HISTORY-BASED ACCOUNTING REFORM: USING MATHEMATICS PERSPECTIVE TO IDENTIFY AND SOLVE SOME MAIN PROBLEMS IN ACCOUNTING EDUCATION AND

STANDARDS

Author: SONY WARSONO, PhD

Email address: swarsono@feb.ugm.ac.id; iarirfan@yahoo.com

Institution: Department of Accounting Faculty of Economics and Business Universitas Gadjah Mada Yogyakarta Indonesia

History-based Accounting Reform

HISTORY-BASED ACCOUNTING REFORM: USING MATHEMATICS PERSPECTIVE TO IDENTIFY AND SOLVE SOME MAIN PROBLEMS IN ACCOUNTING EDUCATION AND STANDARDS

ABSTRACT

Manuscript Type: Perspective Research Issue: Perceived as a pure social science, prominent accounting scholars agree that the current accounting development overemphasizes on rules, and this has wide negative impacts on accounting education and research. Thus, accounting reform is necessary even though it is still unclear the direction of the reform. Research Findings/Insights: The basic thesis of this study is that accounting is an application of mathematics because accounting was documented in the mathematics book and written by Luca Pacioli as a mathematics professor. Firstly, this study shows the inappropriateness of current accounting teaching methods. Specifically, this study shows that the use of debits and credits is purely the application of mathematics. Secondly, this study identifies the limitation of the definition of financial statement elements, and proposes the alternative redefinition of the elements. Thirdly, this study shows that the use of a mathematical perspective helps accounting profession to solve current accounting issues. Finally, this study proposes the development of three pillars, i.e. mathematics, rules, and art, in a balanced manner to do accounting reform. Theoretical/Academic/Policy Implications: This study provides a new perspective that the accounting development is based on the history of accounting itself, i.e. accounting as an application of mathematics. Using the mathematical perspective, not only do accounting scholars improve the accounting education but also we innovate accounting research agenda. In addition, this study offers insights to accounting standard boards interested in developing a global uniform of financial accounting standard that effectively work.

History-based Accounting Reform

HISTORY-BASED ACCOUNTING REFORM: USING MATHEMATICS PERSPECTIVE TO IDENTIFY AND SOLVE SOME MAIN PROBLEMS IN ACCOUNTING EDUCATION AND STANDARDS

INTRODUCTION The 2001 and 2002 accounting scandals were considered the beginning of the wave of the global financial crisis. The wave of the scandals spread widely and resulted in significant damages. Many factors potentially contributed to the scandals (see Ball, 2009). The most recent wave of global financial crisis was the 2007 and 2008 financial crisis sometimes described as the most serious financial crisis since the Great Depression. The crisis was the result of frauds and mistakes committed by managers who were accountable to no one (Zingales, 2009:391). Association of Chartered Certified Accountants (ACCA, 2009) as the global body for professional accountants demands the accounting profession to learn from the year long financial crisis because it is clearly unacceptable that poor quality loans can be sliced, diced and parceled up with an AAA sticker and overvalued on banks balance sheets as a consequence. The magnitude of this worldwide financial crisis calls for a fundamental reassessment of all areas of business and economic scholarship, especially accounting because the main roles of accounting is to provide financial information. The better the accounting as a financial reporting system is, the higher the quality of financial information outcomes will be. It is expected that accounting provides information on what really happens both in micro- and macro-economic activities. In turn, accounting will detect and prevent the global financial crisis. Unfortunately, the accounting development is still far from the expectation. Accounting today is under pressure even from inside. Demski (2007) questions whether accounting is an academic discipline. Fellingham (2007) argues that accounting academicians tend to think in terms of contributions to the current generation of students, instead of to the academy or to future generations of students. Hopwood (2007) argues that accounting researchers increasingly focus on accounting research issues that are insufficiently innovative and increasingly detached from reality. Ball (2008) argues that an understanding of the actual economic role of financial reporting is important from both a positivist scientific perspective and a normative perspective. Recently Basu (2008:426) demanded several scholars to present the topic "What is the most important accounting issue
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where we either think we understand it but in fact do not or have failed to consider the issue in anywhere near the depth it deserves?" Perceived as pure social science, rules are fundamental in accounting (Penno, 2008), like in law and politics. However, in its development, prominent accounting scholars agree that the current accounting development overemphasizes on rules. Over time accounting profession tends to apply a rule-based approach which emphasizes compliance over substance to financial reporting rather than a principle-based approach which emphasizes substance over compliance (Ball, 2009:277). This development has wide and significant negative impacts on accounting education and research (Hopwood, 2007; Demski, 2007; Fellingham, 2007; Ball, 2008, 2009; Arnold, 2009). The current case is the adoption of IFRS (International Financial Reporting Standards). The objective of the IFRS adoption is that a uniform set of accounting standards will achieve the goals of comparability and consistency of financial reporting that applies throughout the world. On the one side, prior research studies find that the adoption of IFRS provides benefits on certain conditions (Daske, Hail, Leuz & Verdi, 2008; Li, 2010; Armstrong, Barth, & Riedl, 2010). Furthermore, the Financial Reporting Policy Committee of the Financial Accounting and Reporting Section of the American Accounting Association concludes that the adoption of IFRS is a desirable goal (AAA FRPC, 2010:117). On the other side, Holthausen (2009) argues that the objective of IFRS adoption would not be successful unless the underlying institutional and economic factors among countries were similar. Another committee in the American Accounting Association, the Financial Accounting Standards Committee favors allowing U.S. companies to choose use of U.S. GAAP or IFRS rather than mandating one global monopoly set of standards. (AAA FASC, 2010). In short, the effectiveness of the IFRS adoption is still debatable. This dilemma is not unusual in accounting standard setting. As a matter of fact, it is unlikely to find one industry, for example the telecommunication or computer industries, applies a single industry standard around the world. Interestingly, even though these telecommunication and computer industries use different standards but they still achieve the goals of comparability and interconnectivity. Accounting reform is necessary and starts running now. The reform is a main part of the enforcement of corporate governance initiatives. Demski (2007:156) challenges accounting
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academicians to do good and redefine the game, and believes that the change will come from young accounting scholars who learn accounting with fun. Recently the former Vice-Chairman of the Financial Accounting Standards Board David Mosso (2010) proposed a new accounting model that measured wealth and provided information about entitys financial health. The model was expected to discourage political tampering. This paper uses a mathematical perspective, especially the double entry system, to propose the accounting reform. The use of a mathematical perspective is appropriate and valid because accounting itself was academically documented in the mathematics book by Luca Pacioli as a mathematics professor (discussed in the second section). Moreover, using the mathematical perspective, this paper shows the inappropriateness of the present accounting education and proposes the solutions (third section), identifies the limitations of the current financial standards and proposes the solutions (fourth section), and proposes the solutions to solve two current accounting issues (fifth section). The final section concludes the discussion.

ACCOUNTING AND MATHEMATICS As widely acknowledged, Luca Pacioli discussed accounting in his mathematics book Summa de Arithmetica, Geometria, Proportioni et Proportionalita (hereafter, Summa). Summas English title would be Collected Knowledge of Arithmetic, Geometry, Proportions and Proportionality (Weis & Tinius, 1991). The first time Summa was published, Luca Pacioli had been teaching mathematics courses in several universities for more than 20 years (Journal of Accountancy, 1987). Sangster, Stoner, & McCarthy (2007) mention that there were 10 chapters in the Summa: a) chapter 1 7 about Arithmetic, b) chapter 8 about Algebra, c) chapter 9 about Business, including, Particularis de Computis et Scripturis translated into Details of Accounting and Recording (Rabinowitz, 2009), and d) chapter 10 about Geometry and Trigonometry. The section of Particularis de Computis et Scripturis appears to be included for the sake of completeness to recognize the importance of arithmetic principles in the application of bookkeeping (Rabinowitz, 2009). Luca Pacioli was neither an accountant nor bookkeeper, but a university professor of mathematics (Peters & Emery, 1978; Weis & Tinius, 1991; Hernandez-Esteve, 1994; Rabinowitz, 2009), astrologer to Pope Leo X, and the author of a number of mathematics books
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(Sangster et al., 2007). Pacioli cleverly explained mathematics in a clear and interesting way reflecting the state of mathematics during the early Renaissance (Weis & Tinius, 1991). Most of accounting literature agrees that the double entry system is an application of mathematics. It was possible that the double entry system had existed hundreds of years before it was published in Summa (Yamey, 1994; Rabinowitz, 2009). Interestingly, the double entry system is one of few principles that stay unchanged for more than 500 years (Hatfield, 1924; Littleton, 1926; Rabinowitz, 2009). In Mathematics Magazine, Ellerman (1985) confirms that the double entry system is purely the application of mathematics. The use of debits and credits in the double entry system is also an application of mathematics. Most of modern accounting textbooks define debits meaning the left side, and credits meaning the right side (e.g. Anthony, Hawkins, & Merchant, 2007; Williams, Haka, & Bettner, 2007; Weygandt, Kieso, & Kimmel, 2008). The definition indicates that the use of debits and credits is identical with algebra that has left and right sides. Peters & Emery (1978) believe that mathematicians did not use negative numbers when Pacioli published the Summa. In the contrary, Scorgie (1989) demonstrates that the negative numbers were known before the publication of the Summa. This study argues that the use of debits and credits in the double entry system is mainly because there is no negative numbers in financial unit. As we all know, accounting uses a monetary unit principle to measure the economic activities (Littleton, 1926). Mathematically, moving negative numbers (suppose minus 5) from the left side of algebra to the right side will change the numbers into positive ones (plus 5). Thus, the use of debits and credits in accounting that conveys financial information is purely an application of mathematics. This argument is important to explain the rules of debits and credits discussed in the next section.

REFORMING THE ACCOUNTING EDUCATION Even though accounting has been taught for more than 500 years, discussions about accounting teaching methods are always appealing. The traditional teaching of accounting has been criticized in many countries (Duff & McKinstry, 2007). While business has experienced dynamic changes, the study of accounting remains essentially the same (Albrecht & Sack, 2000), passive (Bonner, 1999; Boyce, Williams, Kelly, & Yee, 2001), procedural (Dempsey &
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Stegmann, 2001), inadequate in equipping the student with the necessary competencies (Mohamed & Lashine, 2003), and relying merely on a one-way direction of knowledge distribution (Williams, 1993; Saunders & Christopher, 2003). This traditional learning of accounting makes accounting textbooks look similar to one another (Sullivan & Benke, 1997) which in turn makes accounting less attractive to students. A great number of experts have been discussing the need of changes in the teaching methods of accounting (Rankin, Silvester, Vallely, & Wyatt, 2003; Hartnett, Romcke, & Yap, 2004). Albrecht & Sack (2000) argue that the study of accounting needs to be transformed to catch up with changes in technology and globalization. Saudagaran (1996) and Springer & Borthick (2004) noted that the traditional curriculum of accounting, emphasizing memorizing skills, may actually hinder the students efforts to develop the requisite competence in accounting, such as critical thinking. Other researchers suggested the use of information technology to improve the effectiveness of accounting study (Elliott, 1992; Pincus, 1997; Mohamed & Lashine, 2003; David, Maccracken, & Reckers, 2003; Goldwater & Fogarty, 2007). Fordham & Hayes (2009) found that paper color may have significant contribution to student performance in the accounting principles courses. Our accounting textbooks typically consist of little other than a recitation of the more important standards (Ball, 2008:428); We teach the rules, and de-emphasize our contribution to the academy (Fellingham, 2007:160); and We have ceded to regulators the care, feeding, and deepening of our intellectual foundations. (Demski, 2007:156). Those three statements confirm that the teaching of accounting today overemphasizes standards. Some critical issues that might be questioned by students are answered based only on the rules. This paper discusses the two following basic issues problematic in accounting education.

The Rules of Debits and Credits The rules of debits and credits have been much debated by experts. On the one side, experts argue that the mechanism of debits and credits does not make sense (debits and credits are nothing more than pluses and minuses, Ingram, 1998:411), demands the student simply to memorize (Saudagaran, 1996; Pincus, 1997), is too narrowly procedural (Patten & Williams,
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1990; Nelson, 1995), and is liable to convey a mistaken picture about accounting to the student (Pincus, 1997; Diller-Haas, 2004). On the other hand, a number of other experts have tried to maintain the teaching of debits and credits in accounting principles because debits and credits are believed to be part of the vocabulary in our language (Wallace, 1997:230), and because debits and credits are an indispensable part in the learning process of accounting (Vangermeersch, 1997). A number of textbooks state that the rules of debits and credits are arbitrary (Anthony et al., 2007), a rule of thumb (Williams et al., 2007), or customs like the custom of driving on the right-hand side (Weygant et al., 2008:49). Other textbooks briefly describe these rules by providing mathematical illustrations expected to facilitate the students understanding even though the description ends up with an appeal that the student simply memorizes the rules (Walther, 2009). From the mathematical perspective, this debit and credit mechanism actually has an argument which is very clear and easily understandable to the student. In essence, the debit and credit mechanism represents a consequence of the accounting equation whose recording is reflected in the double entry system. The brief description is as follows. Case A. Supposed, Assets = 10, Liabilities = 4, and Equity = 6. The basic accounting equation is 10 = 4 + 6. Next, the amount of assets is the difference between 25 and 15 (25 15), and accounting does not recognize the negative number. Based on the ordered pairs of the group of differences construction (see Ellerman, 1985), the assets with the value of 10 can be recorded either on one side, i.e. 25 is recorded to the debit and 15 to the credit (alternative A), or 15 to the debit and 25 to the credit (alternative B). According to the mathematical formulation, however, the alternative A should be applied because the assets have a positive value and located on the left side of the accounting equation (see Figure 1). The interpretation is that number 15 on the credit deducts number 25 on the debit. As a result, the increase of assets is recorded on the debit while the decrease of assets is recorded on the credit (see Figure 2). ---------------------------------------------Insert Figure 1 about here -----------------------------------------------7

History-based Accounting Reform

---------------------------------------------Insert Figure 2 about here -----------------------------------------------Case B. Supposed, Assets = 10, Liabilities = 4, and Equity = 6. The basic accounting equation is 10 = 4 + 6. Next, the amount of liabilities is the difference between 18 and 14 (18 14), and accounting does not recognize the negative number. Based on the ordered pairs of the group of differences construction (see Ellerman, 1985), the liabilities with the value of 4 can be recorded either on one side, i.e. 18 is recorded to the debit and 14 to the credit (alternative A) or 14 to debit and 18 to the credit (alternative B). According to the mathematical formulation, however, the alternative B should be applied because the liabilities have a positive value and located on the right side of the accounting equation (see Figure 3). The interpretation is that number 14 on the debit deducts number 18 on the credit. As a result, the increase of liabilities is recorded on the credit while the decrease of liabilities is recorded on the debit (see Figure 4). ---------------------------------------------Insert Figure 3 about here --------------------------------------------------------------------------------------------Insert Figure 4 about here ------------------------------------------------

Case C. Supposed, Assets = 10, Liabilities = 4, and Equity = 6. The basic accounting equation is 10 = 4 + 6. Next, the amount of equity is the difference between 36 and 30 (36 30), and accounting does not recognize the negative number. Based on the ordered pairs of the group of differences construction (see Ellerman, 1985), the equity with the value of 4 can be recorded either on one side, i.e. 36 is recorded to the debit and 30 to the credit (alternative A) or 30 to
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debit and 36 to the credit (alternative B). According to the mathematical formulation, however, the alternative B should be applied because the equity has a positive value and located on the right side of the accounting equation (see Figure 5). The interpretation is that number 30 on the debit deducts 36 on the credit. As a result, the increase of equity is recorded on the credit while the decrease of equity is recorded on the debit (see Figure 6). ---------------------------------------------Insert Figure 5 about here --------------------------------------------------------------------------------------------Insert Figure 6 about here ------------------------------------------------

In summary, the rules of debits and credits are based on a mechanism which entirely follows the mathematical logics. In our experience, students can understand and accept the rules more easily than if they have to memorize it. In other words, the use of the mathematical perspective has made irrelevant the assumption that the debit and credit rules are something that should be memorized. With a good reasoning, students may find it easier to apply the debit and credit rules to all kinds of algebraic equations, not just in relation to accounting equation. It is true that the rules of debits and credits tend to be mechanical but the rules are always relevant to be taught in accounting courses because of the following reasons. First, the debit and credit rules convey a picture to students that accounting is based on established knowledge, especially mathematics. Second, as computer science with its binary digits (0 and 1) and the science of electricity with its on and off, accounting is endowed with debits and credits as a unique knowledge, which is used only in accounting. Third, debits and credits can be used to enhance the concreteness of knowledge of accounting; the study of debits and credits tangibilizes the workings of accounting. Tangibilizing the accounting mechanism is important to help
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students understand accounting topics related to keeping journals, posting, which are indeed in the heart of accounting as an academic discipline. Fourth, as accounting students are expected to compile or construct information, not just to use information, they must have acquired basic knowledge of data processing to present useful information (Vangermeersch, 1997). Fifth, knowledge of debits and credits encourages students to think systematically and logically, and to develop the knowledge about accounting dynamics as fast growing science through the implementation of mathematical knowledge.

The Rationale of Accounting Equation In Summa, Luca Pacioli codified the double entry systems which are based on the basic accounting equation as: Assets = Liabilities + Equity (Equation 1). The rationale behind the equation is that assets are resources under the firms control, whose funds come from liabilities and equity (sources of funds). In other words, the rationale of the Equation 1 is that the resources must be always equal to the sources of funds. Then, the equation was expanded to include expense and revenue elements to represent firms economic activities. Expenses and revenues are part of the equity; revenues increase equity, while expenses decrease equity. Thus, the expanded accounting equation was written as: Assets = Liability + Equity + Revenues Expenses (Equation 2a). The rationale of the Equation 2a is that resources must be equal to sources of fund in which revenues and expenses are part of the equity. These rationales are primarily based on the balance-sheet approach so that other accounting variables (i.e. revenues and expenses) are considered secondary and derivative (Dichev, 2008:454). Many textbooks employ Equation 1 to analyze transactions which result in changes in the element of revenues and expenses (e.g., King, Lembke, & Smith, 2001; Porter and Norton, 2001; Warren, Reeve, & Fess, 2002; Libby, Libby, & Short, 2004; Williams et al., 2005; Anthony et al., 2007). Several of these textbooks write down the Equation 2a in their books (Horngren, Sundem, & Elliott, 2002; Weygandt et al., 2008). This study argues that the rationale employed to explain the basic accounting equation (Equation 1) is not consistent with those employed to explain the expanded accounting equation
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(Equation 2a) because the element of expenses on the right side of the equation is not sources of fund. In other words, the rationale employed to explain the basic accounting equation is different from that employed to explain the expanded accounting equation even though both equations are similar. Learning which employs different rationales to explain two things which in essence are closely related is liable to confuse students. Mathematically, Equation 2a can be re-written into Assets + Expenses = Liabilities + Equity + Revenues (Equation 2b). However, it is hard to find textbooks which express accounting equation as expressed in Equation 2b although mathematically Equation 2a and equation 2b are both correct. Ingram (1998) employs Equation 2b merely to simplify the understanding of the logics of debits and credits. Mathematically it is more proper to place elements with the same signs (positive or negative) on the same side because accounting does not recognize negative numbers. Thus, the Equation 2b is preferable to the Equation 2a. For the sake of simplicity, this paper calls the rationale of equation 2b as mathematical rationale, while calls the rationale of equation 2a as conventional rationale. Subramanyam & Wild (2009) and Anthony et al. (2007) argue that the basic accounting equation can be perceived as sources and uses of fund. Therefore, we can interpret that the left side of the Equation 1 and Equation 2b reflect the uses of fund, while the right side reflects the sources of fund. Firms use the funds to acquire assets and/or pay expenses with funds taken from the sources of liabilities, equity, and/or revenues. This mathematical rationale can consistently explain both the basic accounting equation (Equation 1) and the expanded accounting equation (Equation 2b). Vangermeersch (1997) noted that revenues and expenses are separate elements, not subdivisions of equity. Therefore, the placement of revenues and expenses on the same side (Equation 2a) is a compulsion that runs the risk of confusing students. Besides raising the problem of inconsistency in the rationale of accounting equation, two additional reasons make the use of equation 2a unacceptable. Firstly, by definition equity is limited to a residual interest or net assets (FASB, 1985) to the effect that there is no appropriate justification for an explanation as to why the element of revenues and expenses should belong to the equity. Secondly, the attachment of elements, i.e. revenues and expenses, to the other element, i.e.
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equity, may result in their being less than optimal. Analogizing the approaches of data management in the computer system, the database approach provides information which is more up-to-date, standardized, and easier to access than the application-oriented approach because the database approach separate data from their application software (Romney & Steinhart, 2009). More than just offering consistent rationale, the use of mathematical rationale (Equation 2b) will make it much simpler to explain why the elements of assets and expenses should receive the same treatment in relation to debits and credits even though by definition assets and expenses markedly differ from one another; assets represent sources which provide future benefits, while expenses represent a sacrifice of assets (FASB, 1985). Actually, assets and expenses have the same rules of debits and credits because both of them represent the uses of fund.

REFORMING THE ACCOUNTING STANDARDS The International Accounting Standards Committee (IASC) issued the conceptual framework in 1989. It was based on FASB, which adopted the balance sheet model of financial reporting (Camfferman & Zeff, 2007). More specifically, the definition of the elements of financial statements was based on the perspective of assets (Alfredson, Leo, Picker, Pacter, Radford & Wise, 2007). This happened because the standards considered economic resources or assets as central to the existence and operations of an individual entity (FASB, 1985:Par. 11) and the lifeblood of a business enterprise (FASB, 1985:Par. 15). Furthermore, the IASC was replaced by the International Accounting Standards Board (IASB) in 2001. Currently the Joint Project IASB/FASB is redefining the elements of financial statements. The Joint Project IASB/FASB tentatively adopted the following working definitions of asset and liability as follows: An asset of an entity is a present economic resource to which the entity has a right or other access that others do not have. (IASB FASB, 2008:Asset Definition)

A liability of an entity is a present economic obligation for which the entity is the obligor. (IASB FASB, 2008:Liability Definition)
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Essentially the re-definition of the elements of assets and liabilities by the Joint Project IASB/FASB was still based on the same perspective, namely the balance sheet orientation (Dichev, 2008). So far the work of the Joint Project IASB/FASB is still continuing. The tentative definition of the elements of equity has not been issued. Taking a close look at the definition of assets and liabilities made by the Joint Project IASB/FASB, it is predicted that the Joint Project IASB/FASBs efforts to define equity and other elements, including revenues the IASB refers to them as income and expenses, would still be based on the perspective of assets, unless the Boards expand their effort to a more thorough reassessment of their conceptual framework (Dichev, 2008:454). In this case, it is very likely that equity will be defined as net assets, and revenues and expenses would be parts of the equity. The accounting standards actually employ mathematics in defining the elements of financial statements. Equity is defined as net assets, namely the arithmetic difference between assets and liabilities (Alfredson et al., 2007:76). Furthermore, revenues are conventionally defined as asset increases or liability decreases (or a combination of both). Such a definition of revenues is based purely on the accounting equation; increases in revenues (recognition of the occurrence of revenues) on the right side of the accounting equation should be followed by asset increases on the left side of the equation or followed by liability decreases on the right side of the equation (or a combination of both) so that a balance in the accounting equation would be maintained. Unfortunately, the elements of financial statements, especially for revenues and expenses, are not adequately defined to the effect that accounting runs the risk of providing financial information which does not correctly represent the reality of business. The limitation of accounting standards in defining the elements of financial statements and the alternative redefinition of the financial statement elements are discussed below.

The Limitation of the Accounting Standards The use of the asset perspective to define the other elements of financial statements may result in an incomplete definition. In turn, accounting may provide financial information which does not faithfully represent the firms real condition. Many experts have revealed the
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inadequacy of accounting to represent the reality of business (Ball, 2008; Cheney, 2009). Before pointing out the limitations of revenue and expense definitions, we would like to present the definitions of revenues and expenses according to the FASB and IASC as follows.

Revenues are inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entitys ongoing major or central operations. (FASB, 1985:Par. 78)

Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants. (Mirza, Orrell, & Holt, 2008)

Expenses are outflows or other using up of assets or incurrence of liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities that constitute the entitys ongoing major or central operations. (FASB, 1985:Par 80)

Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or the incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. (Mirza et al., 2008)

The above definitions are substantially similar, namely that the recognition of revenues and expenses must be followed by changes in assets and/or liabilities (see Diagram included in the FASB No. 6, 1985). Such a definition disregards revenue/expense transactions, such as barter, that do not produce directly any change in assets/liabilities. Here are two types of cases which reveal limitations in the standards of the elements of financial statements, especially related to the definitions of revenues and expenses.
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Illustrative Case. Business event A: Merchandising firm Q, which is in the business of selling computers, and merchandising firm R, which is in the business of selling furniture, barter their merchandise. According to the standards, both merchandising firms Q and R recognize this business event as a revenue transaction, as in this event there is an increase of assets into each firm. Business event B: Service firm S, which is in the information technology consulting business, and service firm T, which is in the accounting consulting business, barter their main service. According to the standards, both firms S and T should not recognize this business event as a revenue transaction because there is no increase of assets or decrease of liabilities in each of these firms. Accordingly this business event cannot be classified as a revenue transaction by either firm. Business event C: Service firm S, which is in the accounting consulting business, is conducting barter with merchandising firm Q, which is in the business of selling computers. According to the standards, firm S should recognize this business event as a revenue transaction because there is an increase in assets in the form of computers. Firm Q, however, should not recognize this business event as a revenue transaction because there is neither an increase in assets nor decrease in liabilities even though firm Q delivers its services. This business event, therefore, is recognized as a transaction by firm S but cannot be recognized as such by firm Q.

Business event D: Service firm V, which is in the business of advertisement, purchases a number of firm Ws shares (with the intention to own them). The payment is made directly and fully in the form of advertising services delivered by firm V. Firm V should recognize this business event as a revenue transaction because there is an increase in assets in the form of shared investment. According to the standards, however, firm W should not recognize this business event as an expense transaction because there is neither a decrease in assets nor an increase in liabilities as a result of this business event; what results is an increase in equity. Business event E: Service firm X, which is in the business of TV advertising, distributes revenue dividends in the form of services to firm Y, which owns more than 20 percent of the company shares. On the announcement date, firm Y immediately utilizes the revenue dividends.
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According to the standards, firm X should not recognize this business event as a revenue transaction because there is neither an increase in assets nor a decrease in liabilities; what results is an increase in dividends distribution. On the other hand, firm Y should recognize this business event as an expense transaction because the firm receives advertising services and there is a decrease in assets in the form of shared investment (equity method). Therefore, this business event should be recognized as an expense transaction by firm Y but should not be recognized as a transaction by firm X. The illustrative cases above are simulations of transactions that may happen in business on the basis of the expanded accounting equation. In short, the recognition of revenues can be balanced not only by increases in assets or decreases in liabilities, but also by increases in expenses or decreases in equity. Likewise, the recognition of expenses can be balanced by decreases in assets, increases in liabilities, increases in equity, or increases in revenues. Therefore, the current definitions of the elements of revenues (income) and expenses are incomplete. This occurs because the standards argue that revenues and expenses should make a direct impact on the assets and/or liabilities. The inadequacy of the definitions of revenues and expenses is also due to the placement of revenues and expenses under the category of equity.

The Redefinition of the Elements of Financial Statements One of the topics currently discussed in earnest by accounting experts is the approach that should be adopted in constructing financial statements (Haka, 2009). Current standards have opted for the balance sheet approach, while some accounting scholars suggest the use of income statement approach (see Dichev, 2008; AAA FASC, 2007). First and foremost, financial accounting should provide financial information, not just the balance sheet and income statement. Therefore, standards determined by the use of one perspective are likely to underestimate the importance of other perspectives. As demonstrated above, the use of the balance sheet perspective has rendered as un-coverable a large number of business events significantly related to revenues and expenses. Likewise, the use of the income statement approach is likely to underestimate the importance of business events related to assets, liabilities, and equity.

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To solve the problems related to the use of appropriate approaches in the definition of the elements of financial statements, we can take a lesson from the approach employed in data management. Early in the development of the computer, data management employed a fileoriented approach, which tied the data to the application that produced them. As a consequence, in order to access particular data with other applications the data must be converted first. The conversion process may cause changes to the original data. This file-oriented system was considered inefficient, highly susceptible to errors, redundant, etc (Wilkinson, Cerullo, Raval, & Wong-on-Wing, 2000). Modern data management uses a database approach, which separates data from the application that produced them. The database approach makes it possible to produce data which are standardized, consistent, and integrated (Romney & Steinhart, 2009). An analogy can be made between the use of the balance sheet or income statement approach and the file-oriented approach. Mathematically, the expanded accounting equations (Equation 2a and Equation 2b) show that the elements of assets, expenses, liabilities, equity, and revenues are on the same level. The placement of one element above another is inconsistent with the accounting equation. Therefore, we argue that the approach employed in the definitions of the elements of financial statements should be on the basis of an infobase (another word for database, which is already common in the literature of information systems), instead of using either the balance sheet or the income statement approach. With the infobase approach, the elements of financial statements are not tied to the financial information which has been produced. It is only at the end of the accounting period that these elements are designed to produce financial statements. The current definition of the elements of financial statements is mechanistic rather than substantive, especially for the definitions of the elements of equity, revenues (income) and expenses. The mechanistic definition is not flexible enough for future development, and is incapable of providing any information about the subject to be defined. The equation of Assets + Expenses = Liabilities + Equity + Revenues indicates that the left side of the equation reflects the uses of funds, while the right side of the equation reflects the sources of funds. That rationale should, therefore, be employed in defining each element of financial statements. Using the infobase approach, the alternative definitions of the elements of financial statements are as follow. First, assets are uses of fund in the form of resources whose economic
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value can still be utilized in the future. Second, expenses are uses of fund in the form of resources whose economic value has been utilized for the firms activities within a particular period. Third, liabilities are sources of fund from third parties acting as creditors. Fourth, equity is sources of fund from the companys owner, retained earnings (accumulated profits), and sources other than creditors. Fifth, revenues are sources of fund from the firms activities within a particular period. This infobase-based definition of elements of financial statements is more abstract, and covers many more business events than the current mechanistic definition allows for.

MATHEMATICAL PERSPECTIVE TO SOLVE THE CURRENT ISSUES Written documents show that accounting was included in Luca Paciolis mathematic book (Sangster et al., 2007). In its historical progress, however, accounting has developed a focus on rules (Penno, 2008). A large number of rules have been issued to the effect that accounting was well-known as a regulatory enterprise (AAA FASC, 2007). Nevertheless, the development of rules cannot completely protect the users of accounting information (Scott, 2009). Besides focusing on the development of rules, accounting has also developed an emphasis on vocational skills. The teaching of accounting, as a result, has focused largely on vocational skills (Demski, 2007), with little contribution to the academic world (Fellingham, 2007). Financial reporting is not an end in itself. It is a means of communicating to the users of financial reports information that is useful in making choices among alternative uses of scarce resources (FASB, 2006:OB6) and The objective of general purpose financial reporting is to provide financial information . . . (FASB, 2008:OB2). Thus, financial accounting is a tool to be used to provide financial information. As a tool, accounting should be of the same nature as computing, aircraft technology, etc. All these technologies require established knowledge in order to function effectively; to give the best possible contribution to humanity, and to allow for continuous development. This study argues that three major pillars should be developed in a balanced manner to enable accounting to become an academic discipline, namely mathematics, rules, and art. The Joint Project IASB/FASB has been developing the Conceptual Framework for Financial Reporting that underlies financial reporting. Several topics are still debated up to the
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present. These debated topics usually become problematic when we have to choose between two extreme points which appear utterly irreconcilable but which eventually must be accommodated in order to serve the interests of all parties involved. For example, the Joint Project IASB/FASB originally stated in the Preliminary Views of the Conceptual Framework for Financial Reporting that the potential users of financial reports include equity investors, creditors, suppliers, employees, customers, governments and their agencies and regulatory bodies, and the public (FASB, 2006:OB6). Later, the Joint Project IASB/FASB revised the objective of external financial reporting as to provide information that is useful for capital providers including equity investors, lenders, and other creditors (FASB, 2008:OB6). Below are two Joint Project IASB/FASBs objectives as mentioned in the Preliminary Reviews of the Conceptual Framework (FASB, 2006) that can be achieved through the development of the accounting equation.

Stakeholder vs. Stockholder Approaches The objective of external financial reporting is directed to the needs of a wide range of users (stakeholder approach). However, as long as all sources of funds other than liabilities are contained in one element, namely the equity, it will be difficult for financial reporting to provide information which is useful to users other than equity investors and creditors (stockholder approach). As the equity contains various sources of funds the quality of information coming from the element may decrease. For example, current financial reporting is unable to provide a representative picture of the long-term contribution of the management to the company because their performance is periodically moved into the equity. This study argues that this could be the reason for the emergence of conflicts between principals and agents. Likewise, current financial reporting is unable to provide information which is specific about governmental subsidies, donations or facilities received by the firm, as the information about governmental support is mixed up with information about other sources of funds in one big basket called equity. In this information era firms need information that is more detailed and comprehensive in order to make informed decisions. Had the accounting equation consisted of elements that represented specific types of users, information that is useful to a wide range of users might have
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been produced. The accounting equation could be developed along the line of, for instance, Asset + Expenses = Liabilities + Owners Capital + Revenues + Management Contribution + Governmental Fund + Residual Sources.

Relevance vs. Reliability The qualitative characteristics of financial reporting information should be relevant, faithful, comparable, and understandable. However, as long as the elements of accounting equation consist of financial information employing various measurements, it will be difficult to fulfill these qualitative requirements. For example, when assets cover several accounts that employ some measures, the assets are unable to fully meet both the characteristics of relevance and faithful representation. Likewise, the use of various measurements in one element may weaken the comparability and understandability of the financial reporting. This also applies to other elements in the accounting equation, both in the element of balance sheet and income statements. Had the accounting equation consisted of various elements containing information measured with the same (homogenous) measuring tool, the accounting information produced would have acquired the long-awaited characteristics of relevance, faithful representation, comparability, and understandability. For instance, the elements of assets are divided into two, namely value-based assets and historical-cost assets, and the elements of expenses are divided into two, namely accrual-based expenses and cash-based expenses. Elements of the value-based assets reflect the provision of information which is relevant for decision-making, while the elements of historical-cost assets reflect information which is relevant for faithful representation.

THE TRIANGLE OF ACCOUNTING DEVELOPMENT Accounting is a tool to attain a particular aim (Ingram 1998). In other words, accounting should be treated like technology. As a technology, accounting can be made analogous to aircrafts, computers, or any other technological products. Those technologies are developed systematically, logically, and on the basis of sciences whose validity has been so well established that they are capable of growing even further and giving a vast contribution to the humankind.
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We argue that the development of accounting is affected by three interrelated pillars: a. Mathematics; this pillar should be firmly founded upon which accounting may grow. b. Generally accepted accounting principles (GAAP); this pillar serves to ensure that the development of accounting could be well understood and accepted by the users. c. Art/craft; this pillar provides a space for the user for developing the kind of accounting that is most suitable to his wants and needs. The development of accounting should be done through the development of the three pillars mentioned above. The model of accounting development can be illustrated as the following triangle.

MATHEMATICS

BASIC PRINCIPLES

ART/CRAFT

The tremendous growth of the business world has likewise increased the complexities of accounting and financial reporting. Up to now the development of accounting (GAAP) regulations has been intensively done with the hope that such a development may provide the necessary solutions to existing problems. Nevertheless, we cannot expect regulation to completely protect investors (Scott 2009, 15). Therefore, it is expected that a development that gives preeminence to the mathematical pillar would enable accounting to give a significant contribution to mankind. The addition of the revenues and expenses elements would make accounting study dynamic (Vangermeersch, 1997). By using the mathematical perspective, it is expected that accounting study would be more dynamic and capable of inviting the student to develop
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accounting knowledge, rather than to be content with understanding accounting simply as a rule of play established by the business game. The use of the mathematical perspective can also be an initial step toward the development of new models of determining monetary values in financial statements, which up to now have been considered within the competence of other fields.

CONCLUSION The development of financial accounting overemphasizing rules has limited accounting simply to the rules of the game. The use of a mathematical perspective identifies the inappropriateness of current accounting teaching methods and reveals the limitations of the current standard boards in defining elements of financial statements. This study also briefly discusses the use of the mathematical perspective to achieve the ideal objectives expected by the Joint Project IASB/FASB. Accounting should apply mathematical theorems widely. As a preliminary step, we should identify and discuss several persistent questions and problems, including standards, by using the mathematical perspective. Subsequently, developing accounting along the line of the three main pillars, namely mathematics, rules, and arts, should be undertaken in a balanced manner. Like in computer and telecommunication technologies, accounting should be able not only to function as a supporting tool to portray the reality of business, but also to function as a transformer in the future. The use of mathematical perspective in the development of accounting will convey financial information that is useful to prevent, detect, and correct global financial crisis.

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APPENDIX

FIGURE 1 The Mathematics of Numbers Debit/Left Side Debit/Left Side 10 25 15 = Credit/Right Side 4 + 6

FIGURE 2 The Rule of Debits and Credits Assets Debit/Left Side 10 + 28

Credit/Right Side = 4 + 6

History-based Accounting Reform

FIGURE 3 The Mathematics of Number Credit/Right Side Debit/Left Side 10 = 14 Credit/Right Side 4 18 + 6

FIGURE 4 The Rule of Debits and Credits Liabilities Debit/Left Side 10 = Credit/Right Side 4 + + 6

FIGURE 5 The Mathematics of Number Credit/Right Side Debit/Left Side 10 = 4 Credit/Right Side + 30 6 36

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FIGURE 6 The Rule of Debit and Credit Equity Debit/Left Side 10 = 4 Credit/Right Side + 6 +

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