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Author(s): Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield
ISBN(s): 9780471072089, 0471072087
Edition: 11
File Details: PDF, 76.20 MB
Year: 2004
Language: english

1
Financial Accounting
and Accounting Standards
LEARNING
OBJECTIVES
After studying this chapter, you
should be able to:
Identify the major financial
statements and other
means of financial
reporting.
Explain how accounting
assists in the efficient use
of scarce resources.
Identify some of the
challenges facing
accounting.
Identify the objectives of
financial reporting.
Explain the need for
accounting standards.
Identify the major policy-
setting bodies and their
role in the standards-
setting process.
Explain the meaning of
generally accepted
accounting principles.
Describe the impact of
user groups on the
standards-setting process.
Understand issues related
to ethics and financial
accounting.
The Size of the New York City Phone Book . . .
Enron, Global Crossing, Kmart, WorldCom, Williams Co., and Xerox are
examples of companies that have come under the scrutiny of the Securities
and Exchange Commission recently because of accounting issues. Share
prices of all these companies have declined substantially, as investors punish
any company whose quality of earnings is in doubt.
The unfortunate part of accounting scandals is that we all pay. Enron, for
example, at one time had a market capitalization of $80 billion before
disclosure of its accounting irregularities. Today it is bankrupt. Employees
have lost their pension money, investors have lost their savings, and the entire
stock market has become caught up in “Enronitis,” which has led to
substantial declines in the overall stock market. At one point, there were at
least 10 congressional committees involved in inquiries regarding corporate
governance issues, and over 30 Enron-related bills have addressed matters
such as regulation of derivative securities, auditor-client conflicts, and
development of an oversight body to regulate the accounting profession.
As a result of the many concerns expressed by investors about the
completeness and the reliability of the accounting numbers, many companies
have expanded their financial disclosures in their annual reports. For
example, General Electric’s CEO Jeffery Immelt stated, “I want people to think
about GE as we think of GE—as a transparent company.” He noted that GE’s
annual report will be “the size of New York City’s phone book, if necessary”
to provide the information necessary to help investors and creditors make the
proper investing decisions.
It is our hope that meaningful reform will come out of these recent
investigations into sloppy or fraudulent accounting. Although the U.S. is still
considered to have the finest reporting system in the world, we must do better.
As former chair of the FASB Ed Jenkins recently remarked, “If anything
positive results . . . it may be that [these accounting issues] serve as an
indelible reminder to all that transparent financial reporting does matter and
that lack of transparency imposes significant costs on all who participate [in
our markets].”
C H A P T E R
1
C H A P T E R
1

As the opening story indicates, relevant and reliable financial information must be pro-
vided so that our capital markets work efficiently. This chapter explains the environment
of financial reporting and the many factors affecting it. The content and organization
of this chapter are as follows.
PREVIEW OF CHAPTER 1
FINANCIAL ACCOUNTING AND
ACCOUNTING STANDARDS
Financial Statements
and Financial
Reporting
Parties Involved
in Standards Setting
Generally Accepted
Accounting Principles
Issues in
Financial Reporting
Accounting and
capital allocation
Challenges
Objectives
Need to develop
standards
Securities and
Exchange
Commission
American Institute
of CPAs
Financial
Accounting
Standards Board
Governmental
Accounting
Standards Board
The Role of
the AICPA
Political
environment
Expectations gap
International
accounting
standards
Ethics
FINANCIAL STATEMENTS AND FINANCIAL REPORTING
The essential characteristics of accounting are: (1) identification, measurement, and
communication of financial information about (2) economic entities to (3) interested
parties. Financial accounting is the process that culminates in the preparation of fi-
nancial reports on the enterprise as a whole for use by both internal and external par-
ties. Users of these financial reports include investors, creditors, managers, unions, and
government agencies. In contrast, managerial accounting is the process of identifying,
measuring, analyzing, and communicating financial information needed by manage-
ment to plan, evaluate, and control an organization’s operations.
Financial statements are the principal means through which financial information
is communicated to those outside an enterprise. These statements provide the com-
pany’s history quantified in money terms. The financial statements most frequently
provided are (1) the balance sheet, (2) the income statement, (3) the statement of cash
flows, and (4) the statement of owners’ or stockholders’ equity. In addition, note dis-
closures are an integral part of each financial statement.
Some financial information is better provided, or can be provided only, by means
of financial reporting other than formal financial statements. Examples include the
president’s letter or supplementary schedules in the corporate annual report, prospec-
tuses, reports filed with government agencies, news releases, management’s forecasts,
and certifications regarding internal controls and fraud. Such information may be re-
quired by authoritative pronouncement, regulatory rule, or custom. Or it may be sup-
plied because management wishes to disclose it voluntarily.
The primary focus of this textbook concerns the development of two types of fi-
nancial information: (1) the basic financial statements and (2) related disclosures.
2
OBJECTIVE
Identify the major
financial statements
and other means of
financial reporting.

Financial Statements and Financial Reporting • 3
Accounting and Capital Allocation
Because resources are limited, people try to conserve them, to use them effectively, and
to identify and encourage those who can make efficient use of them. Through an effi-
cient use of resources, our standard of living increases.
Markets, free enterprise, and competition determine whether a business is to be
successful and thrive. This fact places a substantial burden on the accounting profes-
sion to measure performance accurately and fairly on a timely basis, so that the right
managers and companies are able to attract investment capital. For example, relevant
and reliable financial information enables investors and creditors to compare the in-
come and assets employed by such companies as IBM, McDonald’s, Microsoft, and
Ford. As a result, they can assess the relative return and risks associated with invest-
ment opportunities and so channel resources more effectively. This process of capital
allocation works as follows.
The financial information
a company provides to
help users with capital
allocation decisions about
the company.
Investors and creditors
use financial reports to
make their capital
allocation decisions.
Users
(present and potential)
The process of
determining how and at
what cost money is
allocated among
competing interests.
Financial Reporting Capital Allocation
ILLUSTRATION 1-1
Capital Allocation
Process
An effective process of capital allocation is critical to a healthy economy. It pro-
motes productivity, encourages innovation, and provides an efficient and liquid mar-
ket for buying and selling securities and obtaining and granting credit.1
As indicated
in our opening story, unreliable and irrelevant information leads to poor capital allo-
cation, which adversely affects the securities markets.
It’s not the economy, anymore, stupid
It’s not the economy anymore. It’s the accounting. That’s what many investors seem to
be saying these days. As indicated in our opening story, even the slightest hint of any
type of accounting irregularity at a company leads to a subsequent pounding of the
company’s stock. For example, a recent Wall Street Journal had the following headlines
related to accounting and its effects on the economy.
Stocks take a beating as accounting worries spread beyond Enron
Williams Cos. delays earnings release to review a unit’s obligations
Global Crossing’s accounting method now being called aggressive
Bank stocks fall as investors take issue with PNC’s accounting
Investors, skeptical of Tyco’s breakup plan, send shares down 20%
It now has become clear that there must be trust in the numbers or investors will
abandon the market and put their resources elsewhere. That is why overseas investors
are pulling their money out of the U.S. market and why the dollar is dropping relative
to other currencies. With investor uncertainty, the cost of capital increases for compa-
nies who need additional resources. In short, relevant and reliable financial information
is necessary for markets to be efficient.
What do the
numbers mean?
1
AICPA Special Committee on Financial Reporting, “Improving Business Reporting — A
Customer Focus,” Journal of Accountancy, Supplement (October 1994).
OBJECTIVE
Explain how accounting
assists in the efficient
use of scarce
resources.

The Challenges Facing Financial Accounting
Although there is a crisis of confidence regarding corporate governance issues, of which
one is proper accounting, much is right about financial reporting in the United States.
The U.S. markets are still the most liquid, deep, secure, and efficient public capital mar-
kets of any country. One reason for this success is that our financial statements and re-
lated disclosures have captured and organized financial information in a useful and re-
liable fashion. However, much still needs to be done. For example, suppose you could
move to the year 2020 and look back at financial reporting today. Here is what you
might read:
• Non-financial Measurements. Financial reports failed to provide some key per-
formance measures widely used by management. For example, nonfinancial meas-
ures such as customer satisfaction indexes, backlog information, and reject rates on
goods purchased, all now used to evaluate the long-term stability of the company,
were provided on an ad hoc basis, if at all.
• Forward-looking Information. Financial reports failed to provide forward-looking
information needed by present and potential investors and creditors. One individ-
ual noted that financial statements in 2000 should have started with the phrase,
“Once upon a time,” to signify their use of historical cost and their accumulation
of past events.
• Soft Assets. Financial reports focused on hard assets (inventory, plant assets) but
failed to provide much information on a company’s soft assets (intangibles). For
example, often the best assets are intangible, such as Microsoft’s know-how and
market dominance, Dell’s unique marketing setup and well-trained employees,
and J.Crew’s brand image.
• Timeliness. Financial statements were prepared only quarterly, and audited fi-
nancials were provided annually. Little to no real-time financial statement infor-
mation was available.
We believe each of these challenges must be met for the accounting profession to
continue to provide the type of information needed for an efficient capital allocation
process. We are confident that changes will occur. Here are some positive signs:
• Already some companies are making voluntary disclosures on information deemed
relevant to investors. Often such information is of a non-financial nature. Regional
banking companies, like BankOne Corp., Fifth Third Bancorp, Sun Trust Banks,
and others, for example, now include, in addition to traditional financial informa-
tion, data on loan growth, credit quality, fee income, operating efficiency, capital
management, and management strategy.
• The World Wide Web was first used to provide limited financial data. Now most
companies offer their annual reports in several formats on the Web. The most in-
novative companies are now offering sections of their annual reports in a format
that can be readily manipulated by the user, such as in an Excel spreadsheet
format.
• More accounting standards are now requiring the recording or disclosing of fair
value information. For example, either investments in stocks and bonds, debt ob-
ligations, and derivatives are recorded at fair value, or information related to fair
values is shown in the notes to the financial statements.
Changes in these directions will enhance the relevance of financial reporting and
provide useful information to users of the financial statements.
Objectives of Financial Reporting
In an attempt to establish a foundation for financial accounting and reporting, a set of
objectives of financial reporting by business enterprises has been identified. Finan-
cial reporting should provide information that:
4 • Chapter 1 Financial Accounting and Accounting Standards
OBJECTIVE
Identify some of the
challenges facing
accounting.
OBJECTIVE
Identify the objectives
of financial reporting.
International
Insight
The objectives of financial re-
porting differ across nations.
Traditionally, the primary objec-
tive of accounting in many con-
tinental European nations and
in Japan was conformity with
the law. In contrast, Canada,
the U.K., the Netherlands, and
many other nations have
shared the U.S. view that the
primary objective is to provide
information for investors. In-
sights into international stan-
dards and practices will be pre-
sented throughout the text.

Is useful to present and potential investors and creditors and other users in mak-
ing rational investment, credit, and similar decisions. The information should be
comprehensible to those who have a reasonable understanding of business and eco-
nomic activities and are willing to study the information with reasonable diligence.
Helps present and potential investors, creditors, and other users assess the
amounts, timing, and uncertainty of prospective cash receipts from dividends or
interest and the proceeds from the sale, redemption, or maturity of securities or
loans. Since investors’ and creditors’ cash flows are related to enterprise cash flows,
financial reporting should provide information to help investors, creditors, and oth-
ers assess the amounts, timing, and uncertainty of prospective net cash inflows to
the related enterprise.
Clearly portrays the economic resources of an enterprise, the claims to those re-
sources (obligations of the enterprise to transfer resources to other entities and own-
ers’ equity), and the effects of transactions, events, and circumstances that change
its resources and claims to those resources.2
In brief, the objectives of financial reporting are to provide (1) information that is use-
ful in investment and credit decisions, (2) information that is useful in assessing cash
flow prospects, and (3) information about enterprise resources, claims to those re-
sources, and changes in them.
The emphasis on “assessing cash flow prospects” might lead one to suppose that
the cash basis is preferred over the accrual basis of accounting. That is not the case. In-
formation based on accrual accounting generally provides a better indication of an
enterprise’s present and continuing ability to generate favorable cash flows than does
information limited to the financial effects of cash receipts and payments.3
Recall from your first accounting course that the objective of accrual basis ac-
counting is to ensure that events that change an entity’s financial statements are
recorded in the periods in which the events occur, rather than only in the periods in
which the entity receives or pays cash. Using the accrual basis to determine net income
means recognizing revenues when earned rather than when cash is received, and rec-
ognizing expenses when incurred rather than when paid. Under accrual accounting,
revenues, for the most part, are recognized when sales are made so they can be related
to the economic environment of the period in which they occurred. Over the long run,
trends in revenues are generally more meaningful than trends in cash receipts.
The Need to Develop Standards
The main controversy in setting accounting standards is, “Whose rules should we play
by, and what should they be?” The answer is not immediately clear because the users
of financial accounting statements have both coinciding and conflicting needs for in-
formation of various types. To meet these needs, and to satisfy the fiduciary4
report-
ing responsibility of management, a single set of general-purpose financial statements
is prepared. These statements are expected to present fairly, clearly, and completely the
financial operations of the enterprise.
As a result, the accounting profession has attempted to develop a set of standards
that are generally accepted and universally practiced. Without these standards, each
Financial Statements and Financial Reporting • 5
2
“Objectives of Financial Reporting by Business Enterprises,” Statement of Financial Ac-
counting Concepts No. 1 (Stamford, Conn.: FASB, November 1978), pars. 5–8.
3
SFAC No. 1, p. iv. As used here, cash flow means “cash generated and used in operations.”
The term cash flows is frequently used also to include cash obtained by borrowing and used to
repay borrowing, cash used for investments in resources and obtained from the disposal of in-
vestments, and cash contributed by or distributed to owners.
4
Management’s responsibility to manage assets with care and trust is its fiduciary respon-
sibility.
OBJECTIVE
Explain the need for

enterprise would have to develop its own standards, and readers of financial state-
ments would have to familiarize themselves with every company’s peculiar account-
ing and reporting practices. It would be almost impossible to prepare statements that
could be compared.
This common set of standards and procedures is called generally accepted ac-
counting principles (GAAP). The term “generally accepted” means either that an au-
thoritative accounting rule-making body has established a principle of reporting in a
given area or that over time a given practice has been accepted as appropriate because
of its universal application.5
Although principles and practices have provoked both de-
bate and criticism, most members of the financial community recognize them as the
standards that over time have proven to be most useful. A more extensive discussion
of what constitutes GAAP is presented later in this chapter.
PARTIES INVOLVED IN STANDARDS SETTING
A number of organizations are instrumental in the development of financial account-
ing standards (GAAP) in the United States. Four major organizations are as follows.
Securities and Exchange Commission (SEC)
American Institute of Certified Public Accountants (AICPA)
Financial Accounting Standards Board (FASB)
Governmental Accounting Standards Board (GASB)
Securities and Exchange Commission (SEC)
External financial reporting and auditing developed and evolved in tandem with the
growth of America’s industrial economy and its capital markets. However, when the
stock market crashed in 1929 and the nation’s economy plunged into the Great De-
pression, there were calls for increased government regulation and supervision of busi-
ness generally and especially financial institutions and the stock market.
As a result, the federal government established the Securities and Exchange Com-
mission (SEC) to help develop and standardize financial information presented to
stockholders. The SEC is a federal agency. It administers the Securities Exchange Act
of 1934 and several other acts. Most companies that issue securities to the public or are
listed on a stock exchange are required to file audited financial statements with the
SEC. In addition, the SEC has broad powers to prescribe, in whatever detail it desires,
the accounting practices and standards to be employed by companies that fall within
its jurisdiction. As a result, the SEC exercises oversight over 12,000 companies that are
listed on the major exchanges (such as the New York Stock Exchange and Nasdaq).
Public/Private Partnership
At the time the SEC was created, no group—public or private—was issuing account-
ing standards. The SEC encouraged the creation of a private standards-setting body be-
cause it believed that the private sector had the resources and talent to develop ap-
propriate accounting standards. As a result, accounting standards have generally
developed in the private sector either through the American Institute of Certified Pub-
lic Accountants (AICPA) or the Financial Accounting Standards Board (FASB).
The SEC has affirmed its support for the FASB by indicating that financial state-
ments conforming to standards set by the FASB will be presumed to have substantial
authoritative support. In short, the SEC requires registrants to adhere to GAAP. In
addition, it has indicated in its reports to Congress that “it continues to believe that the
5
The terms principles and standards are used interchangeably in practice and throughout
this textbook.
OBJECTIVE
Identify the major
policy-setting bodies
and their role in the
standards-setting
process.
International
Insight
The International Organization
of Securities Commissions
(IOSCO) is a group of more
than 100 securities regulatory
agencies or securities ex-
changes from all over the
world. IOSCO was established
in 1987. Collectively, its mem-
bers represent a substantial
proportion of the world’s capital
markets. The SEC is a member
of IOSCO.

initiative for establishing and improving accounting standards should remain in the
private sector, subject to Commission oversight.”
SEC Oversight
The SEC’s partnership with the private sector has worked well. The SEC has acted with
remarkable restraint in the area of developing accounting standards. Generally, the SEC
has relied on the AICPA and FASB to regulate the accounting profession and de-
velop and enforce accounting standards.
Over its history, however, the SEC’s involvement in the development of account-
ing standards has varied. In some cases the private sector has attempted to establish a
standard, but the SEC has refused to accept it. In other cases the SEC has prodded the
private sector into taking quicker action on certain reporting problems, such as ac-
counting for investments in debt and equity securities and the reporting of derivative
instruments. In still other situations the SEC communicates problems to the FASB, re-
sponds to FASB exposure drafts, and provides the FASB with counsel and advice upon
request.
The SEC has the mandate to establish accounting principles. The private sector,
therefore, must listen carefully to the views of the SEC. In some sense the private sec-
tor is the formulator and the implementor of the standards.6
While the partnership be-
tween the SEC and the private sector has worked well, it can be strained when ac-
counting problems are not addressed as quickly as the SEC would like. This was
apparent in the recent deliberations on the accounting for business combinations and
intangible assets and concerns over the accounting for special-purpose entities, high-
lighted in the failure of Enron.
Enforcement
As indicated earlier, companies listed on a stock exchange are required to submit their
financial statements to the SEC. If the SEC believes that an accounting or disclosure ir-
regularity exists regarding the form or content of the financial statements, it sends a
deficiency letter to the company. Usually these deficiency letters are resolved quickly.
However, if disagreement continues, the SEC has the power to issue a “stop order,”
which prevents the registrant from issuing securities or trading securities on the ex-
changes. Criminal charges may also be brought by the Department of Justice for vio-
lations of certain laws. The SEC program, private sector initiatives, and civil and crim-
inal litigation help to ensure the integrity of financial reporting for public companies.
American Institute of Certified Public Accountants (AICPA)
As indicated earlier, the American Institute of Certified Public Accountants (AICPA),
which is the national professional organization of practicing Certified Public Accoun-
tants (CPAs), has been vital to the development of GAAP. Various committees and
boards established since the founding of the AICPA have contributed to this effort.
Committee on Accounting Procedure
At the urging of the SEC, the AICPA appointed the Committee on Accounting Proce-
dure in 1939. The Committee on Accounting Procedure (CAP), composed of practic-
ing CPAs, issued 51 Accounting Research Bulletins during the years 1939 to 1959. (See
Parties Involved in Standards Setting • 7
6
One writer has described the relationship of the FASB and SEC and the development of fi-
nancial reporting standards using the analogy of a pearl. The pearl (financial reporting standard)
“is formed by the reaction of certain oysters (FASB) to an irritant (the SEC)—usually a grain of
sand—that becomes embedded inside the shell. The oyster coats this grain with layers of nacre,
and ultimately a pearl is formed. The pearl is a joint result of the irritant (SEC) and oyster (FASB);
without both, it cannot be created.” John C. Burton, “Government Regulation of Accounting and
Information,” Journal of Accountancy (June 1982).
International
Insight
Nations also differ in the de-
gree to which they have devel-
oped national standards and
consistent accounting practices.
One indicator of the level of a
nation’s accounting is the na-
ture of the accounting profes-
sion within the country. Profes-
sional accounting bodies were
established in the Netherlands,
the U.K., Canada, and the U.S.
in the nineteenth century. In
contrast, public accountancy
bodies were established in
Hong Kong and Korea only in
the last half century.

list at the back of the book.) These bulletins deal with a variety of accounting prob-
lems. But this problem-by-problem approach failed to provide the structured body of
accounting principles that was both needed and desired. In response, in 1959 the AICPA
created the Accounting Principles Board.
Accounting Principles Board
The major purposes of the Accounting Principles Board (APB) were (1) to advance the
written expression of accounting principles, (2) to determine appropriate practices, and
(3) to narrow the areas of difference and inconsistency in practice. To achieve these ob-
jectives, the APB’s mission was to develop an overall conceptual framework to assist
in the resolution of problems as they become evident and to do substantive research
on individual issues before pronouncements were issued.
The Board’s 18 to 21 members, selected primarily from public accounting, also in-
cluded representatives from industry and the academic community. The Board’s offi-
cial pronouncements, called APB Opinions, were intended to be based mainly on re-
search studies and be supported by reasons and analysis. Between its inception in 1959
and its dissolution in 1973, the APB issued 31 opinions. (See complete list at the back
of the book.)
Unfortunately, the APB came under fire early, charged with lack of productivity
and failing to act promptly to correct alleged accounting abuses. Later the APB tack-
led numerous thorny accounting issues, only to meet a buzz saw of opposition from
industry and CPA firms and occasional governmental interference. In 1971 the ac-
counting profession’s leaders, anxious to avoid governmental rule-making, appointed
a Study Group on Establishment of Accounting Principles. Commonly known as the
Wheat Committee for its chair Francis Wheat, this group was to examine the organi-
zation and operation of the APB and determine what changes would be necessary to
attain better results. The Study Group’s recommendations were submitted to the AICPA
Council in the spring of 1972, adopted in total, and implemented by early 1973.
Financial Accounting Standards Board (FASB)
The Wheat Committee’s recommendations resulted in the demise of the APB and the
creation of a new standards-setting structure composed of three organizations—the Fi-
nancial Accounting Foundation (FAF), the Financial Accounting Standards Board
(FASB), and the Financial Accounting Standards Advisory Council (FASAC). The Fi-
nancial Accounting Foundation selects the members of the FASB and the Advisory
Council, funds their activities, and generally oversees the FASB’s activities.
The major operating organization in this three-part structure is the Financial Ac-
counting Standards Board (FASB). Its mission is to establish and improve standards
of financial accounting and reporting for the guidance and education of the public,
which includes issuers, auditors, and users of financial information. The expectations
of success and support for the new FASB were based upon several significant differ-
ences between it and its predecessor, the APB:
Smaller Membership. The FASB is composed of seven members, replacing the rel-
atively large 18-member APB.
Full-time, Remunerated Membership. FASB members are well-paid, full-time
members appointed for renewable 5-year terms. The APB members were unpaid
and part-time.
Greater Autonomy. The APB was a senior committee of the AICPA, whereas the
FASB is not an organ of any single professional organization. It is appointed by
and answerable only to the Financial Accounting Foundation.
Increased Independence. APB members retained their private positions with firms,
companies, or institutions. FASB members must sever all such ties.
Broader Representation. All APB members were required to be CPAs and mem-
bers of the AICPA. Currently, it is not necessary to be a CPA to be a member of the
FASB.
International
Insight
The U.S. legal system is based
on English common law,
whereby the government gener-
ally allows professionals to
make the rules. These rules
(standards) are therefore devel-
oped in the private sector. Con-
versely, some countries follow
codified law, which leads to
government-run accounting
systems.

In addition to research help from its own staff, the FASB relies on the expertise of
various task force groups formed for various projects and on the Financial Account-
ing Standards Advisory Council (FASAC). FASAC consults with the FASB on major
policy and technical issues and also helps select task force members.
Due Process
In establishing financial accounting standards, two basic premises of the FASB are:
(1) The FASB should be responsive to the needs and viewpoints of the entire economic
community, not just the public accounting profession. (2) It should operate in full view
of the public through a “due process” system that gives interested persons ample op-
portunity to make their views known. To ensure the achievement of these goals, the
steps shown in Illustration 1-2 are taken in the evolution of a typical FASB Statement
of Financial Accounting Standards.
•Business
combinations?
Discussion
Memorandum
Exposure
Draft
FASB
Standard
AGENDA
•Derivatives?
•Segment
reporting?
Topics identified and placed on
Board's agenda.
Research and analysis conducted
and discussion memorandum of
pros and cons issued.
Board evaluates research and public
response and issues exposure draft.
Board evaluates responses and changes
exposure draft, if necessary. Final
standard issued.
Public hearing on proposed
standard.
Research
Any more comments?
This will be your final
chance.
Here is
GAAP.
What do
you think?
ILLUSTRATION 1-2
Due Process
The passage of a new FASB Standards Statement requires the support of four of
the seven Board members. FASB Statements are considered GAAP and thereby bind-
ing in practice. All ARBs and APB Opinions that were in effect in 1973 when the FASB
became effective continue to be effective until amended or superseded by FASB pro-
nouncements. In recognition of possible misconceptions of the term “principles,” the
FASB uses the term financial accounting standards in its pronouncements.
Types of Pronouncements
The major types of pronouncements that the FASB issues are:
Standards and Interpretations.
Financial Accounting Concepts.
Technical Bulletins.
Emerging Issues Task Force Statements.
Standards and Interpretations. Financial accounting standards issued by the FASB are
considered generally accepted accounting principles. In addition, the FASB also issues
interpretations that represent modifications or extensions of existing standards. The
Financial
Accounting Series
Statement of
Standards No. 115
Accounting for Certain Investments
in Debt and Equity Securities
APO 145 I12903NVDUS

interpretations have the same authority as standards and require the same votes for
passage as standards. However, interpretations do not require the FASB to operate in
full view of the public through the due process system that is required for FASB Stan-
dards. The APB also issued interpretations of APB Opinions. Both types of interpreta-
tions are now considered authoritative support for purposes of determining GAAP.
Since replacing the APB, the FASB has issued 147 standards and 44 interpretations. (See
list at the back of the book.)
Financial Accounting Concepts. As part of a long-range effort to move away from the
problem-by-problem approach, the FASB in November 1978 issued the first in a series
of Statements of Financial Accounting Concepts as part of its conceptual framework
project. (See list at the back of the book.) The purpose of the series is to set forth fun-
damental objectives and concepts that the Board will use in developing future standards
of financial accounting and reporting. They are intended to form a cohesive set of in-
terrelated concepts, a conceptual framework, that will serve as tools for solving exist-
ing and emerging problems in a consistent manner. Unlike a Statement of Financial Ac-
counting Standards, a Statement of Financial Accounting Concepts does not establish
GAAP. Concepts statements, however, pass through the same due process system (dis-
cussion memo, public hearing, exposure draft, etc.) as do standards statements.
FASB Technical Bulletins. The FASB receives many requests from various sources for
guidelines on implementing or applying FASB Standards or Interpretations, APB Opin-
ions, and Accounting Research Bulletins. In addition, a strong need exists for timely
guidance on financial accounting and reporting problems. For example, in one tax law
change, certain income taxes that companies had accrued as liabilities were forgiven.
The immediate question was: How should the forgiven taxes be reported—as a re-
duction of income tax expense, as a prior period adjustment, or as an extraordinary
item? A technical bulletin was quickly issued that required the tax reduction be re-
ported as a reduction of the current period’s income tax expense. A technical bulletin
is issued only when (1) it is not expected to cause a major change in accounting prac-
tice for a number of enterprises, (2) its cost of implementation is low, and (3) the
guidance provided by the bulletin does not conflict with any broad fundamental ac-
counting principle.7
Emerging Issues Task Force Statements. In 1984 the FASB created the Emerging Issues
Task Force (EITF). The EITF is composed of 13 members, representing CPA firms and
preparers of financial statements. Also attending EITF meetings are observers from the
SEC and AICPA. The purpose of the task force is to reach a consensus on how to ac-
count for new and unusual financial transactions that have the potential for creating
differing financial reporting practices. Examples include how to account for pension
plan terminations; how to account for revenue from barter transactions by Internet
companies; and how to account for excessive amounts paid to takeover specialists. The
EITF also provided timely guidance for the reporting of the losses arising from the ter-
rorist attacks on the World Trade Center on 9/11/01.
We cannot overestimate the importance of the EITF. In one year, for example, the
task force examined 61 emerging financial reporting issues and arrived at a consensus
on approximately 75 percent of them. The SEC has indicated that it will view consen-
sus solutions as preferred accounting and will require persuasive justification for de-
parting from them.
The EITF helps the FASB in many ways. For example, emerging issues often attract
public attention. If they are not resolved quickly, they can lead to financial crises and
scandal and can undercut public confidence in current reporting practices. The next
step, possible governmental intervention, would threaten the continuance of standards
setting in the private sector. In addition, the EITF identifies controversial accounting
Financial
Accounting Series
Statement of
Concepts No. 6
Elements of Financial Statements
a replacement of FASB Concepts Statement No. 3
(incorporating an amendment of
FASB Concepts Statement No. 2)
APO 145 I12903NVDUS
Financial
Accounting Series
FASB Technical Bulletin
1349 MVDN
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asdjog fdvvm.
Reference ADSF dghf gsjhg jgd oijidg as jdoif fdikjdo if the
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ksstreyn jkg dxpofg rk sa d klfdhjfoh
Eiwjer gjfdhgot fih skjf s dkfh lfkgpdojm alknf a
lnkdfjhn fjbd rert kjsdghas jnsdg a iofgge kojgo
shgns akndfs andfjb erktn ma k amln
Wiohrs iofjr dkfhdoiy khjohf sjkhg lksjf lkj s kjldg
lkhgspzdoy iojh oiuft ekjs lkjhjr lsk ghdd
FASB oidfyrtykn askljg jhhpfih sjkh fihytr ksd s
lknhgsf rrtryym skljfhd eijytm kljs smg ls dkgjd
APO 145 I12903NVDUS
EITF ABSTRACTS
A Summary of Proceedings of the
FASB Emerging Issues Task Force
as of September 1999
A
S
FB
7
“Purpose and Scope of FASB Technical Bulletins and Procedures for Issuance,” FASB Tech-
nical Bulletin No. 79-1 (Revised) (Stamford, Conn.: FASB, June 1984).
Financial
Accounting Series
FASB Interpretation No.40
Applicability of Generally Accepted
Accounting Principles to Mutual
Life Insurance and Other Enterprises
an Interpretation of FASB Statements No.12, 80, 97, and 113
APO 145 I12903NVDUS

problems as they arise and determines whether they can be quickly resolved, or whether
the FASB should become involved in solving them. In essence, it becomes a “problem
filter” for the FASB. Thus, it is hoped that the FASB will be able to work on more per-
vasive long-term problems, while the EITF deals with short-term emerging issues.
Governmental Accounting Standards Board (GASB)
Financial statements prepared by state and local governments are not comparable with
financial reports prepared by private business organizations. This lack of comparabil-
ity was highlighted in the 1970s when a number of large U.S. cities such as New York
and Cleveland faced potential bankruptcy. As a result, the Governmental Accounting
Standards Board (GASB), under the oversight of the Financial Accounting Founda-
tion, was created in 1984 to address state and local governmental reporting issues.
The operational structure of the GASB is similar to that of the FASB. That is, it has
an advisory council called the Governmental Accounting Standards Advisory Coun-
cil (GASAC), and it is assisted by its own technical staff and task forces.
The creation of GASB was controversial. Many believe that there should be only
one standards-setting body––the FASB. It was hoped that partitioning standards set-
ting between the GASB, which deals only with state and local government reporting,
and the FASB, which addresses reporting for all other entities, would not lead to con-
flict. Since we are primarily concerned with financial reports prepared by profit-
seeking organizations, this textbook will focus on standards issued by the FASB only.
The formal organizational structure as it currently exists for the development of fi-
nancial reporting standards is presented in Illustration 1-3.
Purpose
Foundation
(FAF)
To establish and improve standards
of financial accounting and reporting
for the guidance and education of the
public, including issuers, auditors
and users of financial information.
Purpose
Standards Board
(FASB)
To select members of the FASB
and GASB and their Advisory
Councils, fund their activities,
and exercise general oversight.
To establish and improve
standards of financial
accounting for state and
local government.
Purpose
Governmental Accounting
Standards Board
(GASB)
To assist respective
Boards on reporting
issues by performing
research, analysis,
and writing functions.
Purpose
Staff and Task
Forces
To consult on major policy issues,
technical issues, project priorities
and selection and organization of
task forces.
Purpose
Governmental Accounting
Standards Advisory Council
(GASAC)
To consult on major policy issues,
technical issues, project priorities
and selection and organization of
task forces.
Purpose
Standards Advisory Council
(FASAC)
ILLUSTRATION 1-3
Organizational Structure
for Setting Accounting
Standards

The Role of the AICPA
For several decades the AICPA provided the leadership in the development of ac-
counting principles and rules. It regulated the accounting profession and developed
and enforced accounting practice more than did any other professional organization.
When the Accounting Principles Board was dissolved and replaced with the FASB, the
AICPA established the Accounting Standards Division to act as its official voice on ac-
counting and reporting issues.
The Accounting Standards Executive Committee (AcSEC) was established within
the Division and was designated as the senior technical committee authorized to speak
for the AICPA in the area of financial accounting and reporting. It does so through var-
ious written communications:
Audit and Accounting Guidelines summarize the accounting practices of specific
industries and provide specific guidance on matters not addressed by the FASB.
Examples are accounting for casinos, airlines, colleges and universities, banks, in-
surance companies, and many others.
Statements of Position (SOP) provide guidance on financial reporting topics un-
til the FASB sets standards on the issue in question. SOPs may update, revise, and
clarify audit and accounting guides or provide free-standing guidance.
Practice Bulletins indicate AcSEC’s views on narrow financial reporting issues not
considered by the FASB.
The AICPA has been the leader in developing auditing standards through its Au-
diting Standards Board. However, the Sarbanes-Oxley Act of 2002 requires the Public
Company Accounting Oversight Board to oversee the development of future auditing
standards. The AICPA will continue to develop and grade the CPA examination, which
is administered in all 50 states.
GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
Generally accepted accounting principles are those principles that have “substantial au-
thoritative support.” The AICPA’s Code of Professional Conduct requires that members
prepare financial statements in accordance with generally accepted accounting principles.
Specifically, Rule 203 of this Code prohibits a member from expressing an opinion that fi-
nancial statements conform with GAAP if those statements contain a material departure
from a generally accepted accounting principle, unless the member can demonstrate that
because of unusual circumstances the financial statements would otherwise have been
misleading. Failure to follow Rule 203 can lead to loss of a CPA’s license to practice.
The meaning of generally accepted accounting principles is defined by Statement
on Auditing Standards (SAS) No. 69, “The Meaning of ‘Present Fairly in Conformity With
Generally Accepted Accounting Principles’ in the Independent Auditor’s Report.” Un-
der this standard, generally accepted accounting principles covered by Rule 203 are
construed to be FASB Standards and Interpretations, APB Opinions, and AICPA Ac-
counting Research Bulletins.
Often, however, a specific accounting transaction occurs that is not covered by any
of these documents. In this case, other authoritative literature is used. Major examples
are: FASB Technical Bulletins; AICPA Industry Auditing and Accounting Guides; and
Statements of Position that have been “cleared” by the FASB.8
These documents are
considered to have substantial authoritative support because the recognized profes-
sional bodies, after giving interested and affected parties the opportunity to react to ex-
posure drafts and respond at public hearings, have voted their issuance. If these pro-
8
SAS No. 69 states that Audit Guides and Statements of Position are assumed to be cleared
(approved) by the FASB unless the pronouncement states otherwise.
OBJECTIVE
Explain the meaning of
generally accepted
accounting principles.

nouncements are lacking in guidance, then other sources might be considered. The hi-
erarchy of these sources is presented in Illustration 1-4.9
If the accounting treatment of
an event is not specified by a category (a) pronouncement, then categories (b) through
(d) should be investigated. If there is a conflict between pronouncements in (b) through
(d), the higher category is to be followed. For example, (b) is higher than (c).
Generally Accepted Accounting Principles • 13
Category (d)
(Least authoritative)
FASB
Implementation
Guides (Q and A)
Widely recognized
and prevalent
industry practices
Category (c) AICPA AcSEC Practice
Bulletins
Category (a)
(Most authoritative)
APB
Opinions
House of GAAP
AICPA
Accounting
Research Bulletins
AICPA
Accounting
Interpretations
FASB Emerging
Issues Task Force
FASB
Standards and
Interpretations
Category (b)
AICPA Industry
Audit and
Accounting Guides
AICPA
Statements
of Position
FASB
Technical
Bulletins
ILLUSTRATION 1-4
The House of GAAP
If none of these pronouncements addresses the event, the support is sought from
other accounting literature. Examples of other accounting literature include FASB Con-
cepts Statements, International Accounting Standards, and accounting articles.
9
See for example, “Remodeling the House of GAAP,” by Douglas Sauter, Journal of Accoun-
tancy (July 1991), pp. 30–37.
You have to step back
Should the accounting profession have principle-based standards or rule-based stan-
dards? Critics of the profession today say that over the past three decades the standards-
setters have moved away from establishing broad accounting principles aimed at en-
suring that companies’ financial statements are fairly presented.
Instead, these critics say, the standards-setters have moved toward drafting volumi-
nous rules that may shield auditors and companies from legal liability if technically fol-
lowed in check-box fashion. That can result in companies creating complex capital struc-
tures that technically comply with GAAP but hide billions of dollars of debt and other
obligations. To add fuel to the fire, the chief accountant of the enforcement division of
the SEC recently noted, “One can violate the SEC laws and still comply with GAAP.”
In short, what he is saying is that it’s not enough to check the boxes and do every-
thing that GAAP requires. You have to then step back and determine whether the over-
all impression created by GAAP fairly portrays the underlying economics of the com-
pany. It is a tough standard and one that auditors and corporate management should
work to achieve.
Source: Adapted from Steve Liesman, “SEC Accounting Cop’s Warning: Playing by the Rules May
Not Head Off Fraud Issues,” Wall Street Journal (February 12, 2002), p. C7.
What do the
numbers mean?

ISSUES IN FINANCIAL REPORTING
Since many interests may be affected by the implementation of an accounting standard,
it is not surprising that there is much discussion about who should develop these stan-
dards and to whom they should apply. Some of the major issues are discussed below.
Standards Setting in a Political Environment
Possibly the most powerful force influencing the development of accounting standards
is user groups. User groups consist of the parties who are most interested in or affected
by accounting standards, rules, and procedures. Like lobbyists in our state and national
capitals, user groups play a significant role. Accounting standards are as much a prod-
uct of political action as they are of careful logic or empirical findings.
User groups may want particular economic events accounted for or reported in a
particular way, and they fight hard to get what they want. They know that the most
effective way to influence the standards that dictate accounting practice is to partici-
pate in the formulation of these standards or to try to influence or persuade the for-
mulator of them. Therefore, the FASB has become the target of many pressures and ef-
forts to influence changes in the existing standards and the development of new ones.10
To top it off, these pressures have been multiplying. Some influential groups demand
that the accounting profession act more quickly and decisively to solve its problems
and remedy its deficiencies. Other groups resist such action, preferring to implement
change more slowly, if at all. Illustration 1-5 shows the various user groups that apply
pressure.
Accounting standards,
interpretations, and bulletins
FASB
Financial community
(analysts, bankers, etc.)
Government
(SEC, IRS, other agencies)
Industry associations
CPAs and
accounting firms
AICPA (AcSEC)
Academicians
Investing public
Business entities
Preparers
(e.g., Financial Executives Institute)
ILLUSTRATION 1-5
User Groups that
Influence the
Formulation of
Accounting Standards
Should there be politics in setting standards for financial accounting and report-
ing? We have politics at home; at school; at the fraternity, sorority, and dormitory; at
the office; at church, temple, and mosque—politics is everywhere. The FASB does not
exist in a vacuum. Standards setting is part of the real world, and it cannot escape pol-
itics and political pressures.
10
FASB board members have acknowledged that many of the Board’s projects, such as “Ac-
counting for Contingencies,” “Accounting for Pensions,” “Statement of Cash Flows,” and “Ac-
counting for Derivatives,” were targets of political pressure.
OBJECTIVE
Describe the impact of
user groups on the
standards-setting
process.

That is not to say that politics in standards setting is evil. Considering the economic
consequences11
of many accounting standards, it is not surprising that special interest
groups become vocal (some supporting, some opposing) when standards are being for-
mulated. The Board must be attentive to the economic consequences of its actions. What
the Board should not do is issue pronouncements that are primarily politically moti-
vated. While paying attention to its constituencies, the Board should base its standards
on sound research and a conceptual framework that has its foundation in economic re-
ality. Even so, the FASB can continue to expect politics and special interest pressures,
since as T. S. Eliot said, “Humankind cannot bear very much reality.”
Issues in Financial Reporting • 15
The Expectations Gap
All professions have come under increasing scrutiny by the government, whether it be
the investment banking profession because of insider trading, the medical profession
because of high costs and Medicare or Medicaid frauds, or engineers because of their
failure to consider environmental consequences in their work.
Recently, it has been the accounting profession’s turn. As indicated earlier, ac-
counting scandals at companies like Enron, Cendant, Sunbeam, Rite Aid, Xerox, and
WorldCom have attracted the attention of Congress. In 2002, legislation—the Sarbanes-
Oxley Act—was enacted; the new law increases the resources for the SEC to combat
fraud and curb poor reporting practices.12
And the SEC has increased its policing ef-
forts, approving new auditor independence rules and materiality guidelines for finan-
cial reporting. In addition, the Sarbanes-Oxley Act introduces sweeping changes to the
institutional structure of the accounting profession. The following are some key provi-
sions of the legislation:
• An accounting oversight board is being established. It will have oversight and en-
forcement authority and will establish auditing, quality control, and independence
standards and rules.
• Stronger independence rules for auditors are now in place. Audit partners, for ex-
ample, will be required to rotate every five years.
11
“Economic consequences” in this context means the impact of accounting reports on the
wealth positions of issuers and users of financial information and the decision-making behavior
resulting from that impact. The resulting behavior of these individuals and groups could have
detrimental financial effects on the providers of the financial information (enterprises). For a
more detailed discussion of this phenomenon, see Stephen A. Zeff, “The Rise of ‘Economic Con-
sequences’,” Journal of Accountancy (December 1978), pp. 56–63. Special appreciation is extended
to Professor Zeff for his insights on this chapter.
12
Sarbanes-Oxley Act of 2002, H. R. Rep. No. 107-610 (2002).
The economic consequences of goodwill
Investors generally ignore an accounting change. But when it substantially affects net
income, stockholders pay attention. One change that will affect many companies is the
new goodwill rules. Before the change, companies that had goodwill were required to
charge it against revenues over time. Under the new rules, companies no longer have
to write off this cost on a systematic basis. The effect on the bottom line for some com-
panies is substantial. For example, assuming no goodwill amortization, International
Paper estimates an income increase of 21 percent, Johnson Controls 16 percent, and
Pepsi Bottling Group 30 percent.
Some believe this change in the rules will make their stock more attractive. Others
argue that it should have no effect because the write-off is a mere bookkeeping charge.
Others argue that the change in the rules has no effect on cash flows, but that investors
will perceive the company to be more profitable, and therefore a good buy in the mar-
ketplace. In short, the numbers have consequences. What do you think?
What do the
numbers mean?

• CEOs and CFOs must forfeit bonuses and profits when there is an accounting re-
statement.
• CEOs and CFOs are required to certify that the financial statements and company
disclosures are accurate and complete.
• Audit committees will need independent members and members with financial
expertise.
• Codes of ethics must be in place for senior financial officers.
Will these changes be enough? The expectations gap—what the public thinks ac-
countants should be doing and what accountants think they can do––is a difficult one
to close. The instances of fraudulent reporting have caused some to question whether
the profession is doing enough. Although the profession can argue rightfully that they
cannot be responsible for every financial catastrophe, it must continue to strive to meet
the needs of society. Efforts to meet these needs will become more costly to society be-
cause the development of a highly transparent, clear, and reliable system will require
considerable resources.
International Accounting Standards
Lawrence Summers, former Secretary of the Treasury, indicated that the single most
important innovation shaping the capital market was the idea of generally accepted ac-
counting principles. Summers went on to say that we need something similar interna-
tionally.
Most countries have recognized the need for more global standards. As a result,
the International Accounting Standards Committee (IASC) was formed in 1973—the
same year the FASB was born—to attempt to narrow the areas of divergence between
standards of different countries.
The objective of the IASC in terms of standards setting was “to work generally for
the improvement and harmonization of regulations, accounting standards and proce-
dures relating to the presentation of financial statements.” Eliminating differences is
not easy. The objectives of financial reporting in the United States often differ from
those in foreign countries, the institutional structures are often not comparable, and
strong national tendencies are pervasive. Nevertheless, much headway has been made
since IASC’s inception.
Recently, the IASC has been restructured and renamed the International Ac-
counting Standards Board (IASB). This new body will work toward the development
of a single set of high-quality global standards. The IASB has a structure similar to
that of the FASB. It is hoped that the establishment of a fully independent international
accounting standards setter will provide the essential convergence needed as we move
to a global capital market system.
It should be emphasized that the United States has a major voice in how interna-
tional standards are being developed. As a result, there are many similarities between
IASB- and U.S.-based standards. Throughout this textbook, international considerations
are presented to help you understand the international reporting environment. In ad-
dition, as noted by the icon in the margin, there is an expanded discussion of interna-
tional accounting on the Take Action! CD that accompanies this textbook. We strongly
encourage you to access the material available on the CD.
Ethics in the Environment of Financial Accounting
Robert Sack, a commentator on the subject of accounting ethics, noted that, “Based on
my experience, new graduates tend to be idealistic . . . thank goodness for that! Still it
is very dangerous to think that your armor is all in place and say to yourself ‘I would
have never given in to that.’ The pressures don’t explode on us; they build, and we of-
ten don’t recognize them until they have us.”
Expanded Discussion of
International Accounting
OBJECTIVE
Understand issues
related to ethics and
financial accounting.
International
Insight
Foreign accounting firms that
provide an audit report for a
U.S.-listed company are subject
to the authority of the account-
ing oversight board (mandated
by the Sarbanes-Oxley Act).

As indicated in this chapter, businesses’ concentration on “maximizing the bottom
line,” “facing the challenges of competition,” and “stressing short-term results” places
accountants in an environment of conflict and pressure. Basic questions such as, “Is
this way of communicating financial information good or bad?” “Is it right or wrong?”
“What should I do in the circumstance?” cannot always be answered by simply ad-
hering to GAAP or following the rules of the profession. Technical competence is not
enough when ethical decisions are encountered.
Doing the right thing, making the right decision, is not always easy. Right is not
always obvious. And the pressures “to bend the rules,” “to play the game,” “to just ig-
nore it” can be considerable. For example, “Will my decision affect my job perform-
ance negatively?” “Will my superiors be upset?” “Will my colleagues be unhappy with
me?” are often questions faced in making a tough ethical decision. The decision is more
difficult because a public consensus has not emerged to formulate a comprehensive
ethical system to provide guidelines. As discussed earlier, the issue has become of such
importance that Congress has legislated that companies must develop a code of ethics
for their senior financial officers.
This whole process of ethical sensitivity and selection among alternatives can be
complicated by pressures that may take the form of time pressures, job pressures,
client pressures, personal pressures, and peer pressures. Throughout this textbook,
ethical considerations are presented for the purpose of sensitizing you to the type
of situations you may encounter in the performance of your professional responsi-
bility.
Issues in Financial Reporting • 17
Expanded Discussion of
Ethical Issues in Financial
Accounting
Here come the politics
Given the current number of accounting scandals mentioned so far in the text, it is not
surprising that both political parties are working hard to ensure that corporate man-
agement be ethical. President Bush, for example, has announced a set of proposals to
crack down on unethical behavior by corporate officials, expanding the offenses sub-
ject to criminal and civil penalties. And both the SEC and the Justice Department are
budgeted to get more funds to combat financial fraud. Bush has indicated “that the fed-
eral government will be vigilant in prosecuting wrongdoers” in American business. At
the same time, the Democratic Party also is pushing for more corporate-reform initia-
tives. One thing is certain—recent events have undermined consumer confidence re-
garding corporate America and the capital markets. Because these issues are hurting
the U.S. economy, politicians are now trying to find answers.
What do the
numbers mean?
Conclusion
The FASB is in its thirtieth year as this textbook is written. Will the FASB survive in its
present state, or will it be restructured or changed as its predecessors were? The next
ten years will be interesting ones in the standards-setting arena. The possibility of global
standards, the crisis of confidence in the capital markets caused by Enron, Tyco, World-
Com, and other accounting failures, and the issue of principle-based versus rule-based
standards are major issues that will affect standards-setting in the United States.
At present, we believe that the accounting profession is reacting responsibly to rem-
edy identified shortcomings. Because of its substantive resources and expertise, the pri-
vate sector should be able to develop and maintain high standards. But it is a difficult
process requiring time, logic, and diplomacy. By a judicious mix of these three ingre-
dients, the profession should continue to develop its own reporting standards with SEC
oversight.

SUMMARY OF LEARNING OBJECTIVES
KEY TERMS
Accounting Principles
Board (APB), 8
Accounting Research
Bulletins, 7
accrual basis accounting,
5
American Institute of
Certified Public
Accountants (AICPA),
7
APB Opinions, 8
Auditing Standards
Board, 12
Committee on
Accounting Procedure
(CAP), 7
economic consequences,
15
Emerging Issues Task
Force (EITF), 10
expectations gap, 16
financial accounting, 2
Standards Board
(FASB), 8
financial reporting, 2
financial statements, 2
generally accepted
accounting principles
(GAAP), 6
Governmental
Accounting Standards
Board (GASB), 11
International Accounting
Standards Board
(IASB), 16
interpretations, 9
objectives of financial
reporting, 4
Securities and Exchange
Commission
(SEC), 6
standards, 9
Standards Statement, 9
Statement of Financial
Accounting
Concepts, 10
technical bulletin, 10
Wheat Committee, 8
Identify the major financial statements and other means of financial reporting. The fi-
nancial statements most frequently provided are (1) the balance sheet, (2) the income
statement, (3) the statement of cash flows, and (4) the statement of owners’ or stock-
holders’ equity. Financial reporting other than financial statements may take various
forms. Examples include the president’s letter and supplementary schedules in the
corporate annual report, prospectuses, reports filed with government agencies, news
releases, management’s forecasts, and certifications regarding internal controls and
fraud.
Explain how accounting assists in the efficient use of scarce resources. Accounting
provides reliable, relevant, and timely information to managers, investors, and cred-
itors so that resources are allocated to the most efficient enterprises. Accounting also
provides measurements of efficiency (profitability) and financial soundness.
Identify some of the challenges facing accounting. Financial reports fail to provide
(1) some key performance measures widely used by management, (2) forward-look-
ing information needed by investors and creditors, (3) sufficient information on a com-
pany’s soft assets (intangibles), and (4) real-time financial information.
Identify the objectives of financial reporting. The objectives of financial reporting
are to provide (1) information that is useful in investment and credit decisions, (2) in-
formation that is useful in assessing cash flow prospects, and (3) information about
enterprise resources, claims to those resources, and changes in them.
Explain the need for accounting standards. The accounting profession has attempted
to develop a set of standards that is generally accepted and universally practiced.
Without this set of standards, each enterprise would have to develop its own stan-
dards, and readers of financial statements would have to familiarize themselves with
every company’s peculiar accounting and reporting practices. As a result, it would be
almost impossible to prepare statements that could be compared.
Identify the major policy-setting bodies and their role in the standards-setting
process. The Securities and Exchange Commission (SEC) is an agency of the federal gov-
ernment that has the broad powers to prescribe, in whatever detail it desires, the ac-
counting standards to be employed by companies that fall within its jurisdiction. The
American Institute of Certified Public Accountants (AICPA) issued standards through its
Committee on Accounting Procedure and Accounting Principles Board. The Financial
Accounting Standards Board (FASB) establishes and improves standards of financial ac-
counting and reporting for the guidance and education of the public. The Govern-
mental Accounting Standards Board (GASB) establishes and improves standards of fi-
nancial accounting for state and local governments.
Explain the meaning of generally accepted accounting principles. Generally accepted
accounting principles are those principles that have substantial authoritative support,
such as FASB Standards and Interpretations, APB Opinions and Interpretations,
AICPA Accounting Research Bulletins, and other authoritative pronouncements.
Describe the impact of user groups on the standards-setting process. User groups
may want particular economic events accounted for or reported in a particular way,
and they fight hard to get what they want. The FASB has become the target of many
pressures and efforts to influence changes in the existing standards and the develop-
ment of new ones. Because of the accelerated rate of change and the increased com-
plexity of our economy, these pressures have been multiplying. Accounting standards
are as much a product of political action as they are of careful logic or empirical
findings.

Understand issues related to ethics and financial accounting. Financial accountants
are called on for moral discernment and ethical decision making. The decision is more
difficult because a public consensus has not emerged to formulate a comprehensive
ethical system that provides guidelines in making ethical judgments.
Questions • 19
1. Differentiate broadly between financial accounting and
managerial accounting.
2. Differentiate between “financial statements” and “finan-
cial reporting.”
3. How does accounting help the capital allocation process?
4. What are some of the major challenges facing the ac-
counting profession?
5. What are the major objectives of financial reporting?
6. Of what value is a common set of standards in financial
accounting and reporting?
7. What is the likely limitation of “general-purpose finan-
cial statements”?
8. What are some of the developments or events that oc-
curred between 1900 and 1930 that helped bring about
changes in accounting theory or practice?
9. In what way is the Securities and Exchange Commission
concerned about and supportive of accounting principles
and standards?
10. What was the Committee on Accounting Procedure, and
what were its accomplishments and failings?
11. For what purposes did the AICPA in 1959 create the Ac-
counting Principles Board?
12. Distinguish among Accounting Research Bulletins,
Opinions of the Accounting Principles Board, and State-
ments of the Financial Accounting Standards Board.
13. If you had to explain or define “generally accepted ac-
counting principles or standards,” what essential char-
acteristics would you include in your explanation?
14. In what ways was it felt that the statements issued by
the Financial Accounting Standards Board would carry
greater weight than the opinions issued by the Ac-
counting Principles Board?
15. How are FASB discussion memoranda and FASB expo-
sure drafts related to FASB “statements”?
16. Distinguish between FASB “statements of financial ac-
counting standards” and FASB “statements of financial
accounting concepts.”
17. What is Rule 203 of the Code of Professional Conduct?
18. Rank from the most authoritative to the least authorita-
tive, the following three items: FASB Technical Bulletins,
AICPA Practice Bulletins, and FASB Standards.
19. The chairman of the FASB at one time noted that “the
flow of standards can only be slowed if (1) producers fo-
cus less on quarterly earnings per share and tax benefits
and more on quality products, and (2) accountants and
lawyers rely less on rules and law and more on profes-
sional judgment and conduct.” Explain his comment.
20. What is the purpose of FASB Technical Bulletins? How
do FASB Technical Bulletins differ from FASB Interpre-
tations?
21. Explain the role of the Emerging Issues Task Force in es-
tablishing generally accepted accounting principles.
22. What is the purpose of the Governmental Accounting
Standards Board?
23. What are some possible reasons why another organiza-
tion, such as the Governmental Accounting Standards
Board, should not issue financial reporting standards?
24. What is AcSEC and what is its relationship to the FASB?
25. What are the sources of pressure that change and in-
fluence the development of accounting principles and
standards?
26. Some individuals have indicated that the FASB must be
cognizant of the economic consequences of its pro-
nouncements. What is meant by “economic conse-
quences”? What dangers exist if politics play too much
of a role in the development of financial reporting stan-
dards?
27. If you were given complete authority in the matter, how
would you propose that accounting principles or stan-
dards should be developed and enforced?
28. One writer recently noted that 99.4 percent of all com-
panies prepare statements that are in accordance with
GAAP. Why then is there such concern about fraudulent
financial reporting?
29. What is the “expectations gap”? What is the profession
doing to try to close this gap?
30. A number of foreign countries have reporting standards
that differ from those in the United States. What are some
of the main reasons why reporting standards are often
different among countries?
31. How are financial accountants challenged in their work
to make ethical decisions? Is technical mastery of GAAP
not sufficient to the practice of financial accounting?
QUESTIONS

CONCEPTUAL CASES
C1-1 (Financial Accounting) Alan Rodriquez has recently completed his first year of studying ac-
counting. His instructor for next semester has indicated that the primary focus will be the area of finan-
cial accounting.
Instructions
(a) Differentiate between financial accounting and managerial accounting.
(b) One part of financial accounting involves the preparation of financial statements. What are the fi-
nancial statements most frequently provided?
(c) What is the difference between financial statements and financial reporting?
C1-2 (Objectives of Financial Reporting) Celia Cruz, a recent graduate of the local state university, is
presently employed by a large manufacturing company. She has been asked by Angeles Ochoa, controller,
to prepare the company’s response to a current Discussion Memorandum published by the Financial Ac-
counting Standards Board (FASB). Cruz knows that the FASB has issued seven Statements of Financial Ac-
counting Concepts, and she believes that these concept statements could be used to support the company’s
response to the Discussion Memorandum. She has prepared a rough draft of the response citing Statement
of Financial Accounting Concepts No. 1, “Objectives of Financial Reporting by Business Enterprises.”
Instructions
(a) Identify the three objectives of financial reporting as presented in Statement of Financial Account-
ing Concepts No. 1 (SFAC No. 1).
(b) Describe the level of sophistication expected of the users of financial information by SFAC No. 1.
(CMA adapted)
C1-3 (Accounting Numbers and the Environment) Hardly a day goes by without an article appear-
ing on the crises affecting many of our financial institutions in the United States. It is estimated that the
savings and loan (SL) debacle of the 1980s, for example, ended up costing $500 billion ($2,000 for every
man, woman, and child in the United States). Some argue that if the SLs had been required to report
their investments at market value instead of cost, large losses would have been reported earlier, which
would have signaled regulators to close those SLs and, therefore, minimize the losses to U.S. taxpayers.
Instructions
Explain how reported accounting numbers might affect an individual’s perceptions and actions. Cite two
examples.
C1-4 (Need for Accounting Standards) Some argue that having various organizations establish ac-
counting principles is wasteful and inefficient. Rather than mandating accounting standards, each com-
pany could voluntarily disclose the type of information it considered important. In addition, if an investor
wants additional information, the investor could contact the company and pay to receive the additional
information desired.
Instructions
Comment on the appropriateness of this viewpoint.
C1-5 (AICPA’s Role in Standards Setting) One of the major groups involved in the standards-setting
process is the American Institute of Certified Public Accountants. Initially it was the primary organiza-
tion that established accounting principles in the United States. Subsequently it relinquished most of its
power to the FASB.
Instructions
(a) Identify the two committees of the AICPA that established accounting principles prior to the es-
tablishment of the FASB.
(b) Speculate as to why these two organizations failed. In your answer, identify steps the FASB has
taken to avoid failure.
(c) What is the present role of the AICPA in the standards-setting environment?
C1-6 (FASB Role in Standards Setting) A press release announcing the appointment of the trustees
of the new Financial Accounting Foundation stated that the Financial Accounting Standards Board (to be
appointed by the trustees) “. . . will become the established authority for setting accounting principles
under which corporations report to the shareholders and others” (AICPA news release July 20, 1972).
Instructions
(a) Identify the sponsoring organization of the FASB and the process by which the FASB arrives at a
decision and issues an accounting standard.

(b) Indicate the major types of pronouncements issued by the FASB and the purposes of each of these
pronouncements.
C1-7 (Government Role in Standards Setting) Recently an article stated “the setting of accounting
standards in the United States is now about 60 years old. It is a unique process in our society, one that
has undergone numerous changes over the years. The standards are established by a private sector en-
tity that has no dominant sponsor and is not part of any professional organization or trade association.
The governmental entity that provides oversight, on the other hand, is far more a friend than a competi-
tor or an antagonist.”
Instructions
Identify the governmental entity that provides oversight and indicate its role in the standards-setting
process.
C1-8 (Politicization of Standards Setting) Some accountants have said that politicization in the de-
velopment and acceptance of generally accepted accounting principles (i.e., standards setting) is taking
place. Some use the term “politicization” in a narrow sense to mean the influence by governmental agen-
cies, particularly the Securities and Exchange Commission, on the development of generally accepted ac-
counting principles. Others use it more broadly to mean the compromise that results when the bodies re-
sponsible for developing generally accepted accounting principles are pressured by interest groups (SEC,
American Accounting Association, businesses through their various organizations, Institute of Manage-
ment Accountants, financial analysts, bankers, lawyers, and so on).
Instructions
(a) The Committee on Accounting Procedures of the AICPA was established in the mid- to late 1930s
and functioned until 1959, at which time the Accounting Principles Board came into existence. In
1973, the Financial Accounting Standards Board was formed and the APB went out of existence.
Do the reasons these groups were formed, their methods of operation while in existence, and the
reasons for the demise of the first two indicate an increasing politicization (as the term is used in
the broad sense) of accounting standards setting? Explain your answer by indicating how the
CAP, the APB, and the FASB operated or operate. Cite specific developments that tend to sup-
port your answer.
(b) What arguments can be raised to support the “politicization” of accounting standards setting?
(c) What arguments can be raised against the “politicization” of accounting standards setting?
(CMA adapted)
C1-9 (Models for Setting Accounting Standards) Presented below are three models for setting ac-
counting standards.
1. The purely political approach, where national legislative action decrees accounting standards.
2. The private, professional approach, where financial accounting standards are set and enforced by
private professional actions only.
3. The public/private mixed approach, where standards are basically set by private-sector bodies that
behave as though they were public agencies and whose standards to a great extent are enforced
through governmental agencies.
Instructions
(a) Which of these three models best describes standards setting in the United States? Comment on
your answer.
(b) Why do companies, financial analysts, labor unions, industry trade associations, and others take
such an active interest in standards setting?
(c) Cite an example of a group other than the FASB that attempts to establish accounting standards.
Speculate as to why another group might wish to set its own standards.
C1-10 (Standards-Setting Terminology) Andrew Wyeth, an administrator at a major university, re-
cently said, “I’ve got some CDs in my IRA, which I set up to beat the IRS.” As elsewhere, in the world
of accounting and finance, it often helps to be fluent in abbreviations and acronyms.
Instructions
Presented below is a list of common accounting acronyms. Identify the term for which each acronym
stands, and provide a brief definition of each term.
(a) AICPA (e) FAF (i) CPA (m) GASB
(b) CAP (f) FASAC (j) FASB
(c) ARB (g) SOP (k) SEC
(d) APB (h) GAAP (l) IASB
Conceptual Cases • 21

C1-11 (Accounting Organizations and Documents Issued) Presented below are a number of ac-
counting organizations and type of documents they have issued.
Instructions
Match the appropriate document to the organization involved. Note that more than one document may
be issued by the same organization. If no document is provided for an organization, write in “0.”
Organization
1. _____ Securities and Exchange Commission
2. _____ Accounting Standards Executive Committee
3. _____ Accounting Principles Board
4. _____ Committee on Accounting Procedure
5. _____ Financial Accounting Standards Board
C1-12 (Accounting Pronouncements) A number of authoritative pronouncements have been issued by
standards-setting bodies in the last 50 years. A list is provided on the left, below, with a description of
these pronouncements on the right.
Instructions
Match the description to the pronouncements.
1. _____ Technical Bulletin
2. _____ Interpretations (of the Financial Account-
ing Standards Board)
3. _____ Statement of Financial Accounting
Standards
4. _____ EITF Statements
5. _____ Opinions
6. _____ Statement of Financial Accounting
Concepts
C1-13 (Issues Involving Standards Setting) When the FASB issues new standards, the implementa-
tion date is usually 12 months from date of issuance, with early implementation encouraged. Paula
Popovich, controller, discusses with her financial vice president the need for early implementation of a
standard that would result in a fairer presentation of the company’s financial condition and earnings.
When the financial vice president determines that early implementation of the standard will adversely
affect the reported net income for the year, he discourages Popovich from implementing the standard un-
til it is required.
Instructions
Answer the following questions.
(a) What, if any, is the ethical issue involved in this case?
(b) Is the financial vice president acting improperly or immorally?
(c) What does Popovich have to gain by advocacy of early implementation?
(d) Which stakeholders might be affected by the decision against early implementation?
(CMA adapted)
C1-14 (Securities and Exchange Commission) The U.S. Securities and Exchange Commission (SEC)
was created in 1934 and consists of five commissioners and a large professional staff. The SEC pro-
fessional staff is organized into five divisions and several principal offices. The primary objective of the
SEC is to support fair securities markets. The SEC also strives to foster enlightened stockholder partici-
pation in corporate decisions of publicly traded companies. The SEC has a significant presence in finan-
cial markets, the development of accounting practices, and corporation-shareholder relations, and has the
power to exert influence on entities whose actions lie within the scope of its authority.
Document
(a) Opinions
(b) Practice Bulletins
(c) Accounting Research Bulletins
(d) Financial Reporting Releases
(e) Financial Accounting Standards
(f) Statements of Position
(g) Technical Bulletins
(a) Official pronouncements of the APB.
(b) Sets forth fundamental objectives and
concepts that will be used in develop-
ing future standards.
(c) Primary document of the FASB that es-
tablishes GAAP.
(d) Provides additional guidance on im-
plementing or applying FASB Stan-
dards or Interpretations.
(e) Provides guidance on how to account
for new and unusual financial transac-
tions that have the potential for creat-
ing diversity in financial reporting
practices.
(f) Represent extensions or modifications
of existing standards.

Instructions
(a) Explain from where the Securities and Exchange Commission receives its authority.
(b) Describe the official role of the Securities and Exchange Commission in the development of fi-
nancial accounting theory and practices.
(c) Discuss the interrelationship between the Securities and Exchange Commission and the Financial
Accounting Standards Board with respect to the development and establishment of financial ac-
counting theory and practices.
(CMA adapted)
C1-15 (Standards-Setting Process) In 1973, the responsibility for developing and issuing rules on ac-
counting practices was given to the Financial Accounting Foundation and, in particular, to an arm of the
foundation called the Financial Accounting Standards Board (FASB). The generally accepted accounting
principles established by the FASB are enunciated through a publication series entitled Statements of Fi-
nancial Accounting Standards. These statements are issued periodically, and over 140 are currently in force.
The statements have a significant influence on the way in which financial statements are prepared by U.S.
corporations.
Instructions
(a) Describe the process by which a topic is selected or identified as appropriate for study by the Fi-
nancial Accounting Standards Board (FASB).
(b) Once a topic is considered appropriate for consideration by the FASB, a series of steps is followed
before a Statement of Financial Accounting Standards is issued. Describe the major steps in the process
leading to the issuance of a standard.
(c) Identify at least three other organizations that influence the setting of generally accepted ac-
counting principles (GAAP).
(CMA adapted)
C1-16 (History of Standards-Setting Organizations) Beta Alpha Psi, your university’s accounting so-
ciety, has decided to publish a brief pamphlet for seniors in high school, detailing the various facets of
the accountancy profession. As a junior accounting major, you have been asked to contribute an article
for this publication. Your topic is the evolution of accounting standards-setting organizations in the United
States.
Instructions
Write a 1–2 page article on the historical development of the organizations responsible for giving us GAAP.
(The most appropriate introduction would explain the increasing need for a more standardized approach
to accounting for a company’s assets.)
C1-17 (Economic Consequences) Presented below are comments made in the financial press.
Instructions
Prepare responses to the requirements in each item.
(a) Rep. John Dingell, the ranking Democrat on the House Commerce Committee, threw his support
behind the FASB’s controversial derivatives accounting standard and encouraged the FASB to
adopt the rule promptly. Indicate why a member of Congress might feel obligated to comment
on this proposed FASB standard.
(b) In a strongly worded letter to Senator Lauch Faircloth (R-NC) and House Banking Committee
Chairman Jim Leach (R-IA), the American Institute of Certified Public Accountants (AICPA) cau-
tioned against government intervention in the accounting standards-setting process, warning that
it had the potential of jeopardizing U.S. capital markets. Explain how government intervention
could possibly affect capital markets adversely.
C1-18 (Standards-Setting Process, Economic Consequences) The following letter was sent to the SEC
and the FASB by leaders of the business community.
Dear Sirs:
The FASB has been struggling with accounting for derivatives and hedging for many years. The FASB
has now developed, over the last few weeks, a new approach that it proposes to adopt as a final stan-
dard. We understand that the Board intends to adopt this new approach as a final standard without
exposing it for public comment and debate, despite the evident complexity of the new approach, the
speed with which it has been developed and the significant changes to the exposure draft since it
was released more than one year ago. Instead, the Board plans to allow only a brief review by
Conceptual Cases • 23

selected parties, limited to issues of operationality and clarity, and would exclude questions as to the
merits of the proposed approach.
As the FASB itself has said throughout this process, its mission does not permit it to consider matters
that go beyond accounting and reporting considerations. Accordingly, the FASB may not have ade-
quately considered the wide range of concerns that have been expressed about the derivatives and
hedging proposal, including concerns related to the potential impact on the capital markets, the weak-
ening of companies’ ability to manage risk, and the adverse control implications of implementing costly
and complex new rules imposed at the same time as other major initiatives, including the Year 2000 is-
sues and a single European currency. We believe that these crucial issues must be considered, if not by
the FASB, then by the Securities and Exchange Commission, other regulatory agencies, or Congress.
We believe it is essential that the FASB solicit all comments in order to identify and address all ma-
terial issues that may exist before issuing a final standard. We understand the desire to bring this
process to a prompt conclusion, but the underlying issues are so important to this nation’s businesses,
the customers they serve and the economy as a whole that expediency cannot be the dominant con-
sideration. As a result, we urge the FASB to expose its new proposal for public comment, following
the established due process procedures that are essential to acceptance of its standards, and provid-
ing sufficient time to affected parties to understand and assess the new approach.
We also urge the SEC to study the comments received in order to assess the impact that these pro-
posed rules may have on the capital markets, on companies’ risk management practices, and on man-
agement and financial controls. These vital public policy matters deserve consideration as part of the
Commission’s oversight responsibilities.
We believe that these steps are essential if the FASB is to produce the best possible accounting stan-
dard while minimizing adverse economic effects and maintaining the competitiveness of U.S. busi-
nesses in the international marketplace.
Very truly yours,
(This letter was signed by the chairs of 22 of the largest U.S. companies.)
Instructions
Answer the following questions.
(a) Explain the “due process” procedures followed by the FASB in developing a financial reporting
standard.
(b) What is meant by the term “economic consequences” in accounting standards setting?
(c) What economic consequences arguments are used in this letter?
(d) What do you believe is the main point of the letter?
(e) Why do you believe a copy of this letter was sent by the business community to influential mem-
bers of the United States Congress?
USING YOUR JUDGMENT
FINANCIAL REPORTING PROBLEM
Kate Jackson, a new staff accountant, is confused because of the complexities involving accounting stan-
dards setting. Specifically, she is confused by the number of bodies issuing financial reporting standards
of one kind or another and the level of authoritative support that can be attached to these reporting stan-
dards. Kate decides that she must review the environment in which accounting standards are set, if she
is to increase her understanding of the accounting profession.

Using Your Judgment • 25
Kate recalls that during her accounting education there was a chapter or two regarding the environ-
ment of financial accounting and the development of accounting standards. However, she remembers that
little emphasis was placed on these chapters by her instructor.
Instructions
(a) Help Kate by identifying key organizations involved in accounting standards setting.
(b) Kate asks for guidance regarding authoritative support. Please assist her by explaining what is meant
by authoritative support.
(c) Give Kate a historical overview of how standards setting has evolved so that she will not feel that she
is the only one to be confused.
(d) What authority for compliance with GAAP has existed throughout the period of standards setting?
INTERNATIONAL REPORTING CASE
Michael Sharpe, former Deputy Chairman of the International Accounting Standards Committee (IASC),
made the following comments before the 63rd Annual Conference of the Financial Executives Institute
(FEI).
There is an irreversible movement towards the harmonization of financial reporting throughout the
world. The international capital markets require an end to:
1 The confusion caused by international companies announcing different results depending on the set
of accounting standards applied. Recent announcements by Daimler-Benz [now DaimlerChrysler]
highlight the confusion that this causes.
2 Companies in some countries obtaining unfair commercial advantages from the use of particular na-
tional accounting standards.
3 The complications in negotiating commercial arrangements for international joint ventures caused by
different accounting requirements.
4 The inefficiency of international companies having to understand and use a myriad of different ac-
counting standards depending on the countries in which they operate and the countries in which
they raise capital and debt. Executive talent is wasted on keeping up to date with numerous sets of
accounting standards and the never-ending changes to them.
5 The inefficiency of investment managers, bankers, and financial analysts as they seek to compare fi-
nancial reporting drawn up in accordance with different sets of accounting standards.
6 Failure of many stock exchanges and regulators to require companies subject to their jurisdiction to
provide comparable, comprehensive, and transparent financial reporting frameworks giving inter-
national comparability.
7 Difficulty for developing countries and countries entering the free market economy such as China
and Russia in accessing foreign capital markets because of the complexity of and differences between
national standards.
8 The restriction on the mobility of financial service providers across the world as a result of different
Clearly the elimination of these inefficiencies by having comparable high-quality financial reporting
used across the world would benefit international businesses.
Instructions
(a) What is the International Accounting Standards Board, and what is its relation to the International
Accounting Standards Committee?
(b) What stakeholders might benefit from the use of International Accounting Standards?
(c) What do you believe are some of the major obstacles to harmonization?

PROFESSIONAL SIMULATION
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Remember to check the Take Action! CD
and the book’s companion Web site
to find additional resources for this chapter.
Directions
In this simulation, you will be asked various questions regarding accounting principles.
Prepare responses to all parts.
Situation
Accounting — Generally Accepted Accounting Principles
Explanation
At the completion of Bloom Company's audit, the president, Judy Bloom, asks about the meaning of
the phrase “in conformity with generally accepted accounting principles” that appears in your audit
report on the management's financial statements. Judy observes that the meaning of the phrase must
include something more and different than what she thinks of as “principles.”
(a) Explain the meaning of the term “accounting principles” as used in the audit report.
(Do not discuss in this part the significance of “generally accepted.”)
(b) President Bloom wants to know how you determine whether or not an accounting principle is
generally accepted. Discuss the sources of evidence for determining whether an accounting
principle has substantial authoritative support. Do not merely list the titles of publications.
Directions Explanation
Situation Resources
Research

LEARNING
OBJECTIVES
After studying this chapter, you
should be able to:
Describe the usefulness of
a conceptual framework.
Describe the FASB’s
efforts to construct a
conceptual framework.
Understand the objectives
of financial reporting.
Identify the qualitative
characteristics of
accounting information.
Define the basic elements
of financial statements.
Describe the basic
assumptions of
accounting.
Explain the application of
the basic principles of
accounting.
Describe the impact that
constraints have on
reporting accounting
information.
The growth of new-economy business on the Internet has led to the development
of new measures of performance. When Priceline.com splashed on the dot-
com scene, it touted steady growth in a measure called “unique offers by users”
to explain its heady stock price. And Drugstore.com focused on “unique
customers” at its Web site to draw investors to its stock. After all, new
businesses call for new performance measures, right?
Not necessarily. The problem with such indicators is that they do not exhibit
any consistent relationship with the ability of these companies to earn profits
from the customers visiting their Web sites. Eventually, as the graphs below
show, the profits never materialized, and stock price fell.
27
C H A P T E R
2
C H A P T E R
2
Conceptual Framework
Underlying Financial
Accounting
Show Me the Earnings!
PRICELINE.COM
Net unique offers by users
3.0 million
2.0
1.0
0
I II III
1999
IV I II III
2000
IV
Stock price
2000-IV
close
$2.13
$120 a share
80
40
0
I II III
1999
IV I II III
2000
IV
DRUGSTORE.COM
Unique customers
2.0 million
1.5
1.0
0.5
0
I II III
1999
IV I II III
2000
IV
Stock price
2000-IV
close
$1.03
$40 a share
30
20
10
0
I II III
1999
IV I II III
2000
IV
According to one accounting expert, investors’ use of nonfinancial measures is
not detrimental when combined with financial analysis, which is based on
measures such as earnings and cash flows. The problem is that during the
recent Internet craze, investors placed too much emphasis on nonfinancial
data. Thus, the new economy may require some new measures but investors
need to be careful not to forget the relevant and reliable traditional ones.1
1
Story and graphs adapted from Gretchen Morgenson, “How Did They Value
Stocks? Count the Absurd Ways,” New York Times (March 18, 2001), section 3, p. 1.

CONCEPTUAL FRAMEWORK
UNDERLYING FINANCIAL ACCOUNTING
• Qualitative
characteristics
• Basic elements
First Level:
Basic Objectives
• Basic assumptions
• Basic principles
• Constraints
As indicated in the opening story about dot-com reporting, users of financial state-
ments need relevant and reliable information. To help develop this type of financial in-
formation, a conceptual framework that guides financial accounting and reporting is
used. This chapter discusses the basic concepts underlying this conceptual framework.
The content and organization of this chapter are as follows.
CONCEPTUAL FRAMEWORK
A conceptual framework is like a constitution: It is “a coherent system of interrelated
objectives and fundamentals that can lead to consistent standards and that prescribes
the nature, function, and limits of financial accounting and financial statements.”2
Many
have considered the FASB’s real contribution—and even its continued existence—to
depend on the quality and utility of the conceptual framework.
Need for Conceptual Framework
Why is a conceptual framework necessary? First, to be useful, standard setting should
build on and relate to an established body of concepts and objectives. A soundly
developed conceptual framework should enable the FASB to issue more useful and
consistent standards over time. A coherent set of standards and rules should be the
result, because they would be built upon the same foundation. The framework should
increase financial statement users’ understanding of and confidence in financial re-
porting, and it should enhance comparability among companies’ financial statements.
Second, new and emerging practical problems should be more quickly solved by
reference to an existing framework of basic theory. For example, Sunshine Mining
(a silver mining company) sold two issues of bonds that it would redeem either with
$1,000 in cash or with 50 ounces of silver, whichever was worth more at maturity. Both
28
OBJECTIVE
Describe the
usefulness of a
2
“Conceptual Framework for Financial Accounting and Reporting: Elements of Financial
Statements and Their Measurement,” FASB Discussion Memorandum (Stamford, Conn.: FASB,
1976), page 1 of the “Scope and Implications of the Conceptual Framework Project” section. For
an excellent discussion of the functions of the conceptual framework, see Reed K. Storey and
Sylvia Storey, Special Report, “The Framework of Financial Accounting and Concepts” (Norwalk,
Conn.: FASB, 1998), pp. 85–88.
• Need
• Development
Second Level:
Fundamental
Concepts
Conceptual
Framework
Third Level:
Recognition and
Measurement

bond issues had a stated interest rate of 8.5 percent. At what amounts should the bonds
have been recorded by Sunshine or the buyers of the bonds? What is the amount of
the premium or discount on the bonds and how should it be amortized, if the bond re-
demption payments are to be made in silver (the future value of which was unknown
at the date of issuance)?
It is difficult, if not impossible, for the FASB to prescribe the proper accounting
treatment quickly for situations like this. Practicing accountants, however, must resolve
such problems on a day-to-day basis. Through the exercise of good judgment and with
the help of a universally accepted conceptual framework, practitioners can dismiss cer-
tain alternatives quickly and then focus on an acceptable treatment.
Development of Conceptual Framework
Over the years numerous organizations, committees, and interested individuals de-
veloped and published their own conceptual frameworks. But no single framework
was universally accepted and relied on in practice. Recognizing the need for a gener-
ally accepted framework, the FASB in 1976 began work to develop a conceptual
framework that would be a basis for setting accounting standards and for resolving
financial reporting controversies. The FASB has issued six Statements of Financial
Accounting Concepts that relate to financial reporting for business enterprises.3
They
are:
SFAC No. 1, “Objectives of Financial Reporting by Business Enterprises,” presents
the goals and purposes of accounting.
SFAC No. 2, “Qualitative Characteristics of Accounting Information,” examines the
characteristics that make accounting information useful.
SFAC No. 3, “Elements of Financial Statements of Business Enterprises,” provides
definitions of items in financial statements, such as assets, liabilities, revenues, and
expenses.
SFAC No. 5, “Recognition and Measurement in Financial Statements of Business
Enterprises,” sets forth fundamental recognition and measurement criteria and
guidance on what information should be formally incorporated into financial state-
ments and when.
SFAC No. 6, “Elements of Financial Statements,” replaces SFAC No. 3 and expands
its scope to include not-for-profit organizations.
SFAC No. 7, “Using Cash Flow Information and Present Value in Accounting Meas-
urements,” provides a framework for using expected future cash flows and pres-
ent values as a basis for measurement.
Illustration 2-1 (on page 30) provides an overview of the conceptual framework.4
At the first level, the objectives identify the goals and purposes of accounting. Ideally,
accounting standards developed according to a conceptual framework will result in
accounting reports that are more useful. At the second level are the qualitative char-
acteristics that make accounting information useful and the elements of financial
statements (assets, liabilities, and so on). At the third level are the measurement and
recognition concepts used in establishing and applying accounting standards. These
concepts include assumptions, principles, and constraints that describe the present re-
porting environment. The remainder of the chapter examines these three levels of the
Conceptual Framework • 29
OBJECTIVE
Describe the FASB’s
efforts to construct a
International
Insight
The IASB has issued a
conceptual framework that is
broadly consistent with that of
the United States.
3
The FASB has also issued a Statement of Financial Accounting Concepts that relates to non-
business organizations: Statement of Financial Accounting Concepts No. 4, “Objectives of Financial
Reporting by Nonbusiness Organizations” (December 1980).
4
Adapted from William C. Norby, The Financial Analysts Journal (March–April 1982), p. 22.

FIRST LEVEL: BASIC OBJECTIVES
As we discussed in Chapter 1, the objectives of financial reporting are to provide in-
formation that is: (1) useful to those making investment and credit decisions who have
a reasonable understanding of business and economic activities; (2) helpful to present
and potential investors, creditors, and other users in assessing the amounts, timing,
and uncertainty of future cash flows; and (3) about economic resources, the claims to
those resources, and the changes in them.
The objectives, therefore, begin with a broad concern about information that is use-
ful to investor and creditor decisions. That concern narrows to the investors’ and cred-
itors’ interest in the prospect of receiving cash from their investments in or loans to
business enterprises. Finally, the objectives focus on the financial statements that pro-
vide information useful in the assessment of prospective cash flows to the business en-
terprise. This approach is referred to as decision usefulness. It has been said that the
golden rule is the central message in many religions and the rest is elaboration. Simi-
larly, decision usefulness is the message of the conceptual framework and the rest is
elaboration.
In providing information to users of financial statements, general-purpose finan-
cial statements are prepared. These statements provide the most useful information
possible at minimal cost to various user groups. Underlying these objectives is the
notion that users need reasonable knowledge of business and financial accounting mat-
30 • Chapter 2 Conceptual Framework Underlying Financial Accounting
First level: The why—goals and purposes
of accounting.
Second level: Bridge between
levels 1 and 3
Third level:
The how—
implementation
ASSUMPTIONS PRINCIPLES CONSTRAINTS
Recognition and Measurement Concepts
QUALITATIVE
CHARACTERISTICS
of
accounting
information
OBJECTIVES
of
financial
reporting
ELEMENTS
of
financial
statements
ILLUSTRATION 2-1
Conceptual Framework
for Financial Reporting
OBJECTIVE
Understand the
objectives of financial
reporting.

ters to understand the information contained in financial statements. This point is
important. It means that in the preparation of financial statements a level of reasonable
competence on the part of users can be assumed. This has an impact on the way and
the extent to which information is reported.
SECOND LEVEL: FUNDAMENTAL CONCEPTS
The objectives (first level) are concerned with the goals and purposes of accounting.
Later, we will discuss the ways these goals and purposes are implemented (third level).
Between these two levels it is necessary to provide certain conceptual building blocks
that explain the qualitative characteristics of accounting information and define the el-
ements of financial statements. These conceptual building blocks form a bridge between
the why of accounting (the objectives) and the how of accounting (recognition and
measurement).
Qualitative Characteristics of Accounting Information
How does one decide whether financial reports should provide information on how
much a firm’s assets cost to acquire (historical cost basis) or how much they are cur-
rently worth (current value basis)? Or how does one decide whether the three main
segments that constitute PepsiCo—PepsiCola, Frito Lay, and Tropicana—should be
combined and shown as one company, or disaggregated and reported as three sepa-
rate segments for financial reporting purposes?
Choosing an acceptable accounting method, the amount and types of information
to be disclosed, and the format in which information should be presented involves de-
termining which alternative provides the most useful information for decision mak-
ing purposes (decision usefulness). The FASB has identified the qualitative charac-
teristics of accounting information that distinguish better (more useful) information
from inferior (less useful) information for decision making purposes.5
In addition, the
FASB has identified certain constraints (cost-benefit and materiality) as part of the con-
ceptual framework; these are discussed later in the chapter. The characteristics may be
viewed as a hierarchy, as shown in Illustration 2-2 on the next page.
Decision Makers (Users) and Understandability
Decision makers vary widely in the types of decisions they make, how they make de-
cisions, the information they already possess or can obtain from other sources, and their
ability to process the information. For information to be useful, there must be a con-
nection (linkage) between these users and the decisions they make. This link, under-
standability, is the quality of information that permits reasonably informed users to
perceive its significance. To illustrate the importance of this linkage, assume that IBM
Corp. issues a three-months’ earnings report (interim report) that shows interim earn-
ings way down. This report provides relevant and reliable information for decision
making purposes. Some users, upon reading the report, decide to sell their stock. Other
users do not understand the report’s content and significance. They are surprised when
IBM declares a smaller year-end dividend and the value of the stock declines. Thus, al-
though the information presented was highly relevant and reliable, it was useless to
those who did not understand it.
Primary Qualities: Relevance and Reliability
Relevance and reliability are the two primary qualities that make accounting infor-
mation useful for decision making. As stated in FASB Concepts Statement No. 2, “the
qualities that distinguish ‘better’ (more useful) information from ‘inferior’ (less useful)
Second Level: Fundamental Concepts • 31
OBJECTIVE
Identify the qualitative
characteristics of
accounting information.
5
“Qualitative Characteristics of Accounting Information,” Statement of Financial Accounting
Concepts No. 2 (Stamford, Conn.: FASB, May 1980).
International
Insight
In Switzerland, Germany, Korea,
and other nations, capital is
provided to business primarily
by large banks. Creditors have
very close ties to firms and can
obtain information directly from
them. Creditors do not need to
rely on publicly available
information, and financial
information is focused on
creditor protection. This process
of capital allocation, however, is
changing.

information are primarily the qualities of relevance and reliability, with some other
characteristics that those qualities imply.”6
Relevance. To be relevant, accounting information must be capable of making a dif-
ference in a decision.7
If certain information has no bearing on a decision, it is irrele-
vant to that decision. Relevant information helps users make predictions about the ul-
timate outcome of past, present, and future events; that is, it has predictive value.
Relevant information also helps users confirm or correct prior expectations; it has feed-
back value. For example, when UPS (United Parcel Service) issues an interim report,
this information is considered relevant because it provides a basis for forecasting annual
earnings and provides feedback on past performance. For information to be relevant,
it must also be available to decision makers before it loses its capacity to influence their
decisions. Thus timeliness is a primary ingredient. If UPS did not report its interim
results until six months after the end of the period, the information would be much
less useful for decision making purposes. For information to be relevant, it should
have predictive or feedback value, and it must be presented on a timely basis.
Reliability. Accounting information is reliable to the extent that it is verifiable, is a
faithful representation, and is reasonably free of error and bias. Reliability is a ne-
cessity for individuals who have neither the time nor the expertise to evaluate the fac-
tual content of the information.
Verifiability is demonstrated when independent measurers, using the same mea-
surement methods, obtain similar results. For example, would several independent
auditors come to the same conclusion about a set of financial statements? If outside
parties using the same measurement methods arrive at different conclusions, then the
statements are not verifiable. Auditors could not render an opinion on such statements.
RELEVANCE RELIABILITY
DECISION MAKERS
AND THEIR CHARACTERISTICS
Verifiability
Timeliness
Predictive
value
DECISION USEFULNESS
Feedback
value
Comparability Consistency
UNDERSTANDABILITY
MATERIALITY
(Threshold for recognition)
COST BENEFITS
(Pervasive constraint)
Users of
accounting information
Constraints
User-specific qualities
Pervasive criterion
Primary qualities
Ingredients
of primary
qualities
Secondary
qualities
Neutrality
Representational
faithfulness
ILLUSTRATION 2-2
Hierarchy of Accounting
Qualities
6
Ibid., par. 15.
7
Ibid., par. 47.

Representational faithfulness means that the numbers and descriptions represent
what really existed or happened. The accounting numbers and descriptions agree with
the resources or events that these numbers and descriptions purport to represent. If
General Motors’ income statement reports sales of $150 billion when it had sales of
$138.2 billion, then the statement is not a faithful representation.
Neutrality means that information cannot be selected to favor one set of interested
parties over another. Factual, truthful, unbiased information must be the overriding
consideration. For example, R. J. Reynolds should not be permitted to suppress infor-
mation in the notes to its financial statements about the numerous lawsuits that have
been filed against it because of tobacco-related health concerns—even though such
disclosure is damaging to the company.
Neutrality in standard setting has come under increasing attack. Some argue that
standards should not be issued if they cause undesirable economic effects on an in-
dustry or company. We disagree. Standards must be free from bias or we will no longer
have credible financial statements. Without credible financial statements, individuals
will no longer use this information. An analogy demonstrates the point: In the United
States, we have both boxing and wrestling matches. Many individuals bet on boxing
matches because such contests are assumed not to be fixed. But nobody bets on
wrestling matches. Why? Because the public assumes that wrestling matches are rigged.
If financial information is biased (rigged), the public will lose confidence and no longer
use this information.
Secondary Qualities: Comparability and Consistency
Information about an enterprise is more useful if it can be compared with similar in-
formation about another enterprise (comparability) and with similar information about
the same enterprise at other points in time (consistency).
Comparability. Information that has been measured and reported in a similar manner
for different enterprises is considered comparable. Comparability enables users to
identify the real similarities and differences in economic phenomena because these dif-
ferences and similarities have not been obscured by the use of noncomparable
accounting methods. For example, the accounting for pensions is different in the United
States and Japan. In the U.S., pension cost is recorded as it is incurred, whereas in Japan
there is little or no charge to income for these costs. As a result, it is difficult to com-
pare and evaluate the financial results of General Motors or Ford to Nissan or Honda.
Also, resource allocation decisions involve evaluations of alternatives; a valid evalua-
tion can be made only if comparable information is available.
Consistency. When an entity applies the same accounting treatment to similar events,
from period to period, the entity is considered to be consistent in its use of accounting
standards. It does not mean that companies cannot switch from one method of ac-
counting to another. Companies can change methods, but the changes are restricted to
situations in which it can be demonstrated that the newly adopted method is prefer-
able to the old. Then the nature and effect of the accounting change, as well as the jus-
tification for it, must be disclosed in the financial statements for the period in which
the change is made.8
When there has been a change in accounting principles, the auditor refers to it in
an explanatory paragraph of the audit report. This paragraph identifies the nature of
the change and refers the reader to the note in the financial statements that discusses
the change in detail.9
Second Level: Fundamental Concepts • 33
8
Surveys of users indicate that users highly value consistency. They note that a change tends
to destroy the comparability of data before and after the change. Some companies take the time
to assist users to understand the pre- and post-change data. Generally, however, users say they
lose the ability to analyze over time.
9
“Reports on Audited Financial Statements,” Statement on Auditing Standards No. 58 (New
York: AICPA, April 1988), par. 34.

In summary, accounting reports for any given year are more useful if they can be
compared with reports from other companies and with prior reports of the same entity.
Beyond touting nonfinancial measures to investors (see opening story), many compa-
nies are increasingly promoting the performance of their companies through the re-
porting of various “pro forma” earnings measures. A recent survey of newswire reports
found 36 instances of the reporting of pro forma measures in just a 3-day period.
Pro forma measures are standard measures, such as earnings, that are adjusted, usu-
ally for one-time or nonrecurring items. For example, it is standard practice to adjust
earnings for the effects of an extraordinary item. Such adjustments make the numbers
more comparable to numbers reported in periods without the unusual item.
However, rather than increasing comparability, it appears that recent pro forma
reporting is designed to accentuate the positive in company results. Examples of such
reporting include Yahoo! and Cisco, which define pro forma income after adding back
payroll tax expense. And Level 8 Systems transformed an operating loss into a pro
forma profit by adding back expenses for depreciation and amortization of intangible
assets.
Lynn Turner, former Chief Accountant at the SEC, calls such earnings measures
EBS—“everything but bad stuff.” He admonishes investors to view such reporting with
caution and appropriate skepticism.
Source: Adapted from Gretchen Morgenson, “How Did They Value Stocks? Count the Absurd
Ways,” New York Times (March 18, 2001), section 3, p. 1; and Gretchen Morgenson, “Expert Advice:
Focus on Profit,” New York Times (March 18, 2001), section 3, p. 14.
Can you compare pro formas?
What do the
numbers mean?
Basic Elements
An important aspect of developing any theoretical structure is the body of basic ele-
ments or definitions to be included in the structure. At present, accounting uses many
terms that have distinctive and specific meanings. These terms constitute the language
of business or the jargon of accounting.
One such term is asset. Is it something we own? If the answer is yes, can we as-
sume that any leased asset would not be shown on the balance sheet? Is an asset some-
thing we have the right to use, or is it anything of value used by the enterprise to
generate revenues? If the answer is yes, then why should the managers of the enter-
prise not be considered an asset? It seems necessary, therefore, to develop basic defi-
nitions for the elements of financial statements. Concepts Statement No. 6 defines the ten
interrelated elements that are most directly related to measuring the performance and
financial status of an enterprise. We list them here for review and information pur-
poses; you need not memorize these definitions at this point. Each of these elements
will be explained and examined in more detail in subsequent chapters.
OBJECTIVE
Define the basic
elements of financial
statements.
ASSETS. Probable future economic benefits obtained or controlled by a particu-
lar entity as a result of past transactions or events.
LIABILITIES. Probable future sacrifices of economic benefits arising from pres-
ent obligations of a particular entity to transfer assets or provide services to other
entities in the future as a result of past transactions or events.
EQUITY. Residual interest in the assets of an entity that remains after deducting
its liabilities. In a business enterprise, the equity is the ownership interest.
ELEMENTS OF FINANCIAL STATEMENTS

The FASB classifies the elements into two distinct groups. The first group of three
elements (assets, liabilities, and equity) describes amounts of resources and claims to
resources at a moment in time. The other seven elements (comprehensive income and
its components—revenues, expenses, gains, and losses—as well as investments by own-
ers and distributions to owners) describe transactions, events, and circumstances that
affect an enterprise during a period of time. The first class is changed by elements of
the second class and at any time is the cumulative result of all changes. This interac-
tion is referred to as “articulation.” That is, key figures in one statement correspond to
balances in another.
THIRD LEVEL: RECOGNITION
AND MEASUREMENT CONCEPTS
The third level of the framework consists of concepts that implement the basic objec-
tives of level one. These concepts explain which, when, and how financial elements
and events should be recognized, measured, and reported by the accounting system.
Most of them are set forth in FASB Statement of Financial Accounting Concepts No. 5,
Third Level: Recognition and Measurement Concepts • 35
INVESTMENTS BY OWNERS. Increases in net assets of a particular enterprise
resulting from transfers to it from other entities of something of value to obtain
or increase ownership interests (or equity) in it. Assets are most commonly re-
ceived as investments by owners, but that which is received may also include
services or satisfaction or conversion of liabilities of the enterprise.
DISTRIBUTIONS TO OWNERS. Decreases in net assets of a particular enter-
prise resulting from transferring assets, rendering services, or incurring liabilities
by the enterprise to owners. Distributions to owners decrease ownership interests
(or equity) in an enterprise.
COMPREHENSIVE INCOME. Change in equity (net assets) of an entity during
a period from transactions and other events and circumstances from nonowner
sources. It includes all changes in equity during a period except those resulting
from investments by owners and distributions to owners.
REVENUES. Inflows or other enhancements of assets of an entity or settlement
of its liabilities (or a combination of both) during a period from delivering or pro-
ducing goods, rendering services, or other activities that constitute the entity’s
ongoing major or central operations.
EXPENSES. Outflows or other using up of assets or incurrences of liabilities (or
a combination of both) during a period from delivering or producing goods, ren-
dering services, or carrying out other activities that constitute the entity’s ongo-
ing major or central operations.
GAINS. Increases in equity (net assets) from peripheral or incidental transactions
of an entity and from all other transactions and other events and circumstances
affecting the entity during a period except those that result from revenues or in-
vestments by owners.
LOSSES. Decreases in equity (net assets) from peripheral or incidental transac-
tions of an entity and from all other transactions and other events and circum-
stances affecting the entity during a period except those that result from expenses
or distributions to owners.10
10
“Elements of Financial Statements,” Statement of Financial Accounting Concepts No. 6 (Stam-
ford, Conn.: FASB, December 1985), pp. ix and x.

“Recognition and Measurement in Financial Statements of Business Enterprises.” Ac-
cording to SFAC No. 5, to be recognized, an item (event or transaction) must meet the
definition of an “element of financial statements” as defined in SFAC No. 6 and must
be measurable. Most aspects of current practice are consistent with this recognition and
measurement concept.
The accounting profession continues to use the concepts in SFAC No. 5 as opera-
tional guidelines. For discussion purposes, we have chosen to identify the concepts as
basic assumptions, principles, and constraints. Not everyone uses this classification sys-
tem, so it is best to focus your attention more on understanding the concepts than on
how they are classified and organized. These concepts serve as guidelines in develop-
ing rational responses to controversial financial reporting issues.
Basic Assumptions
Four basic assumptions underlie the financial accounting structure: (1) economic en-
tity, (2) going concern, (3) monetary unit, and (4) periodicity.
Economic Entity Assumption
The economic entity assumption means that economic activity can be identified with
a particular unit of accountability. In other words, the activity of a business enterprise
can be kept separate and distinct from its owners and any other business unit. For ex-
ample, if the activities and elements of General Motors could not be distinguished from
those of Ford or DaimlerChrysler, then it would be impossible to know which com-
pany financially outperformed the other two in recent years. If there were no mean-
ingful way to separate all of the economic events that occur, no basis for accounting
would exist.
The entity concept does not apply solely to the segregation of activities among
given business enterprises. An individual, a department or division, or an entire in-
dustry could be considered a separate entity if we chose to define the unit in such a
manner. Thus, the entity concept does not necessarily refer to a legal entity. A par-
ent and its subsidiaries are separate legal entities, but merging their activities for ac-
counting and reporting purposes does not violate the economic entity assumption.11
OBJECTIVE
Describe the basic
assumptions of
accounting.
The importance of the entity assumption is illustrated by scandals involving W.R. Grace,
and more recently, Adelphia Communications Corp. In both cases, top employees of
these companies entered into transactions that blurred the line between the employee’s
financial interests and that of the company. At Adelphia, in one of many self-dealings,
the company guaranteed over $2 billion of loans to the founding family. At W.R. Grace,
company funds were used to pay for an apartment and chef for the company chairman.
These insiders not only benefited at the expense of shareholders but also failed to dis-
close details of the transactions, which would allow shareholders to sort out the impact
of the employee transactions on company results.
Whose company is it?
What do the
numbers mean?
11
The concept of the entity is changing. For example, it is now harder to define the outer
edges of companies. There are public companies, such as Enron, with multiple public subsidiaries,
each with joint ventures, licensing arrangements, and other affiliations. Increasingly, loose affil-
iations of enterprises in joint ventures or customer-supplier relationships are formed and dis-
solved in a matter of months or weeks. These “virtual companies” raise accounting issues about
how to account for the entity. See Steven H. Wallman, “The Future of Accounting and Disclo-
sure in an Evolving World: The Need for Dramatic Change,” Accounting Horizons (September
1995).

Going Concern Assumption
Most accounting methods are based on the going concern assumption—that the busi-
ness enterprise will have a long life. Experience indicates that, in spite of numerous
business failures, companies have a fairly high continuance rate. Although accountants
do not believe that business firms will last indefinitely, they do expect them to last long
enough to fulfill their objectives and commitments.
The implications of this assumption are profound. The historical cost principle
would be of limited usefulness if eventual liquidation were assumed. Under a liqui-
dation approach, for example, asset values are better stated at net realizable value (sales
price less costs of disposal) than at acquisition cost. Depreciation and amortization
policies are justifiable and appropriate only if we assume some permanence to the
enterprise. If a liquidation approach were adopted, the current-noncurrent classifica-
tion of assets and liabilities would lose much of its significance. Labeling anything a
fixed or long-term asset would be difficult to justify. Indeed, listing liabilities on the
basis of priority in liquidation would be more reasonable.
The going concern assumption applies in most business situations. Only where
liquidation appears imminent is the assumption inapplicable. In these cases a total
revaluation of assets and liabilities can provide information that closely approximates
the entity’s net realizable value. Accounting problems related to an enterprise in liqui-
dation are presented in advanced accounting courses.
Monetary Unit Assumption
The monetary unit assumption means that money is the common denominator of eco-
nomic activity and provides an appropriate basis for accounting measurement and
analysis. This assumption implies that the monetary unit is the most effective means
of expressing to interested parties changes in capital and exchanges of goods and ser-
vices. The monetary unit is relevant, simple, universally available, understandable,
and useful. Application of this assumption depends on the even more basic assump-
tion that quantitative data are useful in communicating economic information and in
making rational economic decisions.
In the United States, price-level changes (inflation and deflation) are ignored in
accounting, and the unit of measure—the dollar—is assumed to remain reasonably
stable. This assumption about the monetary unit has been used to justify adding 1970
dollars to 2004 dollars without any adjustment. The FASB in SFAC No. 5 indicated
that it expects the dollar, unadjusted for inflation or deflation, to continue to be used
to measure items recognized in financial statements. Only if circumstances change
dramatically (such as if the United States were to experience high inflation similar to
that in many South American countries) will the FASB again consider “inflation
accounting.”
Periodicity Assumption
The most accurate way to measure the results of enterprise activity would be to mea-
sure them at the time of the enterprise’s eventual liquidation. Business, government,
investors, and various other user groups, however, cannot wait that long for such
information. Users need to be apprised of performance and economic status on a timely
basis so that they can evaluate and compare firms, and take appropriate actions. There-
fore, information must be reported periodically.
The periodicity (or time period) assumption implies that the economic activities
of an enterprise can be divided into artificial time periods. These time periods vary,
but the most common are monthly, quarterly, and yearly.
The shorter the time period, the more difficult it becomes to determine the proper
net income for the period. A month’s results are usually less reliable than a quar-
ter’s results, and a quarter’s results are likely to be less reliable than a year’s results.
Investors desire and demand that information be quickly processed and dissemi-
nated; yet the quicker the information is released, the more it is subject to error. This
Accounting
for Changing Prices
International
Insight
Due to their experiences with
persistent inflation, several
South American countries
produce “constant currency”
financial reports. Typically, a
general price-level index is
used to adjust for the effects of
inflation.

phenomenon provides an interesting example of the trade-off between relevance and
reliability in preparing financial data.
The problem of defining the time period is becoming more serious because prod-
uct cycles are shorter and products become obsolete more quickly. Many believe that,
given technology advances, more online, real-time financial information needs to be
provided to ensure that relevant information is available.
Basic Principles of Accounting
Four basic principles of accounting are used to record transactions: (1) historical cost,
(2) revenue recognition, (3) matching, and (4) full disclosure.
Historical Cost Principle
GAAP requires that most assets and liabilities be accounted for and reported on the
basis of acquisition price. This is often referred to as the historical cost principle.
Cost has an important advantage over other valuations: it is reliable. To illustrate
the importance of this advantage, consider the problems that would arise if we adopted
some other basis for keeping records. If we were to select current selling price, for in-
stance, we might have a difficult time in attempting to establish a sales value for a
given item until it was sold. Every member of the accounting department might have
a different opinion regarding an asset’s value, and management might desire still an-
other figure. And how often would it be necessary to establish sales value? All com-
panies close their accounts at least annually, and some compute their net income every
month. These companies would find it necessary to place a sales value on every asset
each time they wished to determine income—a laborious task and one that would re-
sult in a figure of net income materially affected by opinion. Similar objections have
been leveled against current cost (replacement cost, present value of future cash flows)
and any other basis of valuation except cost.
What about liabilities? Are they accounted for on a cost basis? Yes, they are. If we
convert the term “cost” to “exchange price,” we find that it applies to liabilities as
well. Liabilities, such as bonds, notes, and accounts payable, are issued by a business
enterprise in exchange for assets, or perhaps services, upon which an agreed price has
usually been placed. This price, established by the exchange transaction, is the “cost”
of the liability and provides the figure at which it should be recorded in the accounts
and reported in financial statements.
In general, users have indicated a preference for historical cost because it provides
them a stable and consistent benchmark that can be relied upon to measure historical
trends. However, fair value information is thought to be more useful for certain types
of assets and liabilities and in certain industries. For example, many financial instru-
ments, including derivatives, are reported at fair value, and inventories are reported at
lower of cost or market. Certain industries, such as brokerage houses and mutual funds,
prepare their basic financial statements on a fair value basis.
At initial acquisition, historical cost and fair value are the same. In subsequent
periods, as market and economic conditions change, historical cost and fair value of-
ten diverge. Some believe that fair value measures or estimates are needed to provide
relevant information about the expected future cash flows related to the asset or lia-
bility. For example, when long-lived assets decline in value, a fair value measure is
needed to determine any impairment loss.
Statement of Financial Accounting Concepts No. 7 (SFAC No. 7), “Using Cash Flow
Information and Present Value in Accounting Measurements,” provides a framework
for using expected cash flows and present value techniques to develop fair value esti-
mates. These concepts are applied when reliable fair value information is not available
for certain assets and liabilities. In the case of an impairment, reliable market values of
long-lived assets often are not readily available. In this situation, the principles in SFAC
No. 7 can be applied to derive a fair value estimate for the asset.
As indicated, we presently have a “mixed attribute” system that permits the use
of historical cost, fair value, and other valuation bases. Although the historical cost
OBJECTIVE
Explain the application
of the basic principles
of accounting.

principle continues to be the primary basis for valuation, recording and reporting of
fair value information is increasing.12
Revenue Recognition Principle
A crucial question for many enterprises is when revenue should be recognized. Rev-
enue is generally recognized (1) when realized or realizable and (2) when earned. This
approach has often been referred to as the revenue recognition principle. Revenues
are realized when products (goods or services), merchandise, or other assets are ex-
changed for cash or claims to cash. Revenues are realizable when assets received or
held are readily convertible into cash or claims to cash. Assets are readily convertible
when they are salable or interchangeable in an active market at readily determinable
prices without significant additional cost.
In addition to the first test (realized or realizable), revenues are not recognized until
earned. Revenues are considered earned when the entity has substantially accom-
plished what it must do to be entitled to the benefits represented by the revenues.13
Generally, an objective test—confirmation by a sale to independent interests—is
used to indicate the point at which revenue is recognized. Usually, only at the date of
sale is there an objective and verifiable measure of revenue—the sales price. Any basis
for revenue recognition short of actual sale opens the door to wide variations in prac-
tice. To give accounting reports uniform meaning, a rule of revenue recognition com-
parable to the cost rule for asset valuation is essential. Recognition at the time of sale
provides a uniform and reasonable test.
There are, however, exceptions to the rule, as shown in Illustration 2-3.
12
The FASB and IASB currently are working on a project that will result in reporting all fi-
nancial instruments, both assets and liabilities, at fair value. See for example, FASB, Financial Ac-
counting Series, “Preliminary Views on Major Issues Related to Reporting Financial Instruments
and Related Assets and Liabilities at Fair Value,” No. 204B (December 14, 1999).
13
“Recognition and Measurement in Financial Statements of Business Enterprises,” Statement
of Financial Accounting Concepts No. 5 (Stamford, Conn.: FASB, December 1984), par. 83(a) and (b).
The FASB and the IASB have recently added projects on revenue recognition to their agendas.
The projects will develop a comprehensive statement that is conceptually based and can be ap-
plied to the wide range of revenue transactions that have emerged recently.
Revenue should be recognized in the accounting period
in which it is earned (generally at point of sale).
During
production
End
of production
Time
of sale
Time cash
received
We'll ship the
goods this week.
Thanks for
the order.
ILLUSTRATION 2-3
Timing of Revenue
Recognition
During Production. Recognition of revenue is allowed before the contract is com-
pleted in certain long-term construction contracts. In this method revenue is recog-
nized periodically based on the percentage of the job that has been completed, instead
of waiting until the entire job has been finished. Although technically a transfer of own-
ership has not occurred, the earning process is considered substantially completed at

various stages as construction progresses. If it is not possible to obtain dependable
estimates of cost and progress, then revenue recognition is delayed until the job is
completed.
At End of Production. At times, revenue might be recognized after the production
cycle has ended but before the sale takes place. This is the case when the selling price
and the amount are certain. For instance, if products or other assets are salable in an
active market at readily determinable prices without significant additional cost, then
revenue can be recognized at the completion of production. An example would be the
mining of certain minerals for which, once the mineral is mined, a ready market at a
standard price exists. The same holds true for some artificial price supports set by the
government in establishing agricultural prices.
Upon Receipt of Cash. Receipt of cash is another basis for revenue recognition. The
cash basis approach is used only when it is impossible to establish the revenue figure
at the time of sale because of the uncertainty of collection. One form of the cash basis
is the installment sales method, in which payment is required in periodic installments
over a long period of time. Its most common use is in the retail field. Farm and home
equipment and furnishings are typically sold on an installment basis. The installment
method is frequently justified on the basis that the risk of not collecting an account re-
ceivable is so great that the sale is not sufficient evidence for recognition to take place.
In some instances, this reasoning may be valid. Generally, though, if a sale has been
completed, it should be recognized; if bad debts are expected, they should be recorded
as separate estimates.
Revenue, then, is recorded in the period when realized or realizable and earned. Nor-
mally, this is the date of sale. But circumstances may dictate application of the percentage-
of-completion approach, the end-of-production approach, or the receipt-of-cash approach.
Investors in Lucent Technologies got an unpleasant surprise when the company was
forced to restate its financial results in a recent quarter. What happened? Lucent vio-
lated one of the fundamental criteria for revenue recognition—the “no take-back” rule.
This rule holds that revenue should not be booked on inventory that is shipped if the
customer can return it at some point in the future. In this particular case, Lucent agreed
to take back shipped inventory from its distributors, if the distributors are unable to sell
the items to their customers.
Lucent booked the sales on the shipped goods, which helped it report continued
sales growth. However, Lucent investors got a nasty surprise when those goods were
returned by the distributors. The restatement erased $679 million in revenues, turning
an operating profit into a loss. In response to this bad news, Lucent’s stock price de-
clined $1.31 per share or 8.5 percent.
Lucent has since changed its policy so that it will now record inventory as sold only
if the final customer has bought the equipment, not when the inventory is shipped to
the distributor. The lesson for investors is to review a company’s revenue recognition
policy for indications that revenues are being overstated due to generous return provi-
sions for inventory. And remember, no take-backs!
Source: Adapted from S. Young, “Lucent Slashes First Quarter Outlook, Erases Revenue from Lat-
est Quarter,” Wall Street Journal Online (December 22, 2000).
No take backs!
What do the
numbers mean?
Matching Principle
In recognizing expenses, the approach followed is, “Let the expense follow the rev-
enues.” Expenses are recognized not when wages are paid, or when the work is per-
formed, or when a product is produced, but when the work (service) or the product
actually makes its contribution to revenue. Thus, expense recognition is tied to revenue

Type of Cost Relationship Recognition
Product costs: Direct relationship between Recognize in period of revenue
• Material cost and revenue. (matching).
• Labor
• Overhead
Period costs: No direct relationship Expense as incurred.
• Salaries between cost and
• Administrative costs revenue.
ILLUSTRATION 2-4
Expense Recognition
The problem of expense recognition is as complex as that of revenue recognition, as il-
lustrated by Hollywood accounting. Major motion picture studios have been allowed
to capitalize advertising and marketing costs and to amortize these costs against rev-
enues over the life of the film. As a result, many investors have suggested that the stu-
dios’ profit numbers were overstated. Under a new GAAP standard, these costs now
must be amortized over no more than 3 months; in many cases, they must be expensed
immediately. Similarly, the costs related to abandoned projects often were allocated to
overhead and spread out over the lives of the successful projects. Not anymore. These
costs now must be expensed as they are incurred. Here is a rough estimate of the
amounts of capitalized advertising costs some major studios will have to write off.
Capitalized Advertising
Studio (Parent Company) (in millions)
Columbia Tri-Star (Sony) $200
Paramount (Viacom) 200
20th
Century Fox (News Corp) 150
Why the more conservative approach? A lot has to do with a stricter application of
the definitions of assets and expenses. While many argue that advertising and market-
ing costs have future service potential, difficulty in reliably measuring these benefits
suggests they are not assets. Therefore, a very short amortization period or immediate
write-off is justified. Under these new guidelines, investors will have more reliable meas-
ures for assessing the performance of companies in this industry.
Hollywood accounting
What do the
numbers mean?
recognition. This practice is referred to as the matching principle because it dictates
that efforts (expenses) be matched with accomplishment (revenues) whenever it is
reasonable and practicable to do so.
For those costs for which it is difficult to adopt some type of rational association
with revenue, some other approach must be developed. Often, a “rational and sys-
tematic” allocation policy is used that will approximate the matching principle. This
type of expense recognition pattern involves assumptions about the benefits that are
being received as well as the cost associated with those benefits. The cost of a long-
lived asset, for example, must be allocated over all of the accounting periods during
which the asset is used because the asset contributes to the generation of revenue
throughout its useful life.
Some costs are charged to the current period as expenses (or losses) simply because
no connection with revenue can be determined. Examples of these types of costs are
officers’ salaries and other administrative expenses.
Costs are generally classified into two groups: product costs and period costs.
Product costs such as material, labor, and overhead attach to the product. They are car-
ried into future periods if the revenue from the product is recognized in subsequent
periods. Period costs such as officers’ salaries and other administrative expenses are
charged off immediately, even though benefits associated with these costs occur in the
future, because no direct relationship between cost and revenue can be determined.
These expense recognition procedures are summarized in Illustration 2-4.

The conceptual validity of the matching principle has been a subject of debate. A
major concern is that matching permits certain costs to be deferred and treated as
assets on the balance sheet when in fact these costs may not have future benefits. If
abused, this principle permits the balance sheet to become a “dumping ground” for
unmatched costs. In addition, there appears to be no objective definition of “system-
atic and rational.”
Full Disclosure Principle
In deciding what information to report, the general practice of providing information
that is of sufficient importance to influence the judgment and decisions of an informed
user is followed. Often referred to as the full disclosure principle, it recognizes that
the nature and amount of information included in financial reports reflects a series of
judgmental trade-offs. These trade-offs strive for (1) sufficient detail to disclose matters
that make a difference to users, yet (2) sufficient condensation to make the information
understandable, keeping in mind costs of preparing and using it.
Information about financial position, income, cash flows, and investments can be
found in one of three places: (1) within the main body of financial statements, (2) in
the notes to those statements, or (3) as supplementary information.
The financial statements are a formalized, structured means of communicating
financial information. To be recognized in the main body of financial statements, an
item should meet the definition of a basic element, be measurable with sufficient
certainty, and be relevant and reliable.14
Disclosure is not a substitute for proper accounting. As a former chief accountant
of the SEC recently noted: Good disclosure does not cure bad accounting any more
than an adjective or adverb can be used without, or in place of, a noun or verb. Thus,
for example, cash basis accounting for cost of goods sold is misleading, even if accrual
basis amounts were disclosed in the notes to the financial statements.
The notes to financial statements generally amplify or explain the items presented
in the main body of the statements. If the information in the main body of the finan-
cial statements gives an incomplete picture of the performance and position of the
enterprise, additional information that is needed to complete the picture should be in-
cluded in the notes. Information in the notes does not have to be quantifiable, nor does
it need to qualify as an element. Notes can be partially or totally narrative. Examples
of notes are: descriptions of the accounting policies and methods used in measuring
the elements reported in the statements; explanations of uncertainties and contingen-
cies; and statistics and details too voluminous for inclusion in the statements. The notes
are not only helpful but also essential to understanding the enterprise’s performance
and position.
Supplementary information may include details or amounts that present a differ-
ent perspective from that adopted in the financial statements. It may be quantifiable
information that is high in relevance but low in reliability. Or it may be information
that is helpful but not essential. One example of supplementary information is the data
and schedules provided by oil and gas companies: Typically they provide information
on proven reserves as well as the related discounted cash flows.
Supplementary information may also include management’s explanation of the fi-
nancial information and its discussion of the significance of that information. For
example, many business combinations have produced innumerable conglomerate-type
business organizations and financing arrangements that demand new and peculiar ac-
counting and reporting practices and principles. In each of these situations, the same
problem must be faced: making sure that enough information is presented to ensure
that the reasonably prudent investor will not be misled.
The content, arrangement, and display of financial statements, along with other
facets of full disclosure, are discussed in Chapters 4, 5, 23, and 24.
14
SFAC No. 5, par. 63.

Constraints
In providing information with the qualitative characteristics that make it useful, two
overriding constraints must be considered: (1) the cost-benefit relationship and
(2) materiality. Two other less dominant yet important constraints that are part of the
reporting environment are industry practices and conservatism.
Cost-Benefit Relationship
Too often, users assume that information is a cost-free commodity. But preparers and
providers of accounting information know that it is not. Therefore, the cost-benefit re-
lationship must be considered: The costs of providing the information must be weighed
against the benefits that can be derived from using the information. Standards-setting
bodies and governmental agencies use cost-benefit analysis before making their infor-
mational requirements final. In order to justify requiring a particular measurement or
disclosure, the benefits perceived to be derived from it must exceed the costs perceived
to be associated with it.
The following remark, made by a corporate executive about a proposed standard,
was addressed to the FASB: “In all my years in the financial arena, I have never seen
such an absolutely ridiculous proposal. . . . To dignify these ‘actuarial’ estimates
by recording them as assets and liabilities would be virtually unthinkable except for
the fact that the FASB has done equally stupid things in the past. . . . For God’s sake,
use common sense just this once.”15
Although this remark is extreme, it does indicate
the frustration expressed by members of the business community about standards set-
ting and whether the benefits of a given standard exceed the costs.
The difficulty in cost-benefit analysis is that the costs and especially the benefits are
not always evident or measurable. The costs are of several kinds, including costs of col-
lecting and processing, costs of disseminating, costs of auditing, costs of potential liti-
gation, costs of disclosure to competitors, and costs of analysis and interpretation. Ben-
efits accrue to preparers (in terms of greater management control and access to capital)
and to users (in terms of better information for allocation of resources, tax assessment,
and rate regulation). But benefits are generally more difficult to quantify than are costs.
Most recently, the AICPA Special Committee on Financial Reporting submitted the
following constraints to limit the costs of reporting.
Business reporting should exclude information outside of management’s expertise
or for which management is not the best source, such as information about com-
petitors.
Management should not be required to report information that would significantly
harm the company’s competitive position.
A classic illustration of the problem of determining adequate disclosure guidelines is
the question of what banks should disclose about loans made for highly leveraged trans-
actions such as leveraged buyouts. Investors want to know what percentage of a bank’s
loans are of this risky type. The problem is what do we mean by “leveraged”? As one
regulator noted, “If it looks leveraged, it probably is leveraged, but most of us would
be hard-pressed to come up with a definition.” Is a loan to a company with a debt to
equity ratio of 4 to 1 highly leveraged? Or is high leverage 8 to 1, or 10 to 1? The prob-
lem is complicated because some highly leveraged companies have cash flows that cover
interest payments. Therefore, they are not as risky as they might appear. In short, pro-
viding the appropriate disclosure to help investors and regulators differentiate risky
from safe is difficult.
How’s your leverage?
What do the
numbers mean?
OBJECTIVE
Describe the impact
that constraints have on
reporting accounting
information.
15
“Decision-Usefulness: The Overriding Objective,” FASB Viewpoints (October 19, 1983), p. 4.

Management should not be required to provide forecasted financial statements.
Rather, management should provide information that helps users forecast for them-
selves the company’s financial future.
Other than for financial statements, management need only report the information
it knows. That is, management should be under no obligation to gather informa-
tion it does not have, or need, to manage the business.
Certain elements of business reporting should be presented only if users and man-
agement agree they should be reported—a concept of flexible reporting.
Companies should not have to report forward-looking information unless there are
effective deterrents to unwarranted litigation that discourages companies from do-
ing so.
Materiality
The constraint of materiality relates to an item’s impact on a firm’s overall financial op-
erations. An item is material if its inclusion or omission would influence or change the
judgment of a reasonable person.16
It is immaterial and, therefore, irrelevant if it would
have no impact on a decision maker. In short, it must make a difference or it need not
be disclosed. The point involved here is one of relative size and importance. If the
amount involved is significant when compared with the other revenues and expenses,
assets and liabilities, or net income of the entity, sound and acceptable standards should
be followed. If the amount is so small that it is unimportant when compared with other
items, application of a particular standard may be considered of less importance.
It is difficult to provide firm guides in judging when a given item is or is not ma-
terial because materiality varies both with relative amount and with relative impor-
tance. For example, the two sets of numbers presented below illustrate relative size.
Company A Company B
Sales $10,000,000 $100,000
Costs and expenses 9,000,000 90,000
Income from operations $ 1,000,000 $ 10,000
Unusual gain $ 20,000 $ 5,000
ILLUSTRATION 2-5
Materiality Comparison
During the period in question, the revenues and expenses, and therefore the net
incomes of Company A and Company B, have been proportional. Each has had an un-
usual gain. In looking at the abbreviated income figures for Company A, it does not
appear significant whether the amount of the unusual gain is set out separately or
merged with the regular operating income. It is only 2 percent of the net income and,
if merged, would not seriously distort the net income figure. Company B has had an
unusual gain of only $5,000, but it is relatively much more significant than the larger
gain realized by A. For Company B, an item of $5,000 amounts to 50 percent of its net
income. Obviously, the inclusion of such an item in ordinary operating income would
affect the amount of that income materially. Thus we see the importance of the relative
size of an item in determining its materiality.
Companies and their auditors for the most part have adopted the general rule of
thumb that anything under 5 percent of net income is considered not material. Recently
16
SFAC No. 2 (par. 132) sets forth the essence of materiality: “The omission or misstatement
of an item in a financial report is material if, in the light of surrounding circumstances, the mag-
nitude of the item is such that it is probable that the judgment of a reasonable person relying
upon the report would have been changed or influenced by the inclusion or correction of the
item.” This same concept of materiality has been adopted by the auditing profession. See “Au-
dit Risk and Materiality in Conducting an Audit,” Statement on Auditing Standards No. 47 (New
York: AICPA, 1983), par. 6.

the SEC has indicated that it is acceptable to use this percentage for an initial assess-
ment of materiality, but that other factors must also be considered.17
For example, com-
panies can no longer fail to record items in order to meet consensus analysts’ earnings
numbers, preserve a positive earnings trend, convert a loss to a profit or vice versa,
increase management compensation, or hide an illegal transaction like a bribe. In other
words, both quantitative and qualitative factors must be considered in determining
whether an item is material.
The SEC has also indicated that in determining materiality companies must con-
sider each misstatement separately and the aggregate effect of all misstatements. For
example, at one time, General Dynamics disclosed that its Resources Group had
improved its earnings by $5.8 million at the same time that one of its other subsidiaries
had taken write-offs of $6.7 million. Although both numbers were far larger than the
$2.5 million that General Dynamics as a whole earned for the year, neither was dis-
closed as unusual because the net effect on earnings was considered immaterial. This
practice is now prohibited because each item must be considered separately. In addition,
even though an individual item may be immaterial, it may be considered material when
added to other immaterial items. Such items must be disclosed.
Materiality is a factor in a great many internal accounting decisions, too. The
amount of classification required in a subsidiary expense ledger, the degree of accuracy
required in prorating expenses among the departments of a business, and the extent to
which adjustments should be made for accrued and deferred items, are examples of
judgments that should finally be determined on a basis of reasonableness and practi-
cability, which is the materiality constraint sensibly applied. Only by the exercise of
good judgment and professional expertise can reasonable and appropriate answers
be found.
Arguing that a questionable accounting item is immaterial has been the first line of
defense for many companies caught “cooking the books.” That defense is not working
so well lately, in the wake of recent accounting meltdowns at Enron and Global Cross-
ing and the tougher rules on materiality issued by the SEC (SAB 99). For example, in its
case against Sunbeam, the SEC alleged that the consumer-products maker racked up so
many immaterial adjustments under CEO Al “Chainsaw” Dunlap that they added up to
a material misstatement that misled investors about the company’s financial position.
Responding to new concerns about materiality, blue-chip companies, such as IBM
and General Electric are providing expanded disclosures of transactions that used to
fall below the materiality radar. Thus, some good may yet come out of these recent ac-
counting failures.
Source: Adapted from K. Brown and J. Weil, “A Lot More Information Is ‘Material’ After Enron,”
Wall Street Journal Online (February 22, 2002).
Living in a material world
What do the
numbers mean?
Industry Practices
Another practical consideration is industry practices. The peculiar nature of some
industries and business concerns sometimes requires departure from basic theory. In
the public utility industry, noncurrent assets are reported first on the balance sheet to
highlight the industry’s capital-intensive nature. Agricultural crops are often reported
at market value because it is costly to develop accurate cost figures on individual crops.
Such variations from basic theory are not many, yet they do exist. Whenever we find
what appears to be a violation of basic accounting theory, we should determine whether
17
“Materiality,” SEC Staff Accounting Bulletin No. 99 (Washington, D.C.: SEC, 1999).

Other documents randomly have
different content

v. [Son histoire.]
[Faust. Byz.
Hist. Arm. l. 4,
c. 2.
Mos. Chor. Hist.
Arm. l. 2, c. 78
et 81.]
[Mesrob. Hist.
de Nersès, en
Arm. c. 1.]
l'Asie, assez près des frontières orientales de la Perse[146], la partie
n'aurait pas été égale, surtout dans un moment où, pour conserver
la possession de l'Arménie, Sapor était obligé de résister aux
Romains, qui voulaient rétablir dans ce royaume l'Arsacide Tiridate,
qui en avait été dépouillé par Ardeschir. Pour satisfaire le monarque
chinois, sans outrager la mémoire de son père, en retirant à
Mamgon la protection que ce prince lui avait assurée, il engagea le
fugitif à s'éloigner de la Perse et à diriger ses pas vers l'Arménie.
«Je l'ai chassé de mes états, répondit-il aux ambassadeurs chinois,
je l'ai relégué à l'extrémité de la terre, aux lieux où le soleil se
couche; c'est l'avoir envoyé à une mort certaine.»
[143] Dans une Dissertation sur l'origine de la famille des
Orpélians et de plusieurs autres colonies chinoises établies en
Arménie et en Georgie, insérée dans le tome second de mes
Mémoires historiques et géographiques sur l'Arménie, j'ai
rassemblé toutes les raisons qui me semblent démontrer l'identité
de ces deux pays.—S.-M.
[144] La dynastie qui chassa les Han, portait le nom de 'Weï.—S.-
M.
[145] Ce prince mourut vers l'an 240 de J.-C.—S.-M.
[146] Dans le siècle précédent le général chinois Pan-tchao,
gouverneur général de l'Asie centrale, pour l'empereur des Han,
avait porté ses armes jusqu'au bord de la mer Caspienne, et on
avait agité dans son camp la question de savoir si on passerait
cette mer, pour pénétrer dans le Ta-thsin ou l'empire romain.—S.-
M.
—[Mamgon et les siens menèrent pendant plusieurs
années une vie errante au milieu de l'Arménie, mais
quand Tiridate y revint soutenu par les Romains, et
qu'il fit tous ses efforts pour recouvrer la couronne
de ses aïeux[147], Mamgon s'empressa d'aller à sa
rencontre et de lui offrir ses services. Ils furent
acceptés[148] et bientôt récompensés. La puissante
famille des Selkouniens[149] dévouée à la cause du
roi de Perse, possédait le canton de Daron. Seloug,
leur chef, avait profité d'une absence faite par

Tiridate, rétabli sur son trône, pour se révolter et
joindre ses forces aux troupes de Sapor, qui était rentré en Arménie.
Dans le même temps les peuples du nord, excités par les Persans,
pénétraient par un autre côté dans ce royaume. Oda prince des
Amadouniens[150] que Tiridate avait chargé en partant de défendre
ses états, fut tué par Seloug, son gendre, qui aurait peut-être envahi
tout le royaume, sans le prompt retour de Tiridate. Celui-ci après
avoir repoussé Sapor, dirigea ses efforts contre les Barbares du
nord. Cependant les Selkouniens refusaient avec opiniâtreté de
rentrer sous les lois de leur souverain légitime, et Seloug réfugié
dans la forteresse de Slagan, paraissait décidé à s'y défendre
jusqu'à la dernière extrémité. Tiridate chargea Mamgon de le
réduire; il y réussit. Les Selkouniens furent exterminés[151]; il n'en
échappa que deux qui se réfugièrent dans la Sophène[152]. Leurs
biens concédés au vainqueur devinrent l'héritage de la postérité de
Mamgon. Ce guerrier montra encore en d'autres occasions son
attachement pour le roi d'Arménie, qui lui témoigna sa
reconnaissance par la haute faveur et le rang distingué qu'il lui
accorda. Ses descendants ne furent pas moins illustres que lui, par
les services signalés qu'ils rendirent au pays qui était devenu pour
eux une autre patrie. Vatché, fils de Mamgon, revêtu de la dignité de
connétable du royaume, périt en combattant les Perses. Ses enfants
préférèrent perdre leurs domaines et vivre dans des régions
sauvages reléguées à l'extrémité de l'Arménie, plutôt que de subir le
joug des Perses, quand la trahison livra le roi Diran entre les mains
de Sapor. Leur courage, leur fidélité et leurs brillantes qualités
avaient fixé sur eux les yeux de toute la nation dont ils étaient
l'espérance, et Arsace en les rappelant dut céder au vœu d'un
peuple entier. Ils étaient alors quatre frères; Vartan, Vasag, Vahan et
Varoujan: ils descendaient à la quatrième génération de Mamgon;
leur père Ardavazt était fils de Vatché, fils de Mamgon. Vartan l'aîné
reçut l'investiture de la province de Daron, son héritage paternel, et
Vasag fut créé connétable. Pour les deux autres, des
commandements et des charges militaires leur furent donnés. Vasag
se montra constamment digne du haut rang qui lui avait été conféré.
Pendant trente ans il ne cessa de donner des témoignages éclatants
de son dévouement, quelquefois un peu jaloux, pour son prince et

vi. [Nersès est
déclaré
patriarche
d'Arménie.]
[Faust. Byz.
Hist. Arm. l. 4,
c. 3.
Mos. Chor. Hist.
Arm. l. 3, c. 20.
Mesrob, Hist. de
Ners. c. 1.]
son pays, tant dans les conseils que sur les champs de bataille,
jusqu'au jour fatal où sa fidélité fut scellée de son sang.
[147] C'est en l'an 259 que Tiridate rentra en Arménie. Voyez ci-
devant livre I, § 75, t. 1, p. 76.—S.-M.
[148] Moïse de Khoren remarque cependant (lib. 2, c. 78) que
Tiridate, en acceptant les offres de Mamgon, eut la délicatesse de
ne pas le mener avec lui combattre les Persans, sans doute à
cause des liens d'hospitalité qui avaient existé entre le prince
chinois et le roi de Perse.—S.-M.
[149] Cette famille faisait remonter son origine jusqu'à Haik, le
fondateur du royaume d'Arménie. Depuis le temps de Valarsace,
premier roi arsacide, elle possédait par droit d'hérédité le pays de
Daron.—S.-M.
[150] Sur l'origine des Amadouniens, voyez ci-devant, l. vi, § 14, t.
1, p. 410, note 1.—S.-M.
[151] Tiridate, selon Moïse de Khoren (l. 2, c. 81), ordonna
d'épargner ceux des Selkouniens qui échappèrent à la ruine de
leur famille. Il fait mention (l. 3, c. 20) de Gind, un de leurs
descendants, qui vivait sous le règne d'Arsace.—S.-M.
[152] La Sophène était au sud de l'Arménie et limitrophe de la
Mésopotamie.—S.-M.
—[Arsace ne se borna pas à rétablir l'ordre dans
l'administration civile et militaire du royaume; la
religion fut aussi l'objet de ses soins. Depuis la mort
de Housig ou Hésychius, dernier rejeton de saint
Grégoire, qui avait occupé le trône patriarchal de
l'Arménie, une horrible corruption s'était répandue
dans ce pays; des pontifes indignes du sacré
caractère dont ils étaient revêtus y donnaient eux-
mêmes l'exemple du scandale. Le désordre était
universel. Le patriarche Pharhnerseh vertueux, mais
faible, n'avait pu remédier à de tels maux. Son
successeur Sahag[153], non moins respectable que
lui, ne fut pas plus énergique. La foi chrétienne
semblait prête à s'éteindre. Les partisans de l'ancien culte encore
assez nombreux et les sectateurs de la religion persanne,
cherchaient à profiter d'un tel état de choses, pour bannir le

christianisme qui était établi depuis trop peu de temps en Arménie,
et qui n'avait pu y jeter de profondes racines. Il aurait fallu qu'un
nouvel apôtre vînt raffermir l'édifice élevé par saint Grégoire. Au
moment où on l'espérait le moins, cet homme divin parut pour le
salut de l'Arménie. On s'occupait dans une grande assemblée, de
choisir un successeur aux pontifes qui depuis la mort d'Hésychius
avaient rempli le trône de saint Grégoire, quand le bruit se répandit
qu'il existait un descendant du saint patriarche, digne de son aïeul
par ses vertus. C'était Nersès fils d'Athanaginé, fils d'Hésychius. Sa
mère Pampisch était sœur du roi Diran, et par conséquent tante
d'Arsace. Élevé dans sa jeunesse à Césarée de Cappadoce, il avait
été ensuite à Constantinople, où il s'était instruit dans la religion et
les lettres des Grecs; il y avait épousé la fille d'un personnage
distingué nommé Appion, dont il eut un fils unique, Sahag, qui fut
dans la suite patriarche de l'Arménie. Veuf après trois ans de
mariage, Nersès, de retour dans sa patrie, y avait embrassé la
profession des armes. Revêtu de plusieurs dignités militaires, il y
joignait celle de chambellan, dont il exerçait les fonctions auprès de
la personne du roi. Il était encore fort jeune, mais ses vertus
éclatantes et sa valeur lui avaient concilié l'estime universelle. Sa
beauté, sa haute taille et son air majestueux, inspiraient le respect à
tous ceux qui l'approchaient. On n'eut besoin que de prononcer son
nom pour diriger vers lui tous les suffrages, et avec un concert
unanime de louanges, on lui décerna le sceptre patriarchal. Lui seul
sera notre pasteur, s'écriait-on de tous les côtés. Nul autre ne
s'assoira sur le trône épiscopal. Dieu le veut. Étranger à ce grand
mouvement, à tant d'honneurs, il voulut s'y soustraire. Il essaie
d'échapper aux vœux impatients de tout un peuple. Le roi s'indigne,
l'arrête et lui arrachant l'épée royale qu'il portait comme une marque
distinctive de sa dignité, il ordonne de le revêtir sur-le-champ des
habits pontificaux. Un vieil évêque, appelé Faustus, lui confère
aussitôt tous les grades ecclésiastiques, et il est proclamé patriarche
au grand contentement de tous les Arméniens. Son inauguration eut
lieu en l'an 340.
[153] Moïse de Khoren s'est trompé (l. 3, c. 39) en faisant ce
Sahag successeur de Nersès 1er, tandis qu'il fut au contraire son
prédécesseur comme l'atteste Faustus de Byzance (l. 3, c. 17). Le

vii. [Il est sacré
à Césarée.]
[Faust. Byz.
Hist. Arm. l. 4,
c. 4.
Mesrob, Hist. de
Ners. c. 1.]
successeur de Nersès, qui n'est connu que par le même historien
(l. 5, c. 29), fut un certain Housig on Hésychius. Il fut remplacé par
un autre Sahag ou Schahag. Comme Faustus était contemporain
de ces trois patriarches, son témoignage doit être irrécusable. Ce
qui a pu donner lieu à l'erreur de Moïse de Khoren, c'est que tous
trois ils étaient de la même famille, de la race d'Albianus, évêque
de Manavazakerd, compagnon de saint Grégoire dans ses
travaux apostoliques.—S.-M.
—[Depuis le temps de saint Grégoire, il était d'usage
que les patriarches de la Grande-Arménie fussent
sacrés à Césarée en Cappadoce. C'est dans cette
ville que l'apôtre de l'Arménie avait été élevé, et qu'il
avait été instruit dans la religion chrétienne: c'est là
qu'il avait reçu de saint Léonce la mission d'appeler
à l'évangile les peuples encore idolâtres, et qu'il
avait été ordonné évêque. Césarée était, pour ainsi
dire, la mère spirituelle de l'Arménie. Pour se
conformer à l'usage de ses prédécesseurs, Nersès résolut d'aller y
chercher la confirmation du titre éminent qu'il venait d'obtenir. Sur
l'ordre du roi, les plus illustres seigneurs furent désignés pour
assister à son sacre. Antiochus, prince de Siounie, Arschavir, chef
de la race de Camsar, Pakarad, de l'antique famille des Pagratides,
et plusieurs autres non moins nobles[154], le suivirent à Césarée. Un
grand concours d'évêques accourut des contrées voisines, pour
prendre part à cette auguste cérémonie. Lorsque Nersès revint en
Arménie, Arsace et sa cour allèrent à sa rencontre jusqu'à la
frontière. Sous la direction spirituelle de ce saint personnage, la foi
ne tarda pas à refleurir en Arménie; les églises ruinées, les autels
renversés furent rétablis; de nouveaux temples dédiés au vrai Dieu
s'élevèrent sur les débris des édifices idolâtres; des hôpitaux, des
monastères furent fondés; les mœurs s'adoucirent; l'instruction fit
des progrès; enfin si Nersès n'avait pas été arrêté dans la noble
mission qu'il s'était imposée, s'il n'avait pas trouvé des obstacles de
toute espèce, l'Arménie serait parvenue au plus haut degré de
prospérité. Ses travaux furent trop tôt interrompus, et l'Arménie
privée de son pasteur fut déchirée par des maux qui, sans cesse

viii. [Alliance
d'Arsace et de
Sapor.]
[Faust. Byz.
Hist. Arm. l. 4.
c. 16 et 17.
Mesrob, Hist. de
Ners. c. 1 et 5.]
renouvelés, finirent par la livrer sanglante et désolée aux mains de
ses oppresseurs.
[154] Ces autres personnages étaient le grand eunuque; Daniel,
prince de la Sophène; Mehentak, dynaste des Reschdouniens;
Nouïn, dynaste de la Sophène royale; et Bargev, prince de la race
des Amadouniens.—S.-M.
—[Cependant la bonne intelligence subsistait
toujours entre les rois d'Arménie et de Perse: celui-
ci, pour resserrer les nœuds de leur alliance, avait
invité Arsace à venir dans sa capitale. Il y fut comblé
d'honneurs et de présents; Sapor le traita comme un
frère ou comme un fils bien-aimé: vêtus d'ornements
pareils, le front chargé d'un diadème semblable, ils
paraissaient dans les festins assis sur un même
trône, et le temps s'écoulait au milieu des plaisirs.
Sapor avait déclaré Arsace son second, et lui avait
fait don d'un magnifique palais dans l'Atropatène. Rien ne semblait
pouvoir troubler l'harmonie des deux princes. Un jour Arsace visitait
les écuries de Sapor; l'intendant, au lieu de lui rendre les honneurs
qui lui étaient dus, se permit en persan quelques paroles
inconsidérées. Pourquoi, dit-il en faisant allusion à la nature
montagneuse des états d'Arsace, le roi des chèvres d'Arménie vient-
il brouter l'herbe de nos pâturages? Le connétable Vasag entendit ce
propos grossier; il ne put retenir son indignation, et ce malheureux
fut tué. Vasag eut plusieurs fois occasion, de donner de pareilles
marques de son attachement à son souverain. Bien loin d'en être
irrité, Sapor lui en témoigna au contraire sa satisfaction. Cependant
malgré toutes les marques d'amitié qu'il ne cessait de prodiguer à
Arsace, le roi de Perse conservait toujours des inquiétudes dans le
fond de son cœur, il ne pouvait être persuadé de la sincérité de ce
prince; il appréhendait que tôt ou tard des conseils ou son propre
intérêt ne lui ouvrissent les yeux et ne le détachassent de son
alliance, pour le porter à s'unir avec l'empereur contre lui. Les
sollicitudes de Sapor furent si grandes, que, pour les calmer, il fallut
décider Arsace à jurer sur les saints évangiles en présence de tous
les prêtres de Ctésiphon[155], que jamais il ne le tromperait, que
jamais il ne se séparerait de lui. Le prince des Mamigoniens Vartan,

en qui le roi de Perse avait une entière confiance, avait été chargé
de cette négociation. Son frère Vasag, déja irrité contre lui, par une
querelle dont l'amour était cause, fut jaloux de cette faveur, il craignit
pour son crédit auprès d'Arsace et il résolut de brouiller les deux
rois. Il y parvint par ses intrigues; il réussit à jeter des soupçons dans
l'ame d'Arsace, qui, alarmé pour sa sûreté, prit le parti d'abandonner
secrètement la résidence du roi de Perse, et de s'enfuir dans ses
états. Tous les doutes de Sapor se réveillèrent alors; la répugnance
qu'Arsace avait montrée à prononcer les serments qu'il avait exigés,
lui parut la preuve de sa perfidie; il n'eut plus dès lors aucune
confiance en la sincérité du prince arménien. Sa colère retomba sur
les malheureux chrétiens qui habitaient ses états; la fuite d'Arsace
fut ainsi une des causes qui excitèrent la sanglante persécution[156]
qu'ils eurent à souffrir. Sapor jura par le soleil, par l'eau et par le feu,
les plus grandes divinités de la Perse, qu'il n'épargnerait aucun
chrétien. Le prêtre Mari[157] et tout le clergé de Ctésiphon, qui
avaient reçu les promesses d'Arsace, furent ses premières victimes
et bientôt le sang des fidèles coula par torrent. L'évangile sur lequel
Arsace avait juré fut déposé dans le trésor royal, où, lié avec des
chaînes de fer, il resta pour y être à jamais le témoin irréfragable des
serments de ce prince.
[155] La ville de Ctésiphon, ancienne capitale de l'empire des
Parthes, était sur les bords du Tigre du côté de l'orient. Le cours
de ce fleuve la séparait de Séleucie, ville grecque grande et
peuplée. Sous les Sassanides, Séleucie on plutôt le bourg de
Coché qui en était voisin, et Ctésiphon furent réunies sous la
dénomination de Madaïn, c'est-à-dire en arabe, les deux villes.
C'était sans doute la traduction d'un nom qui avait le même sens
dans la langue de cette partie de la Perse. Les Arméniens
l'appelaient Dispon, c'est une altération de Ctésiphon. On
retrouve ce nom dans les écrivains arabes et persans sous la
forme Tisfoun.—S.-M.
[156] Voyez ci-devant, liv. v, § 22, t. 1, p. 331.—S.-M.
[157] Le nom de Mari est fort commun chez les Syriens. On
rencontre plusieurs personnages ainsi appelés, parmi ceux qui
périrent dans les persécutions suscitées par Sapor, mais aucun
d'eux ne peut être celui dont il est question ici. Ils moururent tous
vers la fin du règne de Sapor, ainsi long-temps après l'époque

ix. [Nersès
envoyé à C. P.
est exilé par
Constance.]
[Faust. Byz.
Hist. Arm. lib. 4,
c. 5, 11, 12 et
20.
Mos. Chor. Hist.
Arm. l. 3, c. 20.
Mesrob, Hist. de
Ners. c. 3.]
dont il s'agit. C'est en l'an 347 environ que Baaschemin, évêque
de Ctésiphon, fut martyrisé par les ordres de ce prince, avec une
grande partie de son clergé, dans lequel était sans doute Mari,
dont il est parlé dans le texte de cette histoire.—S.-M.
—[Arsace, de retour dans son royaume, continua
d'entretenir des relations amicales avec Sapor,
malgré les craintes que ce monarque lui inspirait, ou
peut-être même à cause de ces craintes. Il restait
aussi en bonne intelligence avec Constance.
Comme les deux empires étaient alors engagés
dans une guerre opiniâtre qui avait fort affaibli Sapor,
Arsace n'eut pas de peine à conserver une neutralité
que personne n'était intéressé à lui contester. Il
espérait profiter de sa position et faire acheter
chèrement ses secours à celui qui en aurait besoin.
Il fut trompé dans son attente: personne n'eut
recours à lui; et le roi de Perse ayant obtenu à la fin
quelque supériorité sur Constance, sa situation
devint difficile. Ne pouvant plus garder une dangereuse neutralité,
Arsace devait appréhender que tôt ou tard Sapor, déja mécontent de
lui, ne vînt l'inquiéter jusque dans son royaume. Pour se préserver
d'un tel malheur, et se procurer des ressources, il songea à resserrer
l'alliance qui depuis long-temps unissait l'Arménie avec l'empire. Le
patriarche Nersès et dix des principaux seigneurs[158] du royaume
furent envoyés à Constantinople pour y renouveler les anciens
traités. En partant, Nersès laissa pour le remplacer dans ses
fonctions spirituelles un personnage très-révéré, Khad, archevêque
de Pakrévant. A l'époque du voyage de Nersès à Constantinople, on
était au plus fort des troubles causés par les discussions
théologiques que les Ariens avaient suscitées. Les évêques
orthodoxes, chassés de leurs siéges, fuyaient partout devant les
hérétiques, et Constance secondait leurs fureurs de tout son pouvoir.
Nersès partagea les malheurs des prélats persécutés; la pureté de
sa foi et sa courageuse résistance irritèrent l'empereur. Constance
dans sa colère, ne respecta pas le droit des gens, le titre
d'ambassadeur ne put être une sauve-garde pour Nersès, qui fut
contraint de subir un dur exil, dans une île déserte.

x. [Guerre
d'Arsace contre
les Romains.]
[Faust. Byz.
Hist. Arm. l. 4,
c. 11.
Mos. Chor. Hist.
Arm. l. 3, c. 19
et 20.
Mesrob, Hist. de
Ners. c. 3.]
[158] Vartan, dynaste des Mamigoniens; son frère le connétable
Vasag; Mehentag, dynaste des Rheschdouniens; Mehar, des
Andsevatsiens; Gardchoïl Malkhaz, des Khorkhorhouniens;
Mouschk, des Saharhouniens; Domed on Domitius, des
Genthouniens; Kischken, des Bageniens; Sourik, de la vallée de
Hersig; et Verken, des Hapoujiens.—S.-M.
—[Les autres députés arméniens, qui avaient été
corrompus par Constance, revinrent dans leur patrie
chargés de ses dons. Ils portaient en outre de riches
présents destinés à leur roi, auprès duquel ils
devaient accuser le patriarche. L'empereur, pour
apaiser le ressentiment d'Arsace, rendit encore la
liberté à deux princes du sang royal d'Arménie, qui
étaient gardés depuis long-temps comme otages à
Constantinople, et il les renvoya dans leur pays. Ils
étaient neveux d'Arsace; l'un, Dirith, était fils
d'Ardaschès, frère aîné de ce monarque, qui avait
cessé de vivre lorsque Diran, leur père, occupait le
trône. Le dernier, nommé Gnel, avait pour père
Tiridate, autre frère d'Arsace, mais moins âgé. Tiridate avait été
envoyé aussi en otage à Constantinople par son père Diran, et il y
avait été mis à mort, après quelques hostilités commises par les
Arméniens contre l'empire. C'est depuis cette époque que ces deux
princes étaient prisonniers. La nouvelle de la captivité de Nersès
causa une désolation universelle en Arménie; des jeûnes, des
prières y furent ordonnés, et pendant son absence, on ne cessa
d'implorer le Seigneur pour obtenir son retour. Constance n'en avait
pas fait assez pour calmer Arsace et le résoudre à endurer
patiemment l'outrage qu'il avait éprouvé, en la personne du
patriarche. Il résolut d'en tirer vengeance; un armement considérable
se fit, et le connétable Vasag eut ordre d'entrer sur le territoire de
l'empire et de pénétrer dans la Cappadoce. Ce général porta ses
ravages jusque dans les environs d'Ancyre en Galatie, puis il revint
en Arménie. Ces courses se renouvelèrent pendant six ans, et elles
causèrent beaucoup de mal à l'empire. De tels actes d'hostilité
dissipèrent les soupçons de Sapor, et ses ambassadeurs vinrent
trouver Arsace pour lui rappeler leur ancienne amitié, promettant de

xi. [Tyrannie
d'Arsace.]
[Faust. Byz.
Hist. Arm. l. 4,
c. 12.
Mos. Chor. Hist.
Arm. l. 3, c. 19
et 27.
Mesrob, Hist. de
Nersès, c. 4.]
le traiter en frère, s'il joignait ses forces aux armées persanes
destinées à combattre les Romains. Arsace y consentit, et dès lors il
prit part à toutes les entreprises militaires du roi de Perse contre
Constance.
—[L'éloignement et l'exil de Nersès avait été fatal à
l'Arménie et à son roi. Arsace, dirigé jusqu'alors par
ce vertueux personnage, était resté irréprochable. Il
n'en devait pas être long-temps ainsi; jeune, livré à
ses passions, et privé du guide qui en avait arrêté
l'essor, Arsace s'y abandonna sans réserve, et
bientôt il fut un des princes les plus vicieux.
L'archevêque de Pakrévant[159] lui en fit de vifs
reproches, mais sa voix fut impuissante. Arsace
méprisa ses avis, et, livré tout entier à ses
courtisans, il se plongea plus que jamais dans les
débauches et les plaisirs. Ses excès n'eurent plus de
bornes, et pour n'être pas exposé à trouver près de lui des censeurs
importuns, il quitta sa capitale et fixa son séjour dans une vallée
délicieuse située vers les sources méridionales de l'Euphrate[160].
Là, dans un site enchanteur, il jeta les fondements d'une ville qu'il
appela de son nom Arschagavan, c'est-à-dire la demeure d'Arsace.
Cette ville, toute consacrée aux plaisirs, devint le théâtre de la
licence la plus effrénée. Arsace n'y reçut que les gens qui
partageaient et ses goûts et ses vices, de sorte qu'elle devint bientôt
l'asyle de tout ce qu'il y avait de criminel en Arménie. L'archevêque
de Pakrévant y poursuivit son roi; il ne fut point épouvanté de tant
d'horreurs, il y vint reprocher à Arsace ses débordements. Son zèle
fut encore une fois sans succès: Arsace, excédé de ses
représentations et de ses conseils, le fit ignominieusement chasser
de sa présence.
[159] Ce canton, nommé Bagrandavène par Ptolémée (l. 5, c. 13)
dépendait de la province d'Ararad, et était situé vers les sources
de l'Euphrate méridional, au pied du mont Nébad ou Niphatès.
Voyez mes Mémoires historiques et géogr. sur l'Arménie, t. 1, p.
108.—S.-M.

xii. [Intrigues à
la cour
d'Arsace.]
[Faust. Byz.
Hist. Arm. l. 4,
c. 13 et 15.
Mos. Chor. Hist.
Arm. l. 3, c. 22.
Mesrob, Hist. de
Ners. c. 2.]
[160] Cette ville était dans un canton nommé Gog ou Gogovid,
dépendant de la province d'Ararad, à l'occident du mont Masis ou
Ararat.—S.-M.
—[Lorsque Nersès revint de son exil[161], il trouva
l'Arménie très-changée; le bien qu'il y avait fait n'était
plus; la conduite du roi avait mis le désordre partout.
Arsace reçut le patriarche avec honneur; il lui
témoigna la joie qu'il ressentait de son retour, lui
prodiguant les distinctions comme par le passé; mais
il resta sourd à ses remontrances. Ce prince ne
tarda pas à mettre le comble à toutes les infamies
dont il était déja coupable; il y joignit les crimes les
plus affreux. Son neveu Gnel était revenu de
Constantinople, chargé des faveurs de l'empereur.
Constance lui avait accordé les ornements
consulaires[162], voulant ainsi le consoler de la fin cruelle de son
père, mis injustement à mort. Gnel s'était retiré auprès du vieux roi
Diran, son aïeul, qui passait tranquillement ses dernières années
dans la délicieuse retraite qu'il avait choisie au pied du mont
Arakadz. Diran se regardait comme la cause de la mort de Tiridate,
père de Gnel, qu'il avait donné comme otage à l'empereur. Ce
malheur lui avait fait concevoir une amitié d'autant plus vive pour le
fils que Tiridate avait laissé, et il cherchait tous les moyens qui
étaient en son pouvoir, de lui témoigner son attachement. Il lui
destinait l'héritage du beau domaine de Kouasch, où il habitait et les
vastes possessions qui l'environnaient. Gnel était tout-à-fait digne
par ses qualités aimables de la bienveillance de Diran. Tant de
bienfaits accumulés sur la tête du jeune Arsacide par l'empereur et
par le vieux roi d'Arménie, avaient excité contre lui la jalousie de son
cousin Dirith. Celui-ci ne songeait qu'à la satisfaire, en essayant de
faire périr Gnel, quand une nouvelle circonstance contribua encore à
enflammer sa honteuse envie et à la rendre plus criminelle. Gnel
venait de se marier avec une femme célèbre dans toute l'Arménie
par sa grande beauté. C'était Pharandsem, fille d'Antiochus, prince
de Siounie. Tous les seigneurs arméniens conviés à ces noces, en
sortirent enchantés des charmes de sa jeune épouse et des
attentions pleines de graces dont ils avaient été comblés par Gnel.

Dirith, invité comme les autres, était sorti du banquet nuptial épris du
plus violent amour pour Pharandsem. Ne pouvant la posséder que
par un crime, il s'occupa sans différer des moyens de le commettre.
Son ami Vartan, prince des Mamigoniens, qui était écuyer du roi,
s'associa à sa haine et ils réunirent leurs efforts pour la perte de
Gnel; sans balancer ils se rendirent auprès d'Arsace et ils
accusèrent son neveu d'en vouloir à son trône et à sa vie. Une
antique loi[163] de l'état défendait à tous ceux qui étaient issus du
sang royal, le prince héritier seul excepté, d'habiter dans la province
d'Ararad, destinée exclusivement au séjour du souverain et de son
successeur désigné. Gnel avait violé cette loi en résidant auprès de
Diran, dont le palais se trouvait dans la province interdite aux princes
du sang. Tel fut le premier motif de leur accusation. Il n'en fallut pas
davantage. Cette infraction innocente, présentée sous un jour
odieux, suffit pour éveiller les terreurs du roi, qu'il était si facile
d'alarmer. L'affabilité de Gnel, les honneurs qu'il avait reçus de
l'empereur, les présents qu'il ne cessait de distribuer aux princes qui
venaient le visiter, et l'attachement que ceux-ci lui témoignaient,
achevèrent de convaincre Arsace. Vartan jura même par le soleil du
roi qu'il avait entendu de ses oreilles Gnel proférer le vœu impie de
voir périr son oncle, son souverain. Arsace, trompé par ce serment,
chargea le perfide Vartan d'aller lui-même demander à Gnel,
pourquoi au mépris des lois, il s'était permis d'habiter dans la terre
d'Ararad, et lui signifier l'ordre d'en sortir à l'instant, s'il n'aimait
mieux mourir. Gnel obéit sans balancer et il se retira dans la
province d'Arhpérani[164], qui était affectée pour le séjour des
rejetons du sang arsacide. Le vieux Diran privé du seul de ses
descendants, qui pût le consoler dans son malheur, fut vivement
affligé de l'éloignement de son petit-fils; il fit écrire à ce sujet, en des
termes très-durs à son fils ingrat. Celui-ci en fut irrité au dernier
point; croyant sans doute, que Diran favorisait secrètement les
projets qu'il supposait à Gnel, il s'oublia jusqu'à joindre le parricide,
aux crimes dont il s'était déja souillé.
[161] En l'an 349, lorsque les évêques orthodoxes furent rétablis
dans leurs siéges, par suite des sollicitations et des menaces de
Constant.—S.-M.

xiii. [Mort de
Gnel.]
[Faust. Byz.
Hist. Arm. l. 4,
c. 15.
Mos. Chor. Hist.
Arm. l. 3, c. 23.
Mesrob, Hist de
Ners. c. 9.]
[162] Le droit de porter les ornements consulaires était souvent
accordé par les empereurs aux princes étrangers qu'ils voulaient
honorer d'une manière particulière. Cette distinction s'appelait
τίμαι, honores. C'était un ancien usage. L'histoire parle d'un
certain Sohème, roi d'Arménie, qui avait été déclaré consul par
Marc-Aurèle et L. Vérus.—S.-M.
[163] Cette loi avait été faite au milieu du 2e siècle avant notre
ère, par Valarsace, fondateur de la dynastie arsacide en Arménie,
et elle avait été renouvelée par les rois ses successeurs.—S.-M.
[164] La province d'Haschdian, nommée par les anciens
Asthianène et Haustanitis, dans la quatrième Arménie, avait été,
dans l'origine, seule affectée par Valarsace pour le séjour des
branches collatérales de la famille des Arsacides. Mais par la
suite leur postérité s'était tellement multipliée, que cette province
ne put leur suffire. Au milieu du 2e siècle de notre ère, le roi
Ardavazt II, et son frère Diran I, y joignirent les cantons d'Aghiovid
ou Aliovid et d'Arhpérani voisins l'un de l'autre. Le premier
dépendait de la province de Douroupéran, et l'autre du
Vaspourakan. On peut consulter pour tous ces pays mes
Mémoires historiques et géogr. sur l'Arménie, t. 1, p. 92, 101 et
131.—S.-M.
—[L'éloignement de Gnel, ne pouvait satisfaire son
ennemi; possédé d'amour et de jalousie, c'était la
mort de ce malheureux prince qu'il lui fallait. Comme
le canton où Gnel s'était retiré n'était pas éloigné du
lieu infâme où Arsace avait placé sa résidence,
Dirith et Vartan purent souvent, au milieu de leurs
orgies et de leurs parties de plaisirs, rappeler à
Arsace le souvenir de Gnel, et renouveler leurs
calomnies; enfin ils réussirent dans leur détestable
projet. Sous le prétexte d'une grande chasse,
indiquée pour les fêtes qui remplissaient toujours le
commencement du mois de navasardi[165], époque
du renouvellement de l'année arménienne qui s'effectuait alors au
milieu de l'été, le roi résolut de se diriger vers Schahabivan[166], où
se trouvait l'infortuné Gnel; un message expédié à la hâte, l'avertit
de tout préparer pour recevoir le camp royal. Arsace espérait
surprendre Gnel par une visite inattendue, et pouvoir traiter de lèse-

majesté, un désordre dont lui seul aurait été cause. Il fut trompé, tout
avait été disposé par Gnel pour recevoir dignement son souverain;
mais la magnificence qu'il déploya en cette occasion servit plutôt à
justifier qu'à détruire les injustes soupçons d'Arsace. Malgré les
serments que le roi lui avait prodigués pour l'engager à venir sans
crainte dans sa tente, la perte de Gnel fut résolue. Arsace n'eut pas
honte de violer l'hospitalité qu'il recevait, et de faire lâchement
assassiner son hôte au milieu des fêtes qu'il avait préparées lui-
même. Une flèche décochée à dessein, devait frapper Gnel pendant
la chasse royale. Il n'en fut point ainsi, il fallait que la mort de ce
prince fût plus cruelle. On fêtait ce jour-là la mémoire de saint Jean-
Baptiste; et le patriarche Nersès, venu avec la cour ainsi que son
clergé, avait célébré pendant toute la nuit un office en l'honneur du
saint, dans une tente réservée pour lui dans le camp. Gnel, après
avoir pris part à ses prières, quitta le patriarche le matin pour aller
rendre ses devoirs au roi; au moment où il se disposait à franchir le
seuil de sa tente, les gardes l'arrêtent comme un traître, lui attachent
les mains derrière le dos et le conduisent dans un lieu écarté, où ils
lui tranchent la tête. Pharandsem accompagnait son mari: frappée
de terreur en le voyant saisir par les gardes du roi, elle avait pris la
fuite et s'était réfugiée auprès de Nersès, implorant sa protection
pour Gnel, dont elle attestait l'innocence. Le patriarche récitait alors
les prières du matin, il se dirigea sans tarder vers le pavillon royal.
Arsace, encore couché, se douta en le voyant qu'il venait intercéder
en faveur de Gnel; pour ne point se laisser fléchir, il feignit de dormir:
Nersès essaie de le réveiller, il le prie, il le presse d'épargner un
prince toujours fidèle, son parent, le sang de son propre frère.
Arsace, la tête enveloppée dans son manteau, reste insensible à ses
vives instances, gardant un silence obstiné. Il était difficile de prévoir
comment se terminerait une telle scène, quand l'exécuteur vint
annoncer au roi que ses ordres étaient accomplis. Nersès connut
alors la triste vérité: transporté d'une sainte indignation, il se lève, et,
prophétisant au roi les châtiments qu'il devait subir un jour, il le
charge de ses imprécations et se retire en lançant contre lui un juste
et terrible anathème. Arsace sentit, mais trop tard, et son erreur et
l'énormité de son crime; ses yeux furent dessillés par les reproches
du patriarche, et tandis que le peuple entier et les princes arméniens

xiv. [Arsace
épouse
Pharandsem, sa
veuve.]
[Faust. Byz.
Hist. Arm. l. 4,
c. 15.
Mos. Khor. Hist.
Arm. l. 3, c. 24
et 25.
Mesrob, Hist. de
Nersès, c. 2.]
déploraient hautement le sort de Gnel, victime de la calomnie, et lui
préparaient de magnifiques funérailles[167], Arsace mêlait ses larmes
à leurs pleurs, invoquant la miséricorde divine. Pharandsem
s'abandonnait de son côté à sa douleur; son voile déchiré, ses
vêtements en désordre, son désespoir, ajoutaient encore à sa
beauté. Arsace la vit en cet état, son cœur s'enflamma pour elle: il
comprit alors toutes les intrigues qui avaient perdu Gnel et songea à
le venger; mais ce prince, aussi faible que coupable, ne sut pas
signaler son repentir autrement qu'en se souillant par de nouveaux
crimes.
[165] L'ancienne année arménienne était vague et composée de
365 jours de sorte qu'après 1460 ans elle se retrouvait à son point
de départ, après avoir parcouru toutes les saisons. Elle se divisait
en douze mois de trente jours chacun, auxquels on ajoutait cinq
jours complémentaires. Le premier de ces mois se nommait
Navasardi, il commençait à cette époque au milieu de l'été vers le
temps du solstice.—S.-M.
[166] Ce lieu est dans le canton d'Arhpérani.—S.-M.
[167] Gnel fut enterré, selon Moïse de Khoren (l. 3, c. 23) dans la
ville royale de Zarischad (Faustus de Byzance, l. 4, c. 55, qui était
située dans le canton d'Aghiovid. Voyez Mémoires historiques et
géographiques sur l'Arménie, t. 1, p. 106.—S-M.
—[Cependant Dirith, impatient de recueillir le fruit de
son forfait, ne tarda pas lui-même à justifier les
soupçons du roi, en faisant publiquement éclater
l'amour qu'il ressentait pour Pharandsem. Il ne rougit
même pas de témoigner à cette princesse que
l'excès de son amour avait seul causé le malheur de
Gnel, croyant sans doute, par un aussi étrange
aveu, mieux exprimer toute la force de la passion
quelle lui avait inspiré. Dirith voulait peut-être aussi
toucher la vanité de cette femme; mais en
renouvelant ses chagrins, il ne fit qu'exciter sa juste
indignation. La publicité que Dirith donnait à ses
sentiments pour Pharandsem, inspira de l'espoir à
Arsace; il crut qu'en punissant l'assassin de Gnel, il
pourrait s'acquérir des droits sur le cœur de son infortunée veuve.

La résistance de Pharandsem ne rebuta pas Dirith: dans son
aveuglement, il eut l'impudence de s'adresser au roi, pour qu'il
contraignît cette princesse de condescendre à ses désirs, en le
prenant pour époux. Arsace lui répondit qu'il connaissait ses
odieuses machinations, et que le sang de Gnel demandait
vengeance. Dirith comprit que sa perte était prochaine, et qu'il devait
songer à se garantir du courroux du roi. Il s'enfuit, mais on le
poursuivit avec l'ordre de le tuer partout où on le rencontrerait; on
l'atteignit au milieu des marais de la province de Pasen[168], et il y fut
tué. C'est ainsi que le meurtre de Gnel fut vengé par un autre crime.
[168] Voyez ci-devant, livre vi, § 14, t. 1, p. 411, note 2.—S.-M.
—[Arsace, débarrassé du perfide Dirith, ne tarda pas à ajouter une
nouvelle iniquité à toutes celles qu'il avait déja commises, en
épousant la veuve de son neveu. Pharandsem n'avait pour lui aucun
amour. La personne du roi ne lui inspirait qu'une aversion accrue
encore par les circonstances qui avaient amené leur union, et qui
n'étaient guère propres à lui donner pour Arsace un vif attachement.
Cependant, grace à la passion que ce prince ressentait pour elle,
Pharandsem acquit un grand pouvoir dans l'état; elle en profita pour
faire périr Vaghinag, issu comme elle de la race des Siouniens[169],
et pour faire accorder à son père Antiochus le commandement
confié à ce général. Antiochus devint, par l'élévation de sa fille, le
favori d'Arsace et son principal ministre; cependant malgré la
naissance d'un fils nommé Para[170], dont elle devint mère quelque
temps après, l'éclat de la couronne ne put consoler Pharandsem,
elle conserva toujours pour Arsace un dégoût invincible, et elle ne
cessait de lui en donner des preuves.
[169] Voyez ci-devant, liv. vi, § 14, t. 1, p. 410.—S.-M.
[170] Ce prince nommé Para par Ammien Marcellin est appelle
Bab ou Pap par les Arméniens. Il pourrait se faire que le premier
nom provint d'une mauvaise lecture des manuscrits de l'historien
latin. C'est une sorte d'erreur fort commune. Pour me conformer à
l'usage, je continuerai de l'appeler Para. Les écrivains modernes
comme Tillemont (Hist. des emper., t. v, Valens, art. 12, note 12),
et Lebeau, ont cru que la reine Olympias, femme d'Arsace, avait
été la mère de Para, et ils ont appliqué à cette princesse ce

xv. Arsace
marche au
secours du roi
de Perse.
[Faust. Byz.
Hist. Arm. l. 4,
c. 20.
Mesrob, Hist. de
Nersès, c. 2.]
xvi. [Brouilleries
entre les deux
rois.]
[Faust. Byz.
Hist. Arm. l. 4,
c. 20.
qu'Ammien Marcellin dit en plusieurs endroits de la mère de Para,
qu'il ne nomme pas dans son texte. C'est une erreur qui sera
corrigée dans le texte de Lebeau, toutes les fois qu'elle s'y
présentera. Pour l'éviter, il aurait fallu qu'ils pussent consulter les
auteurs arméniens. Ils ignoraient qu'Arsace avait eu une autre
femme. Faustus de Byzance, écrivain contemporain, Moïse de
Khoren et tous les auteurs arméniens, s'accordent à dire que le
fils d'Arsace était né de Pharandsem. C'est donc à cette
princesse, et non à Olympias, qu'il faut rapporter ce qu'Ammien
Marcellin raconte de la mère de Para.—S.-M.
—[Pendant tout ce temps, Arsace avait continué de
persévérer dans son alliance avec le roi de Perse et
de lui fournir des secours dans la guerre qu'il
soutenait contre les Romains. Lors de l'expédition
que Sapor entreprit dans la Mésopotamie en l'an
350, il fit prier le roi d'Arménie de venir le joindre
avec toutes ses forces. Une armée nombreuse se
réunit sous les ordres du connétable Vasag et se
dirigea vers le midi. Arsace la rejoignit avec les
principaux seigneurs arméniens, en prit le
commandement et s'avança jusque sous les murs
de Nisibe, où était le rendez-vous indiqué par Sapor. Les Arméniens
y arrivèrent les premiers; surpris de ne pas y trouver les Perses, ils
ne voulurent pas les attendre et ils marchèrent aux Romains,
campés non loin de là et bien supérieurs en nombre. Arsace céda à
l'impatience de ses soldats, et vaillamment secondé par Vasag, il
obtint une victoire complète. Quand Sapor arriva, il fut si charmé du
service signalé qu'Arsace lui avait rendu, qu'il s'empressa de lui en
témoigner sa reconnaissance, par les magnifiques présents et par
les honneurs dont il le combla, ainsi que les chefs arméniens.
—[L'alliance des deux rois semblait cimentée pour
jamais, Sapor ne cessait de montrer à Arsace des
preuves de son amitié, et enfin, après avoir pris l'avis
de son conseil, il se proposait pour resserrer encore
leur union, de lui donner sa fille en mariage. Ce qui
devait en apparence assurer leur bonne intelligence,
fut au contraire la cause de leur rupture. Antiochus

Mesrob, Hist. de
Nersès, c. 2.]
xvii. [Arsace fait
assassiner
Vartan envoyé
de Sapor.]
[Faust. Byz.
Hist. Arm. l. 4.
fut alarmé du projet de Sapor; voyant son crédit et
l'état de sa fille fortement compromis s'il s'exécutait,
il prit ses mesures pour y mettre obstacle. Tandis
que Sapor pressait Arsace de le suivre dans l'Assyrie pour y jouir
des honneurs qu'il lui préparait et pour y devenir l'époux de sa fille,
Antiochus avisait au moyen de les rendre irréconciliables. Il parvint à
force d'argent à corrompre un des conseillers de Sapor, qui
s'introduit mystérieusement dans le camp d'Arsace, et lui fait part
des prétendues trahisons que le roi de Perse machinait contre lui,
ajoutant qu'elles ne tarderaient pas d'être mises à exécution, et qu'il
ne lui restait que le temps d'y échapper par la fuite. Arsace
récompense cet officieux conseiller, et, saisi d'une terreur panique, il
s'empresse de faire connaître à ses généraux l'avis important qu'il
vient de recevoir. Ceux-ci, déja impatients de rentrer dans leur
patrie, furent tous d'avis de partir sans différer: on décampe au
milieu de la nuit, on abandonne précipitamment les tentes et la
plupart des objets qu'elles contenaient; on n'emporte que les armes.
Arsace était déja bien loin avant que les Perses s'aperçussent de sa
retraite précipitée. Ils n'en furent avertis qu'au lever de l'aurore; ils
durent être étonnés d'une fuite aussi prompte et que rien ne
paraissait motiver. Le roi, mieux instruit de la faiblesse et de la
versatilité d'Arsace, soupçonna les causes d'une conduite aussi
étrange; et, pour ne pas jeter le trouble dans son armée, il feignit de
croire que c'était une opération concertée entre eux, puis il dépêcha
un messager chargé de rassurer Arsace par les plus grands
serments pour l'engager à revenir et le prémunir contre les faux
rapports qui lui avaient été faits. Les instances de cet envoyé furent
inutiles; les terreurs d'Arsace l'emportèrent encore une fois sur les
protestations de Sapor, il continua sa marche vers ses états, et
depuis il n'eut plus aucune relation d'amitié avec ce prince.
—[Sapor n'avait cependant pas encore perdu tout
espoir de détruire les préventions d'Arsace, et de
l'engager à rentrer dans son alliance. Vartan le
Mamigonien vint en Arménie avec des lettres du roi
de Perse, remplies des plus fortes assurances de
son attachement. Arsace allait encore donner une
nouvelle preuve de son inconstance; il avait de

c. 18.
Mos. Khor. Hist.
Arm. l. 3, c. 25.]
xviii. [Les
princes
arméniens se
révoltent contre
Arsace.]
[Mos. Khor.
Hist. Arm. l. 3,
c. 27.
Mesrob, Hist. de
Ners. c. 4.]
l'inclination pour Vartan, il n'en fallait pas davantage
pour le gagner et le faire consentir à renouer avec
Sapor. Arsace, ébranlé, était près de céder, quand le
connétable Vasag revint à la cour: il suffit de sa
présence pour tout changer. Il convainquit sans peine le roi que
Vartan était un traître, dont le dessein secret était de le livrer au
prince persan, et qu'il devait se hâter de s'en défaire, s'il ne voulait
perdre et lui et l'Arménie. La reine, qui avait beaucoup de pouvoir
sur l'esprit d'Arsace, acheva de le persuader; elle n'avait pas oublié
la part que Vartan avait prise au meurtre de Gnel, et d'ailleurs
redoutant pour elle et pour son père les conséquences de l'alliance
persanne, elle se joignit à Vasag. Ils l'emportèrent dans l'esprit
irrésolu du roi, la mort de Vartan fut décidée, le caractère
d'ambassadeur ne put le protéger contre la jalousie et la haine de
son frère, qui ne tarda pas à le faire assassiner en vertu des ordres
d'Arsace. Ce dernier attentat acheva de rendre les deux rois
irréconciliables.
—[Tant de crimes avaient irrité contre Arsace les
princes arméniens et l'Arménie toute entière.
Couvert du sang de son père et de ses neveux,
toujours environné et dirigé par des hommes
pervers, il était devenu l'objet d'une haine
universelle. Elle se manifesta par une révolte
presque générale. Les princes de la race de
Camsar, chéris des Arméniens à cause de leur noble
origine et de leurs belles qualités, redoutables par
leurs vastes possessions et par leur valeur, en
donnèrent le signal. Nerseh, fils d'Arschavir, se mit à
la tête des peuples soulevés; un général persan,
envoyé par Sapor, lui amena des troupes, et leurs forces réunies
vinrent attaquer Arsace, qui, tranquille dans sa ville d'Arschagavan,
s'y abandonnait sans inquiétude à ses honteuses voluptés. Surpris
dans sa retraite, il eut à peine le temps de s'échapper, et, suivi du
seul Vasag, il se réfugia chez les Ibériens au milieu du Caucase.
Arschagavan fut livré aux flammes; on rasa ses édifices jusque dans
leurs fondements, et ses habitants, objets de l'exécration de
l'Arménie entière, furent tous égorgés, hommes et femmes. Les

xix. [Apostasie
de Méroujan
prince des
Ardzrouniens.]
[Faust. Byz.
Hist. Arm. l. 4,
c. 23.
Mos. Khor. Hist.
Arm. l. 3, c. 27
et 35.]
enfants seuls furent redevables de la vie aux pressantes
sollicitations de Nersès.
—[L'exemple donné dans le nord et au centre de
l'Arménie, fut imité dans le midi. Le prince des
Ardzrouniens, nommé Méroujan, dont les états
s'étendaient sur les bords du lac de Van, embrassant
une partie de sa circonférence et se prolongeant au
loin dans les montagnes des Curdes, s'était aussi
soulevé. Ce dynaste, puissant entre tous les chefs
arméniens, appartenait à l'une des plus anciennes
familles du pays. Cette race illustre passait pour être
issue d'un des fils du grand roi d'Assyrie
Sennacherib, qui, sept siècles avant notre ère,
s'étaient réfugiés en Arménie, après le meurtre de
leur père. Elle subsistait donc depuis mille ans; sept siècles après
elle était encore en possession des mêmes pays, qu'ils
abandonnèrent à l'empereur Basile II, dont ils reçurent en échange
le territoire de Sébaste et d'autres domaines dans l'Asie-
Mineure[171]. Des vues ambitieuses se mêlèrent à la révolte de
Méroujan, le mépris et la haine qu'Arsace avait mérité, lui firent
concevoir l'espérance de monter sur le trône d'Arménie; dans ce
dessein, pour se créer des partisans, il renonce à la religion
chrétienne, embrasse celle des Mages et jure de la faire recevoir
dans ses états particuliers et dans toute l'Αrménie. Il croyait ainsi
engager dans son parti ceux qui ouvertement ou secrètement étaient
encore attachés à l'ancien culte de l'Arménie; il pensait aussi que
Sapor le soutiendrait avec plus de zèle dans son entreprise. La
première tentative de Méroujan ne fut pas heureuse, il avait été
vaincu par Vasag et contraint de s'enfuir en Perse, mais favorisé par
la révolte générale des princes arméniens, il ne tarda pas à rentrer
en campagne. A la tête de toutes les troupes de l'Atropatène, il dirige
sa marche en suivant le cours du Tigre, qu'il remonte du sud au
nord, et pénètre dans l'Arménie par la frontière méridionale: partout
le meurtre, le pillage, l'incendie signalent son passage; l'Arzanène,
l'Ingilène, la Grande-Sophène, la Sophène royale, le canton de
Taranaghi[172], ne furent bientôt qu'un monceau de ruines. Méroujan

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