative practice which produces a kind of objectivity (Porter 1992), finance, and markets.
(p. 304) Accounting as profession, finance as discipline
From the historical reflections above, it should be evident that definitions of “accounting” and “finance” are only ever approximations. Both have complex and specific histories which vary across jurisdictions, and hence their relationship with one another is always singular and changing. Yet, we might begin tentatively by trying to distinguish between “finance” and “accounting” as categories of practice and as categories of scholarly discipline. As categories of practice we know that the terms are used loosely and often interchangeably. In many countries, the role of “finance” director in an organization is generally, but not always, held by someone who has formal qualifications as a professional accountant. Practitioners also often refer to the “finance” function in organizations, which might include non-accountant specialists trained in financial economics and undertaking work in, for example, treasury management practices such as foreign currency hedging.
Such variations in the practical use of “finance” and “accounting” as labels, and the history of these uses, are undoubtedly of interest to sociologists, not least sociologists of professions. Practice labels can be, and often are, aspirational rather than descriptive; their use may be policed more or less strongly by professional bodies and associations, and the underlying array of practices to which they refer can overlap or diverge. As Hacking (2004) also suggests, such categories and their embodiment in repetitive performances by actors constitute identities as well as fields of practice. There is no doubt that accounting is the older practice label around which professions have been constructed. Some states have granted monopoly rights to suitably qualified accountants to provide audits of financial statements. Interestingly, there are no such regulatory barriers to entry for those who would prepare financial statements or those who are specialists in financial economics and valuation methods. Such barriers as exist in these markets for expertise are primarily reputational and economic. While there are efforts to generate new occupational associations that accredit practitioners of finance, they have yet to replicate the kind of cultural authority which the accountancy profession has acquired around auditing and which lawyers have acquired around advocacy.
Underlying these developments in the practical field, the earlier discussion also shows how accounting and finance bear a complex relation to one another as disciplines at different times and places, mediated largely by their respective relationships with economics. At the level of pedagogy, students in accounting programs at universities study basic elements of finance, such as the use of discounted present values in investment appraisal. This knowledge base might be described under the label of “business decisions” rather than “finance.” Others are exposed to more advanced issues, such as valuation theory, portfolio analysis, and option pricing. In some settings the categories of finance and accounting are subsumed within yet another—that of “financial management.” In others, (p. 305) there are departments of “Finance and Accounting,” though divorces are also not uncommon in recent history, reflecting increasing specialization on both sides.
The distinction made above between “practices” and “disciplines” should not itself be taken for granted as a given. Scholarly disciplines may emerge from mundane practices of control (Foucault 1977) and then, having acquired institutional autonomy and a degree of professionalization, begin to operate in a more critical and analytical relationship to those very same practices. As we saw above, practice itself can come to be reformed and transformed via the influence of theoretical abstractions developed and refined in the academy. So there is no generalizable relationship between practice and discipline, but rather a variety of ways in which academic disciplines, like accounting and finance, become linked to their material praxis.
This means that where finance ends and accounting begins, either as an occupation or as a discipline, is not a given but is a function of specific complexes of knowledge and practice which are hybrid and constantly changing (Miller, Kurunmaki, and O’Leary 2008). The story told above is one of finance emerging from the field of accounting and acquiring its autonomy as financial economics, only for financial accounting to engage in a process of catch-up to make accounting more like finance. This dynamic of change for both accounting and finance is likely to continue in further cycles of conflict and coproduction (Cooper and Robson 2006). We cannot predict the shape of this configuration of accounting and finance or the structures of expertise which will form and reform around it.
Accounting and economics
So far the discussion has focused on the shifting relationship between accounting and finance. Yet underlying this relationship is a more fundamental and varying one between accounting and economics. At one level, the relationship involves status hierarchy: Cambridge University refused to establish a chair in accounting, arguing that it was a practical art and not a scientific discipline (Puxty, Sikka, and Willmott 1994: 153). Yet Klamer and McCloskey (1992) show how economics has always been conceptually dependent on accounting as a “master metaphor,” not least for conceptualizing the stocks and flows of national income. Furthermore, some economists explicitly engaged with accounting, the problem of income measurement (Hicks 1939) and the very meaning of “income” itself (Macintosh et al. 2000). This has given rise to an “income-theory” tradition within accounting which persists today. Indeed, conceptions of “comprehensive income” arising from this tradition, which were regarded by practitioners for many years as dangerous, have become enshrined in contemporary financial accounting practice as defined by the IASB—yet another example of the financialization of financial accounting.
At another level, the relationship is governed by the varied pedagogic constellations of accounting and economics. For example, a number of European countries developed (p. 306) traditions of “business economics” in which accounting and economics came to be closely integrated (Busse von Colbe 1996; Lindenfeld 1990; Zambon 1996); the United Kingdom is an exception in this respect (Napier 1996). This means that the relationship between economics, accounting, and finance is itself relative to cultural configurations of “business economics” (e.g., Betriebswirtschaftslehre in Germany) as an institutionalized category. In the UK the separation of accounting and economics was reinforced by the absence of any body of economic theory relating specifically to the business organization (Napier 1996). This resulted in only periodic and ad hoc interactions and exchanges across the institutional divide between universities and practice, a divide which hardened as the UK accounting profession, with the exception of Scotland, developed its own practical and somewhat anti-academic agenda for knowledge development. The result is an uneasy relationship between accounting academia and practice which is not generally found in countries such as Germany and the Netherlands (Busse von Colbe 1992; Hopwood 1988; Power 1997; Schipper 1994).
Yet the twists and turns of the relationship between accounting and economics are not confined to the comparative mapping of knowledge forms around the enterprise and the structuring of business education. At the level of practice, the relationship is also important to the constitution of organizations themselves. Hopwood (1992) argues that there is no essence to accounting and its uses; the “abstract generality of economic discourse” provides the context and motive for mobilizing accounting as a change agent in organizations. Hopwood confirms the gap between the appropriation of theory by practice and actual practice that Whitley observes in the case of finance. Theories of decision-making and information economics have been applied to accounting, but they provide an economic conception of accounting which is often at odds with the way accounting is actually used (see also Young 2006). Indeed, Hopwood suggests that economics is essentially disappointed with a world which does not conform to its analytical constructs, even though these same constructs are also being used to provide new rationales and purpose to accounting, to financialize accounting as we saw above.
The relationship between accounting and economics is therefore a complex and uncertain one. One is not a simple reflection of the other. The present practice of the accounting craft cannot be deduced from economic conceptions of it and economic ideas for its change and reform, although often articulated, find it difficult to become entangled with a craft that appears to have independence from what are seen as its essential roles. (Hopwood 1992: 130)
Hopwood provides two empirical illustrations of the point. During the economic depression of the 1770s, Josiah Wedgwood, the producer of high-quality porcelain goods, realized that he needed to know his “cost” of production. This was not as simple as it might seem today. Cost was an economic category which informed a discourse but which lacked a material infrastructure. The “facts” of cost could not simply be revealed but needed to be created and operationalized via a change in administrative and accounting processes. Once created, once cost had a degree of facticity, then Wedgwood could begin to see his organization in economic terms and could subject it to further (p. 307) economic analysis. In trying to reveal something presumed to be there already—cost—a new organizational economy was created (Hopwood 1987).
Hopwood's second study concerns reforms in the health-care field. Because of the managerial dominance of the medical profession, accounting was for many years largely a minor transactional and background feature of hospitals without strategic significance: “The costs of patients, of diagnostic treatments and of disease categories remained the vaguest conceptual possibilities. They certainly were not facts” (Hopwood 1992: 139). Yet the lack of microfinancial practices of control came under pressure and, despite initial resistance from the medical profession, slowly began to change. New accounting objects were created to operationalize and make cost visible at the microlevel; the creation of new administrative and accounting infrastructures enabled economic reforms and related demands for efficiency to gain increasing organizational traction. Via accounting change, hospitals could be imagined as economic entities in a manner that health economics could not achieve: “economics does not reveal what is already there. Rather it provides a basis for the attribution of new meanings and roles to accounting . . .” (Hopwood 1992: 141).
Here and elsewhere Hopwood has argued that accounting is deeply implicated in the construction and expansion of the “sphere of the economic,” which in turn gives accounting new roles: “To be realised, the economic potential needs to invest in modes of observing and recording …” Furthermore, while he carefully distinguishes economics as discipline from economic praxis, Hopwood's focus is on organizations and on how economics gets connected to the organization via the creation of an accounting facticity (see also Hines 1988). This in turn makes organizations more economic and creates a new strategic trajectory for accounting. Importantly, “the ambiguity of economics does not in and of itself constrain the practical use of economic concepts” (Hopwood 1992: 136).
Applied specifically to financial accounting, Hopwood's ideas are highly suggestive in two respects. First, in specific settings the introduction of financial accounting is part of a reform process intended to create a new kind of economic entity. In the context of hospital reform in Finland, Kurunmaki (1999) shows how hospitals were made into “accounting entities” and how financial accounting does not simply represent an organization but is deeply involved in constructing one with distinctive characteristics. Second, it is useful to distinguish between counting, financial statements, and the forms of second- and third-order calculations which they enable (Power 2004). For example, the modern firm is now surrounded by a range of ratios that define “return on capital,” “leverage,” “solvency,” and “liquidity.” Although these ratios and metrics are based on financial statements they also acquire a life of their own and circulate as shorthand for economic performance across different organizations and fields, being used by communities of analysts, credit-rating organizations, and many others. Such ratios define parameters of strength and weakness, and success and failure (Miller and Power 1995). By virtue of their compression and abstraction, they enable diverse entities to be compared and ranked.
In summary, this section suggests that accounting, both managerial and financial, plays a role in making economics operational in organizations, and in representing and (p. 308) therefore constructing “economic” entities. The power of accounting as a change agent consists precisely in the capacity of its representations to become, in turn, part of the way the organization looks at and intervenes in itself. From this point of view, economics requires accounting to make the world of organizations more like its theories of the firm, and financial economics needs fair value accounting to literally “real-ize” its conception of value. The sociological significance of accounting resides in this role as a critical relay between ideas of its economic potential and actual practices.
Social studies of accounting and finance
The previous sections have looked at the emergence of financial accounting and how this history has been shaped by a relationship with finance and economics, both at the level of pedagogy and discipline, and at the level of practice. The fair value discussion provides a dramatic example where all these levels collide. What emerges from an otherwise complex picture is that financial accounting matters because it is much more than a neutral mirror of organizational life. Indeed, financial accounting is performative in the simple sense that it is difficult to distinguish clearly its “representational and interventionist uses” (Vollmer, Mennicken, and Preda 2009: 622). Analyses of the “performative” character of accounting significantly predate the treatment of this idea within certain areas of the social studies of finance (e.g., Callon 1998; MacKenzie and Millo 2003) and focus on the manner in which accounting “visibilities” influence behavior (Miller 1994; Power, 1994a, 1994b: 373). There is a parallel between those studies of finance focusing on the material practices, ideas, and instruments that play a role in the dynamic constitution of financial markets, and accounting studies which, following Hopwood (1992), have been concerned with the role of accounting information systems in constituting organizations as economic entities, and in so doing structuring the action and cognition of their members around various forms of performance measurement. As Miller (1994: 4) puts it, the idea of accounting as a social and institutional practice seeks “to draw attention to the ways in which the ‘economic’ domain is constituted and reconstituted by the changing calculative practices that provide a knowledge of it.”
Social studies of accounting suspend or “bracket” the technical and progressivist aura of accounting. Burchell et al. (1980) provide one of the earliest challenges to the traditional decision-theoretic and technical rationale of accounting systems by suggesting the very different roles that accounting may play. When information objectives are certain, and causal relationships are well understood, then accounting can provide “answers” in a machine-like manner and seems to have the technical characteristics celebrated in textbooks and pedagogy. But these epistemic and organizational conditions are rare; in most instances accounting plays a variety of complex and contingent roles, for example as ammunition in adversarial situations, as a rationalization of decisions taken for other reasons, or, more positively, as an experimental means of discovery and learning. Once the apparent technical and commonsensical conception of accounting (p. 309) was challenged in this way, the door was opened to a new field of sociologically informed studies of accounting and accountants.
In another key article, Burchell, Clubb, and Hopwood (1985) document the rise and fall of the “value-added” statement as an accounting innovation. This new accounting statement was a contingent product of specific institutional forces and interests. The value-added statement enabled these interests to be, temporarily at least, refined, expressed, and materialized. Unlike the conventional profit and loss account and balance sheet, “value-added” accounting was intended to make visible the contribution of labor and other noncapital factors of production to surplus or “value added.” The article positions value-added accounting as an endogenous “event” in an institutional field. Importantly, Burchell et al. (1985: 390) argue that value-added accounting statements were far from being technically standardized and were highly ambiguous in their meaning and scope. Yet this ambiguity was a critical feature of the wide appeal of value-added accounting: “the very ambiguity of value added might, in other words, be implicated in its emergence and functioning.”
More generally, social studies of accounting conceptualize it as a calculative practice whose precise shape is contingent on institutional factors, such as generalized demands for improved efficiency as we saw in a previous section, but which also reshapes the organizational environment and context of decision-making. Accounting gives visibility to economic variables (e.g., cost, profit, return on capital, value) to which actors react by attributing significance. In some cases these variables of performance may be internalized as a way of thinking and framing organizational activity and identities (Miller and O’Leary 1987). This kind of reactivity is potentially generalizable to a wide variety of calculative practices, such as rankings (Espeland and Sauder 2007) and other performance metrics. Inspired by the work of Michel Foucault, these and other key accounting studies place emphasis on accounting as a mode of governing, on the power of sectional interests, and on the discourses that mobilize accounting change (Power 2011). These studies explore the manner in which organizational and professional boundaries are fluid and are permeated by institutions and ideas. From this methodological point of view, the distinction between internal (managerial) and external (financial) accounting that was introduced at the beginning of this chapter could be subject to greater critical analysis than hitherto. Such an analysis might reveal how calculative practices at particular places and time have institutionalized the boundary of the firm and have defined the distinction between its “inside” and “outside” (Kaplan and Johnson 1987).
This chapter provides a selective overview of the complex relationship between accounting and finance. It addresses the history of financial accounting and how questions of valuation necessitated the input of finance. It also discusses the transformation of finance itself and the emergence of financial economics as an engine of financial markets and financial instruments, which themselves created accounting difficulties and led to (p. 310) the “fair value” accounting debate. And, despite pressure to subsume accounting as a part of finance and economics, it has also argued that accounting provides a vehicle for realizing and operationalizing economic ideas. Indeed, the social studies of accounting literature provides many examples of how accounting has been implicated in constructing organizations as comparable accounting entities, not merely representing them. Underlying all these developments are the shifting tectonics of different forms of professional and academic expertise vying continually for priority. The fair value debate discussed above might be a good place to begin to unlock the mechanisms by which accounting, finance, and markets are co-constituted.
That this is a complex, multilayered picture should be in no doubt. Hopwood (1992) goes as far as to suggest that accounting has no essential purpose in and of itself, and must be given one and mobilized by wider aims, whether this is finance, economics, or some other value system such as sustainability. There is no essential relationship between conceptions of, and ambitions for, the accounting craft, which is itself a shifting assembly of techniques that shade into elements of other disciplines, including finance: “If the economic is as likely to result from accounting as it is to induce it, then there are limits to the extent to which it is meaningful to explore the underlying and enduring economic truths of accounting” (Hopwood 1992: 142). No doubt much the same can be said of finance, especially in the light of the postcrisis challenges to its neoclassical foundations (Colander et al. 2009; Fox 2009).
If there is no essential relationship between finance and accounting, then they can only be analyzed as an evolving terrain of rationales, interests, and instruments though which actors and their interests are “made up” (Hacking 2004). Indeed, it is at the “margins” of practices where the dynamics of field development in general, and the relationship between accounting and finance in particular, are most interesting and contentious (Miller 1998). The fair value debate shows this clearly. Finally, such analyses should be mindful of the need for methodological symmetry, as advocated by the strong program in the sociology of knowledge. Accounting and finance practices that seem to fail merit as much, if not more, attention than those that seem powerful and endure. It is in failure and crisis that the underlying logics and assumptions of practice are most clearly revealed, not least assumptions about what is and is not of value.
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