Accounting Standards and Global Convergence Revisited:Social Norms and Economic Concepts*
S S†The Faculty of Economics
MEIJI GAKUIN UNIVERSITY

ABSTRACTe 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 on market practices. is trend, combined with the pursuit of a formal framework
not amenable to adjustment through feedback from market tests, has unavoidably brought
about a top-down approach. Under this approach, the uniformity of standards from theviewpoint 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 in capital markets, has been affected by a mechanicalapplication of the asset-liability approach and fair value measurement with scantattention 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 decide on
the direction and degree of convergence on an a priori basis.
JEL Classification: M40; M48
Key Words: Accounting Standards; Convergence; Social Norms;
Income Concepts; Asset-Liability Approach; Fair Value Measurement* e author is indebted to Shyam Sunder (Yale University), Yoshitaka Fukui (Aoyama Gakuin University), Karim Jamal (Universityof Alberta), Kees Camfferman (Free University of Amsterdam) and Stephen A. Zeff (Rice University) for their helpful comments
and suggestions. Any remaining faults are the author’s own.
† Corresponding Author. Address Meiji Gakuin University 1-2-37 Shirokanedai, Minato-ku, Tokyo JAPAN 108-8636
Telephone +81- 3-5421-5206 E-mail saito@eco.meijigakuin.ac.jp
Copyright©2011 Research Institute for Economics & Business Administration - Kobe University.

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1. Introduction
e task of this paper is to take a look at accounting standards on a global convergence pathanew, and address any problems underlying the process. Historically speaking, the main driving
force of accounting standards setting has changed from market participants, including accounting
professionals, to domestic governmental or private-sector regulatory bodies, and further tointernational standards setters. ese changes have been accompanied by changes in the ways inwhich accounting standards are to be set, from the bottom-up approach which emphasizes thecareful observation of market practices, to the top-down approach which strongly reflects theregulatory a priori perspective. e latter approach appears to have 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 a common
measure of value, just as diverse attributes of assets traded on markets which cannot be captured inprices are abstracted away. Nevertheless, the author believes that standards which force companies touniformly appraise their transactions and acquired resources based only on their superficial 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.
is belief alone makes it worthwhile for the author to reexamine the current standards from amarket-oriented perspective. Given that information disclosure relies on market discipline, it seems
appropriate to first pay careful attention to the autonomous function of markets in the developmentof norms.

2. Evolution of Accounting Standards and “Standards for Standards Setting”
2.1 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 used
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 inductively.1 is process led to the
GAAP (Generally Accepted Accounting Principles) concept, which finally won consensus from the
1920s to 1930s, when the modern accounting system was established in the United States.
e 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 Institute of Accountants(AIA), an association of accountants who were then gaining recognition as an established profession.
By the mid-1920s, a voluntary information disclosure system was in place that was centered on
the New York Stock Exchange. In 1934, the Securities and Exchange Commission (SEC), whose1

is stance is epitomized by May (1943) and Littleton (1953) in which we can clearly see the influence of classical U.S.
pragmatism, particularly the views on truth held by James (1907).

Saito: Accounting Standards and Global Convergence Revisited107

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
deferred to the private sector retaining its jurisdiction to develop standards, and, with the SEC’s
blessing, a committee that was set up in the AIA worked on the development of GAAP by compilingbest practices. is was the initial scheme for establishing standards 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 1960s.2 is approach favored the direct recognition/measurement of such visible andreal 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 rise to theConceptual 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 comparabilityof financial information, has become a stated goal. Although this integration drive at first camemainly 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 (asopposed 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 the European
standards setter, has moved forward with a top-down standardization initiative increasingly reliant
on formal definitions of concepts while competing with the FASB for the leadership in the global
unification of standards.
2.2 From Emerging Social Norms to Deductive Written Rules
e next question is how actual standards have changed over the course of the historic evolutionof “the standards for standards”. Early accounting standards, which tried to embody best practices,were basically a subset of social norms as defined by Posner (1974, 1997). ey more or less fit thedescription “shared expectations of members of society about the behavior of others”. e adoptionof the deductive normative approach has transformed such prototypical accounting standards fromsoft “social norms” into hard “written” rules (Sunder, 2005a, 2005b). As a result, the objectives offinancial statements, qualitative characteristics of accounting information, and definitions of elementsof 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 get along withthe view that their usefulness should be judged from the actual outcomes brought about by theirapplication of basic ideas. is trial-and-error process dovetails with informal norms, especially thosecalled “best 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, theirpremises 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 to2

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).

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be disappointing.
In recent times, however, this once flexible system has become more and more rigid turning intoa regime that ordains standards mechanically derived from an unproven preconceived conceptual
framework. is trend has been strongly influenced by the global convergence movement as wellas various factors that have brought about the aforementioned change from informal social norms
to formal normative standards. is change has occurred partly because the review of proposed
rules based on market tests, though relatively easy within a single country, is far more difficult once
adopted across borders. e territorial monopoly enjoyed by a national standards setter and the global
monopoly enjoyed by an international standards setter have completely different influence over theprocess 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 this sense,
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
3.1 ree Key Concepts
As discussed in the preceding section, the move toward global convergence has played aprominent role in changing the character of accounting standards. ree key concepts are crucial inunderstanding the process.
e 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?
e second key concept is the asset-liability approach of accounting measurement. isapproach 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.
e former issue is which of the two, assets and liabilities or revenues and expenses, should haveprimacy 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. is is an asset-liability approach in terms of conceptual definition.
e latter issue is which should have primacy in valuation. If stock information is thought to be
more useful than flow information, we should choose an asset-liability approach in terms of valuation.

Saito: Accounting Standards and Global Convergence Revisited109

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.
e 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 and pseudomarket value. Under the fair value rule, we should evaluate stock or assets and liabilities in terms ofpresent value rather than initial acquisition cost and disclose accordingly. Moreover, this requirement
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 information is also useful
in appraising corporate value as a whole. However, no consensus has yet to be reached concerning
such critical questions as: to what extent fair value represents the value of the firms in its entirety
as well as each stock item; how useful the change in fair value of assets and liabilities as income
information is.
3.2 Single Set of High-Quality Standards: Compatibility of Two Requirements
e first question is whether uniformity (culminated into a single set) and high-quality
are mutually 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. e quality of standards in terms of information usefulness,
however, directly depends upon how accurately disclosed information can convey the actual 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 by eliminating biases inducedby these systems as much as possible. If national accounting standards are unified but countryspecific institutional systems which are potential sources of several biases are left unchanged, an
improvement in the quality or usefulness of information cannot be a foregone conclusion. On thecontrary, uniformity and high quality are not likely to be fully compatible.3
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 isolationa 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. is parable showsthat no one knows beforehand the optimum unification level of standards. It can only be determinedin an incentive compatible manner through market transactions, which, at the same time, will set an
optimum path toward the unification of standards.4
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 automatically lead to the unification of practices, while the latter
is more important than the former from an investor’s point of view. In order to evaluate the degree of unification of practices, wehave to keep in mind that even the same accounting standards are interpreted in the context of their application to actual corporate
behavior and, as such, 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).
3

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ere 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. e 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.
e model itself is not fixed, and should continue to evolve into a better one by incorporating
the best part of national standards through competition between different sets of institutional
systems. is process will further promote institutional reforms in individual countries. Ideally,
convergence processes should follow this scenario to simultaneously achieve the homogenization andimprovement of standards. It is this market-oriented approach that will realize convergence in thetrue sense of the word through competitive institutional reforms in each country and a consequent
bottom-up global unification.5
3.3 Asset-Liability Approach: Relationship with Income Recognition
e clean surplus relationship is a fundamental constraint in accounting, measurement requiringthat the change in equity (net assets) be equal to income if no capital transactions with shareholders
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.
e 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. us the essence of accounting measurement toallocate cash flow based on either the valuation of assets and liabilities or the recognition of revenues
and expenses. Although the term “allocate” is no longer in vogue among accountants, it is at theheart of the matter: the relationship between assets and liabilities on the one hand and revenues andexpenses on the other.
In the asset-liability approach, assets and liabilities as visible and concrete concepts are used todefine revenues and expenses as invisible and abstract concepts. erefore cash flow is intertemporally
allocated according to the recognition and measurement of (change of ) stock items on the balance
sheet. While it is not appropriate to discuss the pros and cons of this method, the important point
is how accurately the total value of assets (minus liabilities) determined in this manner can track the
corporate value in its entirety. As long as the core competence of a firm is inseparable from its offbalance-sheet “goodwill” (e.g., its human resources), there is no guarantee that the aggregate value ofindividual 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 basedon the asset-liability approach is of limited use for investor decision making.
e 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 not unreasonable
to expect an information disclosure system to provide information users with present (and past)5

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

Saito: Accounting Standards and Global Convergence Revisited111

income (stream) and leave the rest for them to work out. ere is no income without changes in
assets and liabilities. However, whether they alone determine an income concept which is useful forthe valuation of a firm is another matter. Being a necessary condition does not guarantee sufficiency
for income recognition.6
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 is aneed 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 thebottom 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 they cannot
be included in net income but constitute “other comprehensive income (OCI)”. While windfall
gains are excluded from income as an economic concept to be discussed later, they need to betransferred (recycled) to net income in corporate accounting, which allocates cash flow associatedwith investment projects intertemporally, when they satisfy the requirements for inclusion into net
income.7 e problem lies with what condition should be met to transfer items such as windfall gains
from OCI to net income. e Accounting Standards Board of Japan (ASBJ) has proposed release fromthe 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, theysatisfy the condition for inclusion in net income once there no longer exists any substantial risk.
3.4 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. is pseudo-market
price is a construct made on the basis of average market expectations rather than the firm’s own
estimation of value in use or the discounted value of future financial results to be realized throughthe use of the asset. e issue is to what extent fair value (as understood in this sense) should beapplied to both asset valuation and income recognition. So far, while the IASB sticks to the principlethat calls for the full application of fair value to financial instruments, it has actually proposed andset standards falling short of full application. In this regard, the IASB does not seem to be muchconcerned about a systematic investigation of its principle.8
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
In a word, the asset-liability approach defines income (revenues and expenses) from assets and liabilities rather than assets andliabilities from income.
7
is is because the total income generated from an investment project over its entire period is equal to the total 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 and liabilities whose fair value (changes) has a one-to-one
correspondence to stock price (changes) of the firm. Dichev (2007) expresses the similar view.
6

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characterized by the existence of a liquid market and the freedom of the firm over their liquidation
without being constrained by its business purposes. Because liquidation at exit price is the only way
to achieve financial results from their possession, the only relevant criterion of financial instruments
is exit price not specific to the firm which holds them. e application of fair value accounting tothose kinds of investments is consistent with the ASBJ’s risk-release concept mentioned above. If afinancial 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 of investment 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 the investment
is not released from risk until its cash flow is finalized, regardless of its current market value. It is truethat a fair value measurement of financial investments is more desirable than not, but the change invalue of business investments, even if recognized on the balance sheet, is better excluded from net
income and relegated to OCI as a windfall until the investment results are finalized. e usefulness of
net income information has been confirmed by numerous empirical studies.9 Although International
Financial Reporting Standard (IFRS) No. 9 of 2010 has not abolished net income as a concept, thecriteria 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
relationship between income and net assets on the balance sheet. However, if part of comprehensive
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 the conceptual framework defines
shareholders’ equity, which satisfies the clean surplus relationship with net income, as part of net
assets (therefore shareholders’ equity is not equal to net assets in Japan). Because the recycle of OCI
is a necessary condition for the recovered clean surplus, the information value of net income may
be lost if recycling is not allowed. Although the IASB failed to abolish net income, it seems to havesucceeded in rendering it meaningless.

4. Usefulness of Information: Comprehensive Income and Net Income
4.1 Quantitative Analysis: Empirical Test of Usefulness
e 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 by empiricalstudies (Wakabayashi, 2010). While OCI, when disclosed in addition to net income, may be creditedwith 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 the soleincome concept? Some researchers try to answer this question by reconstructing comprehensive
income from accounting data obtained under the current standards. However, we have only stock
9

See Wakabayashi (2010) for a comprehensive up-to-date survey of U.S. empirical studies and her own research using Japanesedata.

Saito: Accounting Standards and Global Convergence Revisited113

price data obtained under the current regime which requires the disclosure of net income. In orderto answer the posed question, we would need data obtained under a hypothetical no-net-income
regime, which does not exist by definition. is methodological criticism is in line with a well-known
argument (Lucas critique): because a policy or institutional change has the potential to alter people’s
expectations and behavior by affecting their incentives, a model consisting of parameters estimatedon past data under the old regime cannot be used to evaluate its impact. erefore, the validityof the argument for the comprehensive-income-only regime based on 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 andbehavior including implicit as well as explicit contracts and customs.
e discussion brings about an even more important issue. As has been widely pointed out, thistype 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 is established between
income number and stock price, it may be possible to “explain” stock price behavior by recognizing a“risk” of the company due to changes in its income and comparing it with 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 anempirical 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.
4.2 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 and others, hasbeen a focus of attention,10 and used to justify a specific set of standards. Recently, a joint projectof the FASB and IASB has released a document that seeks a theoretical basis of the 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 to arrive at an appropriate
concept of income. In the context of the current argument, this income can be 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. erefore, 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 isintertemporally 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). erefore capital value increases if an expected future revenue stream is1011

In addition to Hicks (1946), important contributions include Fisher (1906, 1930), Lindahl (1933) and Kaldor (1955).
See Bromwich et al. (2010) for a theoretical critique of the joint project.

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revised 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 as measured in terms of
the potential for consumption, could not be maintained.12
e unexpected difference in capital value between the beginning and the end of the period cangive rise to two different income concepts depending on which point is used as reference. If capitalvalues 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 measured on
the basis of expectations held at the end of the period, it will be defined as income ex post. 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 that the informationthat became available at the end of the period would have been available at the beginning of theperiod was not a major concern for Hicks. is is likely to be the reason why his income ex postconcept is not adjusted for windfalls.
e 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 foreconomic income is his income No. 2 ex ante.13 However, accounting information is based on expost measurement. e 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 formationof 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 tobe the most appropriate concept for accounting measurement regardless of Hicks’s indifference to expost 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. erefore an
approximate concept of income ex post that corresponds to Hicks’s income No. 2 ex ante is a powerfulweapon to examine measurement rules. is ex-post concept enables us to propose what kind of
accounting information is useful conceptually and to designate areas where empirical studies are mostinformative.
Moreover, it exactly matches the ASBJ’s main concept of investment results released from risk.
Based on this concept, the ASBJ has proposed separate measurement rules for business investments,
which is made for achieving business results specific to the company concerned, and for financial
investments, which is made for achieving capital gains through arm’s-length market transactions.
erefore unrealized windfalls must be relegated to OCI but recycled into net income once gains orlosses are realized.14

See the implication of unexpected changes for Hicks (1946, pp.184-185) and Fisher (1906, pp.287-288).
It means that in the real world where future expectations are constantly changing and the term structure of interest rates is notflat, 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, be claimed to support the approach. See Fukui (2011) for a detailed
analysis.
14
See Saito (2009) for a more detailed analysis.
1213Saito: Accounting Standards and Global Convergence Revisited115

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. e ongoing global standards development process lacks an adequate feedback
mechanism to incorporate the results of usefulness tests into basic concepts and overemphasizes
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 abalance 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.
is 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 tomediate 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.

116

e Japanese Accounting Review, 1 (2011), 105-117

T 1: I EX ANTE  EX POST
Capital value, beginningof period

Capital value, end of
periodEconomic income

Valuation, beginning of period

0

V0

0

V1

0

V1– 0V0 : ex ante

Valuation, end of period

1

V0

1

V1

1

V1 – 1V0 : ex post

Suppose capital value V changes from 0V0 to 1V1 during the period. We also assume that capitalvalue at the beginning would be 1V0 based on expectations at the end, and that at the end would be
0V1 based on expectations at the beginning. Income ex post is defined as the difference between capitalvalue at the beginning of the period and that at the end based on expectations at the end, represented
as (1V1 – 1V0). Comprehensive income is roughly equal to (1V1 – 0V0), which is the actual difference
between capital value at the beginning of the period and that at the end of the period, based on
expectations of respective points in time. e difference between 1V0 and 0V0 represents windfalls.
Capital value at the beginning of the period 1V0 is a hypothetical construct with hindsight revaluatedon the basis of facts that unfolded during the period and expectations held at the end.
Although income ex ante may be an ideal concept for economic theory, accounting informationmust 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) and nonmonetary items. e 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. e total amountis the once celebrated variable income concept.
In this approach, whereas ex-post changes in the value of monetary items are fully included inincome, 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 for which, cash
flow is realized.15 We can claim that this scheme is a logical consequence of the view that a company
is a bundle of investment projects with the fact that income earned throughout the entire life of a
project equals net cash flow for the project on an ex post basis. While changes in the value of nonmonetary items based on changes in expectations are excluded temporarily from income, variable
income keeps them on the balance sheet and puts them back into income when they are realized asmonetary items (i.e., cash flow).16
Although this concept was reconsidered by Solomons (1961), it seems to have been forgotten
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
However, if the life of a project were infinite, capital appreciation (depreciation) due to the change of interest rates would never berecognized as income.
16
If aggregated over the entire investment period, a temporal difference between variable income and the “objective” concept ofincome ex post (Hicks did not differentiate ex post from ex ante concepts in case of his objective ones) vanishes. e variable
income concept is also consistent with release from the risk of investment, the ASBJ’s guiding principle for income recognition.
15

Saito: Accounting Standards and Global Convergence Revisited117

economic (theoretical) point of view. e author believes that the variable income concept and others
that approximate economic income under the constraint of the real world deserve more attention if asystematic study on the usefulness of income information has any merit.

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