Accounting Standards andGlobal Convergence Revisited:Social Norms and Economic Concepts
Shizuki Saito
Meiji Gakuin University

No. 11-01

Accounting Standards and Global Convergence Revisited:Social Norms and Economic Concepts
Shizuki Saito

Abstract
The leitmotifs underlying accounting standards setting have undergone changes over time,from best practices to a normative approach and then to global convergence. In the process,accounting standards have gradually lost their character as a set of informal social norms based onmarket practices. This trend, combined with the pursuit of a formal framework not amenable toadjustment through feedback from market tests, has unavoidably brought about a top-down
approach. Under this approach, the uniformity of standards from the viewpoint of regulators has
been given priority over the usefulness of income information for users of financial statements.
Consequently income information, which plays an essential role in the valuation of companies incapital markets, has been affected by a mechanical application of the asset-liability approach andfair value measurement with scant attention to a marked difference in business transactions.
Because investors today almost disregard national borders, the homogenization of accounting
information is certainly an important goal. To achieve this goal, however, it is necessary to facilitate
the spontaneous homogenization of norms based on an evolutionary market process which enables
standards setters to incorporate vox populi into accounting standards themselves rather than decideon the direction and degree of convergence on an a priori basis.
JEL classification: M40, M48
Keywords: Accounting standards, Convergence, Social norms, Income concepts, Asset-liability
approach, Fair value measurement

1. Introduction
The task that the editorial committee has assigned the author is to take a look at accounting
standards on a global convergence path anew, and address any problems underlying the process.
Historically speaking, the main driving force of accounting standards setting has changed from

The author is indebted to Shyam Sunder (Yale University) and Yoshitaka Fukui (Aoyama Gakuin
University) for their helpful comments and suggestions. Any remaining faults are the author’s own.

1market participants, including accounting professionals, to domestic governmental or private-sector
regulatory bodies, and further to international standards setters. These changes have beenaccompanied by changes in the ways in which accounting standards are to be set, from thebottom-up approach which emphasizes the careful observation of market practices, to the top-down
approach which strongly reflects the regulatory a priori perspective. The latter approach appears tohave been intensified in recent years. As a consequence, the uniformity of standards has been
increased, while the scope for market feedback to exert influence on standards has diminished.
Accounting information tends to focus on quantitative differences of companies in theircommon characteristics rather than qualitative differences that remain even in their seemingly
similar activities. Although such qualitative differences certainly affect corporate profitability,
accounting information necessarily relies on uniformity that subjects all qualitative differences to acommon measure of value, just as diverse attributes of assets traded on markets which cannot be
captured in prices are abstracted away. Nevertheless, the author believes that standards which force
companies to uniformly appraise their transactions and acquired resources based only on theirsuperficial similarity ignoring company-specific differences in investment objectives and purposes
will neither emerge as rational interactions of market participants nor take root by promoting
uniformity of practice. This belief alone makes it worthwhile for the author to reexamine thecurrent standards from a market-oriented perspective. Given that information disclosure relies onmarket discipline, it seems appropriate to first pay careful attention to the autonomous function ofmarkets in the development of norms.

2. Evolution of Accounting Standards and “Standards for Standards Setting”(1) Meta-rules for accounting standards
As a first step of investigating the potentially desirable characteristics of accounting standards,
including convergence, there is a need to consider standards for standards setting or meta-rules on
which accounting standards setting have been based throughout history. Accounting standards used2

to be regarded as an inventory of best practices tested and proved in capital markets. Markets are
said to have developed accounting standards by collecting useful behavioral rules, putting them intoa means-to-an-end structure, and codifying surviving practices inductively1. This process led to the
GAAP (Generally Accepted Accounting Principles) concept, which finally won consensus fromthe 1920s to 1930s, when the modern accounting system was established in the United States.
The history of U.S. accounting standards is said to have begun in 1917 when Uniform
Accounting was released by the Federal Reserve Board with the support of the American Instituteof Accountants (AIA), an association of accountants who were then gaining recognition as anestablished profession. By the mid-1920s, a voluntary information disclosure system was in placethat was centered on the New York Stock Exchange. In 1934, the Securities and Exchange
Commission (SEC), whose jurisdiction includes accounting standards setting, was established.
However, by this time, voluntary information disclosure had become widely practiced among U.S.
companies. As a result, the SEC delegated its jurisdiction to develop standards to the private sector,
and, with the SEC’s blessing, a committee that was set up in the AIA worked on the developmentof GAAP by compiling best practices. This was the initial scheme for standards setting in the
United Sates.
Under this scheme, however, standards tended to become not only fragmentary but also
inconsistent. As a result, people began exploring a more constitutive (normative) approach that was
designed to deductively derive standards from a small number of a priori premises or basic
concepts in the early 1960s2. This approach favored the direct recognition/measurement of such
visible and real elements as economic resources rather than the development of a measurement
mechanism for such invisible and constructed quantities as profits based on professional judgment.
It drew people’s attention to the frame of references on which its rules are based, eventually giving

1This stance is epitomized by May (1943) and Littleton (1953) in which we can clearly see the influence ofclassical U.S. pragmatism, particularly the views on truth held by James (1907).
2
A seminal work is Moonitz (1961), published as result of a research project conducted by the American
Institute of Certified Public Accountants (AICPA; renamed from AIA).

3

rise to the Conceptual Framework Project of the Financial Accounting Standards Board (FASB) in
the 1970s and 1980s.
More recently since the arrival of a new century, global convergence, i.e., the integration andunification of accounting standards across borders as a means to ensure the worldwide
comparability of financial information, has become a stated goal. Although this integration drive atfirst came mainly from the need specific to Europe for unifying accounting standards throughout
the region after the unification of European capital markets, the development of international
standards (as opposed to European regional standards) to ensure the ready acceptance of European
companies’ financial statements without reservation in the United States was also kept in mind. In
this process, the International Accounting Standards Board (IASB), originally thought to be theEuropean standards setter, has moved forward with a top-down standardization initiative
increasingly reliant on formal definitions of concepts while competing with the FASB for theleadership in the global unification of standards.
(2) From emerging social norms to deductive written rules
The next question is how actual standards have changed over the course of the historic
evolution of “the standards for standards”. Early accounting standards, which tried to embody bestpractices, were basically a subset of social norms as defined by Posner (1974, 1997). They more orless fit the description “shared expectations of members of society about the behavior of others”.
The adoption of the deductive normative approach has transformed such prototypical accounting
standards from soft “social norms” into hard “written” rules (Sunder, 2005a, 2005b). As a result,the objectives of financial statements, qualitative characteristics of accounting information, anddefinitions of elements of financial statements now are derived from a formal conceptual
framework rather than inductively emerge from best practices or widely shared social norms.
Both informal social norms and a formal conceptual framework approaches agree that theirusefulness should be judged from the actual outcomes brought about by their application of basic
ideas. This trial-and-error process dovetails with informal norms, especially those called “best4practices”, because they are a compilation of rules that are actually in use and are known to be
useful. On the other hand, in the case of the deductive derivation of formal standards, their premises
are just assumptions to be proved. For this reason, a relatively flexible system used to be
maintained allowing the premises to be changed in case the rules deduced from them turned out tobe disappointing.
In recent times, however, this once flexible system has become more and more rigid turning
into a regime that ordains standards mechanically derived from an unproven preconceived
conceptual framework. This trend has been strongly influenced by the global convergence
movement as well as various factors that have brought about the aforementioned change frominformal social norms to formal normative standards. This change has occurred partly because thereview of proposed rules based on market tests, though relatively easy within a single country, is far
more difficult once adopted across borders. The territorial monopoly enjoyed by a national
standards setter and the global monopoly enjoyed by an international standards setter havecompletely different influence over the process of standards setting.
If global convergence is being pursued in a top-down fashion without a feedback mechanismthat is capable of fairly and efficiently incorporating outcomes of market experiences in individual
countries into common international standards, newly devised rules from a priori premises, rather
than existing rules that are actually in use somewhere in the world, will be imposed worldwide.
While the due process for standards setting includes the incorporation of feedback from individual
countries, to what extent their needs are considered is another issue. We do not live in an idyllic
world where our views would be adequately reflected if we followed IASB’s leadership. In thissense, the current regime seems to put us in a straitjacket of standards based on a written
framework.

3. Key Concepts for Convergence: A Critical Review(1) Three key concepts
5

As discussed in the preceding section, the move toward global convergence has played aprominent role in changing the character of accounting standards. Three key concepts are crucial inunderstanding the process.
The first key concept is a single set of high-quality standards as the goal of standards setting.
While a global single set of standards appears to increase the comparability of accounting
information, standard setters should quest for not just comparability but also high-quality in
information disclosure. However, can we pursue comparability and high-quality simultaneously
without any tradeoff?
The second key concept is the asset-liability approach of accounting measurement. Thisapproach attempts to calculate accounting numbers through appraising stock value on the balance
sheet and is considered the antithesis of the traditional revenue-expense approach which starts withthe measurement of flow value on the income statement. We should keep in mind that there are
two separate issues to be carefully distinguished when examining these opposing approaches: how
to organize accounting information systematically, and how to utilize accounting information forvaluation.
The former issue is which of the two, assets and liabilities or revenues and expenses, shouldhave primacy in conceptual definition. Because stock and flow are interlinked through the clean
surplus relation, we cannot define stock and flow concepts independently. In this regard, it seems
reasonable to use assets and liabilities, more concrete concepts, to define revenues and expenses,
more abstract ones rather than vice versa. This is an asset-liability approach in terms of conceptual
definition.
The latter issue is which should have primacy in valuation. If stock information is thought tobe more useful than flow information, we should choose an asset-liability approach in terms ofvaluation. However, is stock information or assets and liabilities, more useful than flow information
or revenues and expenses (summarized in income)? We cannot claim that this question has been
firmly settled.
6

The third key concept is fair value measurement. Fair value originally meant market value.
However, because market value does not always exist, it now refers to both market value andpseudo-market value. Under the fair value rule, we should evaluate stock or assets and liabilities interms of present value rather than initial acquisition cost and disclose accordingly. Moreover, thisrequirement has also led to the birth of a new income concept, comprehensive income, as a change
in fair value over a period of time. Fair value advocates have tirelessly argued that such informationis also useful in appraising corporate value as a whole. However, no consensus has yet to bereached concerning such critical questions as: to what extent fair value represents the value of thefirms in its entirety as well as each stock item; how useful the change in fair value of assets andliabilities as income information is.
(2) Single set of high-quality standards: compatibility of two requirements
The first question is whether uniformity (culminated into a single set) and high-quality aremutually compatible. As discussed above, the purpose of unifying accounting standards andpractices worldwide is presumably to facilitate investors to evaluate accounting information
without being bothered by national borders. The quality of standards in terms of information
usefulness, however, directly depends upon how accurately disclosed information can convey theactual state of a company. While various institutional systems that collectively control the behavior
of companies (e.g., legislations such as corporate law and tax code, and regulatory frameworks
such as financial, industrial and price regulations) affect how firms disclose their information,accounting standards are expected to promote high-quality undistorted information disclosure byeliminating biases induced by these systems as much as possible. If national accounting standards
are unified but country-specific institutional systems which are potential sources of several biases
are left unchanged, an improvement in the quality or usefulness of information cannot be a7foregone conclusion. On the contrary, uniformity and high quality are not likely to be fullycompatible3.
In this kind of problem, the path dependency and cross-complementarity of institutional
systems cannot be ignored. Social systems, including accounting standards, are constrained by theirown past, and influence each other because of their complementary relationships. For example,
assume that three interrelated systems, A, B, and C, exist, and these systems have developed into
combination of A1, B1, and C1 in one country and A2, B2, and C2 in another. Even if A1 is in
isolation a more desirable form of A than A2, it is not clear whether this holds true when A1 is
combined with B2 and C2. Namely, if A2 is replaced with A1, the cost of a mismatch between A1,
on the one hand, and B2 and C2, on the other, may exceed the incremental benefit of A1 over A2.
This parable shows that no one knows beforehand the optimum unification level of standards. It
can only be determined in an incentive compatible manner through market transactions, which, atthe same time, will set an optimum path toward the unification of standards4.
There are two approaches to achieving a global convergence of institutional systems. One isto first set uniform standards and to force individual countries to adopt them. The other is to treat
uniform standards as a model and allow each country to reform its respective set of institutional
systems consonant with the model. Each individual country is required to develop the best possible
set of institutional systems and modify its standards accordingly to attract as much capital as
possible. The model itself is not fixed, and should continue to evolve into a better one byincorporating the best part of national standards through competition between different sets of3

A more fundamental question is whether the unification of standards guarantees the international
comparability of information. As Ball (2006) points out, the unification of standards does not automaticallylead to the unification of practices, while the latter is more important than the former from an investor’s pointof view. In order to evaluate the degree of unification of practices, we have to keep in mind that even the sameaccounting standards are interpreted in the context of their application to actual corporate behavior and, assuch, is greatly influenced by the relationship among (the global) accounting standards and other distinctly
national institutional systems in each country.
4
If differences remain among individual countries in the process, they must be considered necessary rather
than undesirable at least for a while (maybe decades). On this issue, see Dye & Sunder (2001) and Sunder(2002).

8

institutional systems. This process will further promote institutional reforms in individual countries.
Ideally, convergence processes should follow this scenario to simultaneously achieve thehomogenization and improvement of standards. It is this market-oriented approach that will realize
convergence in the true sense of the word through competitive institutional reforms in each country
and a consequent bottom-up global unification5.
(3) Asset-liability approach: relationship with income recognition
The clean surplus relationship is a fundamental constraint in accounting, measurement
requiring that the change in equity (net assets) be equal to income if no capital transactions withshareholders occur during the period. It can be expressed in the following equation:
Equity at end of period - Equity at beginning of period= Revenues - Expenses = Income.
The identity shows that the balance sheet is constrained by the income statement and vice versa
because assets minus liabilities always equal equity by definition.
Given the time-series of cash flow, accounting accruals affect the pattern of period income
but cannot alter the sum of the entire income stream. Thus the essence of accounting measurement
to allocate cash flow based on either the valuation of assets and liabilities or the recognition ofrevenues and expenses. Although the term “allocate” is no longer in vogue among accountants, it isat the heart of the matter: the relationship between assets and liabilities on the one hand andrevenues and expenses on the other.
In the asset-liability approach, assets and liabilities as visible and concrete concepts are used
to define revenues and expenses as invisible and abstract concepts. Therefore cash flow isintertemporally allocated according to the recognition and measurement of (change of) stock itemson the balance sheet. While it is not appropriate to discuss the pros and cons of this method, theimportant point is how accurately the total value of assets (minus liabilities) determined in this5

An example worthy of mention is the corporate law system in the United States, where the existence of
mutually distinct state laws with the non-binding Model Business Corporation Act has been encouraging
innovations interdependently through market competition among state laws.

9manner can track the corporate value in its entirety. As long as the core competence of a firm isinseparable from its off-balance-sheet “goodwill” (e.g., its human resources), there is no guaranteethat the aggregate value of individual assets that are recognized on the balance sheet has a stable
relationship with the corporate value, the estimation of which is its stock price. Unless this link
exists, accounting information based on the asset-liability approach is of limited use for investor
decision making.
The corporate value of a firm is not simply the total value of its assets but depends on futurefinancial results expected from those assets. For this reason, future-oriented permanent income(normalized income converted from expected net cash flow) is likely to be a proxy for corporate
value rather than the present market value of individual assets or its approximation. It is notunreasonable to expect an information disclosure system to provide information users with present(and past) income (stream) and leave the rest for them to work out. There is no income withoutchanges in assets and liabilities. However, whether they alone determine an income concept which
is useful for the valuation of a firm is another matter. Being a necessary condition does notguarantee sufficiency for income recognition6.
Comprehensive income, which is measured only from changes in the value of assets andliabilities (excluding capital transactions with shareholders), is likely to be an indicator with little
information content. If the total value of recognized assets has little if any direct relationship withcorporate value, the fact that comprehensive income is mechanically derived from it poses a serious
question on its usefulness to explain stock price behavior. In case its usefulness is wanting, there isa need to devise an income indicator that has greater information value than comprehensive income.
Traditionally, that role has been played by net income (or “earnings” in U.S. parlance). Although it
is not known whether net income is the best indicator, it is at least an accounting concept of incomethat has been developed by the capital market participants over the past century. Net income or the6

In a word, the asset-liability approach defines income (revenues and expenses) from assets and liabilities
rather than assets and liabilities from income.

10

bottom line of financial statements, which is equal to comprehensive income minus (unexpected)
windfall gains, has been used for the estimation of permanent income.
Windfall gains, when recognized, become part of comprehensive income, although theycannot be included in net income but constitute “other comprehensive income (OCI)”. Whilewindfall gains are excluded from income as an economic concept to be discussed later, they need to
be transferred (recycled) to net income in corporate accounting, which allocates cash flow
associated with investment projects intertemporally, when they satisfy the requirements forinclusion into net income7. The problem lies with what condition should be met to transfer items
such as windfall gains from OCI to net income. The Accounting Standards Board of Japan (ASBJ)
has proposed release from the risks of investment instead of traditional realization as its guiding
principle for income recognition. While financial results (cash flow) expected from investments are
inherently uncertain and risky, they satisfy the condition for inclusion in net income once there nolonger exists any substantial risk.
(4) Fair value measurement: scope of application
Fair value, which is the third key concept, is basically the exit price, but for assets that do nothave a market price, an estimate that approximates such a price must be devised. This
pseudo-market price is a construct made on the basis of average market expectations rather than thefirm’s own estimation of value in use or the discounted value of future financial results to berealized through the use of the asset. The issue is to what extent fair value (as understood in thissense) should be applied to both asset valuation and income recognition. So far, while the IASB
sticks to the principle that calls for the full application of fair value to financial instruments, it has
actually proposed and set standards falling short of full application. In this regard, the IASB does
not seem to be much concerned about a systematic investigation of its principle8.

7This is because the total income generated from an investment project over its entire period is equal to thetotal net cash flow on an ex post basis.
8
Quite a few accounting scholars have expressed a view close to the ASBJ’s on the scope of fair value
measurement. For example, Penman (2007) argues that the application should be limited to assets and11

On the other hand, the ASBJ has been arguing that fair value accounting should be applied to
all assets and liabilities considered financial investments in the sense that they are held for theimmediate realization of monetary gains, regardless of their external forms. Financial investments
are characterized by the existence of a liquid market and the freedom of the firm over theirliquidation without being constrained by its business purposes. Because liquidation at exit price isthe only way to achieve financial results from their possession, the only relevant criterion offinancial instruments is exit price not specific to the firm which holds them. The application of fairvalue accounting to those kinds of investments is consistent with the ASBJ’s risk-release concept
mentioned above. If a financial investment is made in the expectation of achieving a capital gain,
actual or estimated exit price enables the firm to confirm a realized gain (or loss) as a result ofinvestment released from risk (ASBJ, 2006).
In the case of an investment made in the expectation of achieving business results (business
investment), the value of assets does not necessarily agree with market value because theinvestment is not released from risk until its cash flow is finalized, regardless of its current market
value. It is true that a fair value measurement of financial investments is more desirable than not,but the change in value of business investments, even if recognized on the balance sheet, is betterexcluded from net income and relegated to OCI as a windfall until the investment results are
finalized. The usefulness of net income information has been confirmed by numerous empiricalstudies9. Although International Financial Reporting Standard (IFRS) No. 9 of 2010 has notabolished net income as a concept, the criteria to differentiate elements of net income from those of
OCI are not clear, and the clean surplus relationship no longer holds between net income and equity
because of the ban on recycling OCI.
If comprehensive fair value accounting is adopted (or no change in fair value is excluded
from income), net income and comprehensive income are the same, and there is a clean surplus
liabilities whose fair value (changes) has a one-to-one correspondence to stock price (changes) of the firm.
Dichev (2007) expresses the similar view.
9
See Wakabayashi (2010) for a comprehensive up-to-date survey of U.S. empirical studies and her own
research using Japanese data.

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relationship between income and net assets on the balance sheet. However, if part ofcomprehensive income is excluded from net income, then the clean surplus relationship no longer
holds between net income and net assets. For this reason, ASBJ’s discussion paper on theconceptual framework defines shareholders’ equity, which satisfies the clean surplus relationshipwith net income, as part of net assets (therefore shareholders’ equity is not equal to net assets inJapan). Because the recycle of OCI is a necessary condition for the recovered clean surplus, theinformation value of net income may be lost if recycling is not allowed. Although the IASB failed
to abolish net income, it seems to have succeeded in rendering it meaningless.

4. Usefulness of Information: Comprehensive Income and Net Income(1) Quantitative analysis: empirical test of usefulness
The next issue is the usefulness of accounting information, arguably the most important
aspect to determine the quality of accounting standards. In the context of the current argument, itcomes down to the relevance of net income, which equals comprehensive income minus windfalls
classified as OCI (for now, limited to revaluation gains or losses of assets and liabilities
characterized as business investments). On this topic, the verdict is unambiguous: the usefulness of
net income information in terms of its correlation with stock price has been amply confirmed byempirical studies. While OCI, when disclosed in addition to net income, may be credited with
marginal information value, the dominance of net income in terms of information usefulness isbeyond question.
What would happen if net income were abolished and comprehensive income became thesole income concept? Some researchers try to answer this question by reconstructing
comprehensive income from accounting data obtained under the current standards. However, wehave only stock price data obtained under the current regime which requires the disclosure of net
income. In order to answer the posed question, we would need data obtained under a hypotheticalno-net-income regime, which does not exist by definition. This methodological criticism is in line13with a well-known argument (Lucas critique): because a policy or institutional change has thepotential to alter people’s expectations and behavior by affecting their incentives, a model
consisting of parameters estimated on past data under the old regime cannot be used to evaluate its
impact. Therefore, the validity of the argument for the comprehensive-income-only regime basedon the correlation between comprehensive income and stock price in a world where net income
information existed is seriously called into question because net income information is most likely
to affect people’s expectations and behavior including implicit as well as explicit contracts andcustoms.
The discussion brings about an even more important issue. As has been widely pointed out,
this type of empirical studies pretends to test the causality that is assumed to exist between
accounting information and stock price, but can at best find statistical correlations. As such, it does
not prove any existence of causality, let alone explain its inherent mechanism. If a correlation isestablished between income number and stock price, it may be possible to “explain” stock pricebehavior by recognizing a “risk” of the company due to changes in its income and comparing itwith the market-wide risk (e.g., beta) under the capital assets pricing model (CAPM). However,any attempt to generalize this idea into causality has little prospect because CAPM (or any
theoretically clean model) fares badly as an empirical model. Unless we find a theory based on
deep parameters invariant to any policy change, we should be skeptical about any policy
recommendation “supported” by empirical tests.
(2) Qualitative analysis: concept of economic income
To complement quantitative studies, we should qualitatively analyze the usefulness of
income information. In this context, the concept of economic income, as proposed by Hicks andothers, has been a focus of attention10, and used to justify a specific set of standards. Recently, ajoint project of the FASB and IASB has released a document that seeks a theoretical basis of the10

In addition to Hicks (1946), important contributions include Fisher (1906, 1930), Lindahl (1933) andKaldor (1955).

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asset-liability approach and comprehensive income in Hicks’s income concept (FASB/IASB,
2005)11. In particular Hicks’s income No. 1 concept has been extensively used as a first model toarrive at an appropriate concept of income. In the context of the current argument, this income canbe defined as a maximum amount of money that can be spent in the current period while
maintaining the equity value measured at the beginning of the same period.
However, if the capital value is a function of financial results that are expected to be achievedin the future, it certainly depends on the term structure of interest rate. Therefore, what is closer tothe central concept of income in the context of interdependence between capital value and income,as pointed out by Hicks (1946, pp. 174-176), is the amount that can be spent in the current period
and is expected to be spent in each ensuring period (income No. 2). Because this income does notinclude capital appreciation (or depreciation) due to the expected change of interest rates, income
No. 1 does not coincide with income No. 2, a “closer” concept than the former, unless the interest
rate is intertemporally constant.
Moreover, there is always an unexpected difference between its valuation at the beginning of
the period and that at the end of the period due to a change in future expectations (i.e., unexpected
windfall gains or losses). Therefore capital value increases if an expected future revenue stream isrevised upward and/or expectations of accompanying interest rates are revised downward.
However, if (part of) the increased value brought about by the change of expectations were spent
immediately, then future revenues would decrease correspondingly and the level of wealth asmeasured in terms of the potential for consumption, could not be maintained12.
The unexpected difference in capital value between the beginning and the end of the period
can give rise to two different income concepts depending on which point is used as reference. If
capital values at the beginning and the end of the period are measured on the basis of expectations
held at the beginning of the period, the difference will be defined as income ex ante. If they are
11
12

See Bromwich et al. (2010) for a theoretical critique of the joint project.

See the implication of unexpected changes for Hicks (1946, pp.184-185) and Fisher (1906,
pp.287-288).
15

measured on the basis of expectations held at the end of the period, it will be defined as income expost. Of these two income concepts, only income ex ante is directly relevant to economic decisions.
Retrospectively estimating the capital value at the beginning of the period on the assumption thatthe information that became available at the end of the period would have been available at the
beginning of the period was not a major concern for Hicks. This is likely to be the reason why his
income ex post concept is not adjusted for windfalls.
The above discussion shows that Hicks would not endorse the use of his income No. 1 ex
post for justifying the asset-liability approach. In this regard, a more meaningful approximate
concept for economic income is his income No. 2 ex ante13. However, accounting information isbased on ex-post measurement. The role of accounting income is to examine projected results
based on ex-ante expectations in comparison with corresponding ex-post facts and use the outcome
for the formation of future expectations. Given that income No. 2 ex ante is a concept that excludes
windfalls, this role can only be played by a similar but ex-post concept. Income ex post that
excludes windfalls seems to be the most appropriate concept for accounting measurement
regardless of Hicks’s indifference to ex- post concepts (see Appendix).
Should expectations not change during a period due to the absence of any uncertainty, there
would be no need to consider windfalls, but in such a world, accounting information itself would be
unnecessary. However, fortunately or not, we live in a world full of uncertainty. Therefore an
approximate concept of income ex post that corresponds to Hicks’s income No. 2 ex ante is a
powerful weapon to examine measurement rules. This ex-post concept enables us to propose whatkind of accounting information is useful conceptually and to designate areas where empiricalstudies are most informative.
Moreover, it exactly matches the ASBJ’s main concept of investment results released fromrisk. Based on this concept, the ASBJ has proposed separate measurement rules for business13

It means that in the real world where future expectations are constantly changing and the term structure ofinterest rates is not flat, the use of Hicks’s income No. 1 concept as a theoretical basis for the asset-liability
approach and comprehensive income is not warranted. Income No. 2 cannot, as a matter of course, beclaimed to support the approach. See Fukui (2011) for a detailed analysis.

16

investments, which is made for achieving business results specific to the company concerned, andfor financial investments, which is made for achieving capital gains through arm’s-length market
transactions. Therefore unrealized windfalls must be relegated to OCI but recycled into net income
once gains or losses are realized14.

5. Conclusion
Income concepts discussed in the preceding section have been proposed to be useful forinvestment decisions (ex ante) and evaluations (ex post) and are accordingly subject to usefulness
tests designed for various purposes. Nevertheless, it should be emphasized that the function ofincome information can be clarified through a careful economic analysis of investment behavior.
Where a concept used as the premise is a dogma for which no method exists to explain its
usefulness empirically, the conclusion can be nothing but a dogma, no matter how consistent the
deduction process may be. The ongoing global standards development process lacks an adequate
feedback mechanism to incorporate the results of usefulness tests into basic concepts andoveremphasizes consistency with a priori conceptual frameworks. It seems that this kind of
pseudo-consistency is mistaken for consistency as a necessary condition for the falsifiability of a
proposition (Popper, 1968, sec. 24).
As stated at the beginning of the paper, rules for market transactions, including accounting
standards, used to be rooted in social norms that emerged from actual transactions and were almost
unanimously recognized as useful by market participants. Such social norms have gradually been
replaced by uniform standards to suit the definitions of a priori concepts adopted by standards
setters, and this transformation has been accelerated in the course of global convergence, resulting
in diminished usefulness of information. Under these circumstances, standards reform is required to
avoid hasty unification and to devise a mechanism that promotes the autonomous and evolutionary
development of informal norms through market tests. Two tasks are urgently needed: to strike a
14

See Saito (2009) for a more detailed analysis.

17balance between the uniformity and quality of standards; and to find an optimal trade-off between
the comparability and usefulness of information by flexibly adjusting the definitions of concepts on
an ongoing basis to the outcome of the aforementioned processes.
This approach proposed here does not necessarily reject written rules, including a writtenconceptual framework. However, a conceptual framework is not a set of a priori normative rulesthat ultimately determine accounting standards. Instead, it should be a set of guiding principles for
codifying informal social norms that are shared by market participants into formal accounting rules
such as standards. Other guiding principles underlying the structure of the market economy may
also play a role in the codification of informal social norms into legal norms on the basis of thehistorical development of that structure. While the selection of guiding principles greatly influences
how standards turn out to be, the selection itself ultimately depends on social norms. It is not
guiding principles but social norms that determine laws and standards, while guiding principles
serve to mediate between informal social norms and formal standards.

Appendix: Economic Income and Variable Income
We can clarify the conceptual distinction between accounting and economic income if wekeep in mind that any capital valuation is based on a particular set of expectation which are always
changing, as shown in Table 1.
Table 1: Income ex ante and ex post
Capital value,

Capital value,

beginning of period

end of period

Valuation, beginning of period

0V0

0V1

0V1 -0V0: ex ante

Valuation, end of period

1V0

1V1

1V1 -1V0: ex post

Economic income

Suppose capital value V changes from 0V0 to 1V1 during the period. We also assume that
capital value at the beginning would be 1V0 based on expectations at the end, and that at the end
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would be 0V1 based on expectations at the beginning. Income ex post is defined as the difference
between capital value at the beginning of the period and that at the end based on expectations at theend, represented as (1V1 -1V0). Comprehensive income is roughly equal to (1V1-0V0), which is theactual difference between capital value at the beginning of the period and that at the end of theperiod, based on expectations of respective points in time. The difference between 1V0 and 0V0
represents windfalls. Capital value at the beginning of the period 1V0 is a hypothetical constructwith hindsight revaluated on the basis of facts that unfolded during the period and expectations heldat the end.
Although income ex ante may be an ideal concept for economic theory, accounting
information must be based on measurement with hypothetical hindsight. One of the noteworthy
attempts in formulating accounting income in contrast to economic income is Alexander (1950). In
his framework, assets are approximately divided into monetary items (cash and its equivalents) andnon-monetary items. The investment results from monetary items including windfalls are based on
ex-post valuation, while the valuation of non-monetary items is based on systematic amortization,
an ex-ante rather than ex-post concept.
Alexander tried to solve this apparent inconsistency with the help of economic income but
simultaneously avoid the hypothetical value 1V0 by regarding a firm as a bundle of independent
projects with finite investment periods: the investment results for the monetary and non-monetary
items are evaluated with (1V1-0V0) and (0V1-0V0) respectively, and added together. The total
amount is the once celebrated variable income concept.
In this approach, whereas ex-post changes in the value of monetary items are fully included
in income, unexpected changes (1V1 -0V1) in the value of non-monetary items are temporarily
excluded from income and become part of income in the period in which, and for the portion forwhich, cash flow is realized15. We can claim that this scheme is a logical consequence of the viewthat a company is a bundle of investment projects with the fact that income earned throughout the15

However, if the life of a project were infinite, capital appreciation (depreciation) due to the change ofinterest rates would never be recognized as income.

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entire life of a project equals net cash flow for the project on an ex post basis. While changes in thevalue of non-monetary items based on changes in expectations are excluded temporarily fromincome, variable income keeps them on the balance sheet and puts them back into income when
they are realized as monetary items (i.e., cash flow)16.
Although this concept was reconsidered by Solomons (1961), it seems to have beenforgotten again. While economic income itself can be directly applicable to accounting standards
on income information under very limited conditions (Beaver, 1981, Chap. 3; Christensen &Demski, 2003, Chap. 3), it clarifies what is desirable in the formulation of accounting income
concepts from an economic (theoretical) point of view. The author believes that the variable
income concept and others that approximate economic income under the constraint of the realworld deserve more attention if a systematic study on the usefulness of income information has any
merit.

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If aggregated over the entire investment period, a temporal difference between variable income and the“objective” concept of income ex post (Hicks did not differentiate ex post from ex ante concepts in case of his
objective ones) vanishes. The variable income concept is also consistent with release from the risk ofinvestment, the ASBJ’s guiding principle for income recognition.

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