Some of the most important and far-reaching revolutions in our history have been accomplished without firing a shot. In our political structure these revolutions occur almost daily and often have profound implications for both this generation and the next. After being more or less dormant for many years, the winds of change are blowing through the United States accounting profession and bringing with them some suggestions for changes which, if adopted, would have a profound effect not only upon our balance sheets but also upon our society. Before we all proceed by small steps down the yellow brick road labeled "current-value accounting," it might be prudent to pause and ask ourselves some basic questions about to whom we are accounting and for what purposes.

Since the private sector must demonstrate responsibility in making its own decisions, I am now and always have been a strong supporter of the Financial Accounting Standards Board. If this body does not resolve the various thorny issues before us, then that resolution will most certainly be made in the public sector. Once the government starts to write rules and regulations, it will become increasingly difficult to attract outstanding people to your profession, because you will turn from imaginative accountants into bookkeepers attempting to comply with thousands of pages of regulations that will be churned out by some bureaucracy.

During the relatively short time that FASB has been in existence, a great deal of work has been done on some very hard problems. The danger that now presents itself is the common historical phenomenon that secondary consequences of primary actions are often far more important than the original actions themselves. The most common one might be a drug that can cure one illness only to give you another and worse disease. Before we prescribe the wonder drug of current-value accounting, much care should be given to the possible side effects, which may well be worse than our current disease. In an attempt to foster intellectual conceptual purity in accounting, we run a very real danger that the secondary consequences of rule changes will be devastating for our society. If we do not take care, we may participate in an operation of great technical brilliance in which the patient dies.

As our society becomes more specialized, I think it is fair to observe that more and more groups are doing more and more talking to themselves and less and less communicating with the rest of the world. Right at this moment, there are dozens of trade association meetings in session, and each one has developed a special vocabulary, which over time serves its purposes well, but becomes almost totally unintelligible to others. People outside a given group are often unable even to follow the drift of the conversation. Even an unstructured collection of people whose only common denominator is ownership of a citizens' band radio, have developed a distinctive language. This trend in our society, while no doubt interesting to sociologists, has not until recently begun to impact adversely the whole structure of our society.

Today we are faced with a widening gap in the communications between the accounting fraternity and its audience of bankers, managers, investors and the general public. The intellectual accounting exercises which are now starting to move from drawing room dialogues to the marketplace appear to be entirely self-propelled in the sense that virtually no one outside a relatively small group of accounting theorists is demanding such sweeping changes. There just is no demand for a whole new accounting system from people who must use the product. Investors are already being confused by the current over recording of short-term swings, which tends to obscure the basic long-term trends of the business in which they have invested. In a world of floating exchange rates, to wash each jiggle in the international currency markets through current earnings merely distorts a company's results without taking note of the relationship between currencies over a longer time frame.

The futility of this approach so far as producing meaningful data is concerned is illustrated by Citicorp's own experience. Between July 1 and August 30, 1973, translation gains and losses went from a $12 million gain to an $8 million loss, a $20 million swing in just two months, although during that time there was no significant change in our currency position. By year-end 1974 exchange rates had adjusted so that, despite the short-term fluctuations, the net impact over two years was less than 2% of total earnings. Fortunately, our stockholders were not confused because we were using the reserve method of accounting at that time, which method is no longer permitted.

Bankers and other lenders make no demands for current-value accounting for the simple reason that one of the first rules of credit analysis is to study comparable data over time. There is no real demand from industry generally for sweeping changes in accounting concepts, since rule changes are justified only when they improve information and yield better decisions. Most businessmen and bankers believe that accounting conventions should not drive business decisions, but rather should reflect them in a meaningful manner.

In reciting these facts, I am not suggesting that there are not some inadequacies in our present accounting rules. The Standards Board has accepted a tough assignment to devise better financial statements to give better information. A great deal of thought has been given to the primary consequences of rule changes, but sometimes not enough thought is given to tracing through secondary consequences. The first level of inquiry is the propriety of changing historical accounting rules, which while flawed, nevertheless have served as an understandable communication bridge between business, lenders, accountants and the general public. Before we blow up this bridge, we must be sure that there is another one in place.

The second level of question is far more important than the technical arguments about the conceptual purity of accounting procedures. This level is the secondary consequences to our society of the accounting changes being proposed. If the current direction in which the accounting profession is headed is followed to its logical extreme, the impact in our country over time on unemployment, on state and municipal financing, on home financing from savings-and-loan associations, on obtaining insurance coverage, and on the ability of banks and the financial intermediaries to stick with their customers during the next recession, will be far more important than any new technical triumphs or disasters we encounter along the way.

If lenders are to be required to reprice their long-term financial assets to market value each month-end with the resultant offset against earnings, they will obviously be strongly motivated to purchase only securities with very short maturities, which are relatively unaffected by changes in interest rates.

The political explosion which will occur when the fifty governors and the thousands of mayors across the country come to learn that by a stroke of the pen their long-term school bonds or general-obligation bonds have suddenly become unattractive to any institutional purchaser will be heard far and wide. The needs of states and municipalities to continue to finance themselves will not go away in the foreseeable future, and an accounting rule that would force them to issue only short-term obligations would create an unsound financial pattern, which is just the reverse of what is called for by sound practice. If an accounting change drives a business decision in the wrong economic direction, we should stop and examine it before plunging ahead to create a situation that will exacerbate the already difficult position of many states, cities and municipalities.

A similar phenomenon might occur in the banking business. The record of American banks in seeing their customers through the worst recession in 40 years is one in which the industry can take some pride. Instead of forcing companies into bankruptcy, banks worked intensively with their borrowers to restructure debt, to adjust interest payments and restate maturities. The result has been to keep thousands of American workers employed in dozens of companies throughout the land that otherwise might have failed. Both the social and the financial results are good. If we proceed along the road the current FASB discussion draft appears to be taking us, every time a debt needs to be restructured, lenders will have a strong incentive not to work out problems with the borrowers, but merely to throw them into bankruptcy, with the consequent rise in unemployment rates. In the next economic downturn, if the concepts embodied in the current FASB discussion draft should be adopted, lenders would have no incentive to attempt to work out problems with borrowers. For their part, corporate borrowers would be hard pressed to find anyone who would be agreeable to restructuring their liabilities to see them through hard times and to help them maintain their employment rolls until the general economic climate improved. The burden would, of course, fall hardest on the small-and medium-sized firms. Once again we would produce a socially undesirable result with no offsetting gain in the usefulness of financial data. It would be a poor trade-off by any standard.

Things that we now take for granted, like the ability to obtain adequate insurance coverage for our families and our businesses, could well be adversely impacted. Should the current accounting trends continue and be applied generally, it might well become increasingly difficult to obtain insurance coverage every time interest rates rose in response to some shift in monetary or fiscal policy. The so-called Kenny ratio, that is, the annualized premium written as a multiple of an insurance company's net worth, would gyrate wildly if statutory surplus were computed in accordance with current-value accounting. This result would occur because if current-value concepts applied to long-term bonds as well as equities, they would have to be written up and down as markets changed. In high-rate environments, as long-term bonds fell in the marketplace and the book net worth of the company shrank or even evaporated, you or I might be unable to get insurance coverage on our homes, our cars or our lives. Available insurance coverage might be frozen or even shrink because many regulators look at this ratio as one means of determining how much insurance may safely be written by a given company. An accounting rule which would have this effect is unacceptable to our society.

All of these proposed rule changes are little pieces of a large mosaic of some kind of current-value accounting.

In all of these possible results of the imposition of current-value accounting, the economic reality of a given transaction has not changed; we have merely changed how it is reported. The effect of these proposals is to shift earnings and/or expenses from next year to this year or vice versa. The dollars of profit or loss over time are the same.

When the short-term effect of a particular accounting system may significantly influence whether or not a particular, and otherwise desirable, business transaction is to be undertaken at all, accounting has moved outside its legitimate parameters of measurement and reporting and taken on an inappropriate motivational force of its own.

The advocates of current-value accounting score intellectual points with each other without thoroughly taking into account the side effects on society of their laboratory experiments. Recently, for example, Lee J. Seidler did some arithmetic with the 1974 U.S. Steel balance sheet and profit-and-loss statement. Using replacement costs, Mr. Seidler computed that U.S. Steel would have shown a net income of $3.1 million rather than $691 million that was reported. A case can be made that this restatement tells somebody something, but it certainly does not communicate anything useful to people who are retired on pensions that are paid in part by the very real dividends declared by the Steel Corporation. The pensioner standing at the mailbox waiting for his check is unimpressed with this exercise for a very simple reason. You and I, and anyone else who stands at the check-out counter in the supermarket, know that the only kind of dollars the cashier takes are current dollars, because that is the only kind of dollars you and I get paid in and the only kind that circulates. While there is a lot of conversation in the economic community about "real dollars" or "constant dollars," the plain fact is that no one ever spent a constant dollar, no one ever got paid in a constant dollar, and no one ever saved a constant dollar. Constant dollars are an economic concept and not an accounting one.

The concept of current-value accounting or replacement-cost accounting rests in the last analysis upon first being able to measure with some accuracy the effects of inflation, and second on assuming inflation is not a cost of doing business. Unfortunately, the state of the art is such that no reliable inflation index exists nor, in my judgment, will one soon be created. The reasons for this are simple. None of the indexes that have been constructed are able to measure quality. It is very easy to say that the cost of medical care has gone up very sharply, but it is much harder to measure definitively the quality of that care. Your children will not get polio, because of the Salk vaccine which did not exist in the early 1940s. Your children will not get mastoid, because of the invention of penicillin. There are thousands of people walking around leading useful lives with an electric heart pacemaker who would have died 10 years ago. A constant dollar a few years ago could not buy a pacemaker, or penicillin, or the Salk vaccine-only current dollars will buy these products. All of the people who have been saved by modern medicine are living proof of the improved quality of medical care which no amount of gold, constant dollars, or any other substitute could have purchased a few years ago. An index that fails to measure such a vital fact in our society is deficient for use in general application. In addition to quality, which is not adequately reflected in the indexes, most of them also fail to measure productivity and real increases in wages. One way to measure our progress is to compute the work time needed by the average person to earn enough money to purchase a major appliance. A simple formula would be to take the average retail price of an appliance divided by the average hourly earnings of production workers in manufacturing. In 1947, for example, the average person worked 377 hours to buy a room air conditioner; today he or she has to work only 50 hours to buy today's better product. In 1947, one would have worked 209 hours to buy a refrigerator; today that number is 65. This is true across the whole range of appliances, and these numbers again do not reflect the fact that the air conditioner of today is a far better piece of equipment than its predecessor made in 1947. The concept then of simplistic replacement costs fails by a very wide margin to tell the story of what has actually transpired in our economy. For these and many other reasons, FASB has deferred action on inflation-adjusted accounting.

There are reasonable people who would argue that a corporation operating with assets purchased for 50% less than today's replacement costs may have a cost advantage over another company with newly purchased assets and, therefore, that the first corporation is able to realize a higher return on capital. This higher return on capital might be said to compensate it for the fact that its depreciation allowance would not cover replacement costs of assets.

Depreciation as an expense of doing business is certainly a valid accounting concept. It seems to me that the shift away from depreciation on historical cost toward computing depreciation on some kind of replacement value is simply an intelligent attempt to produce the cash flow necessary for increased capital investments. The reason industry is genuinely concerned about replacing its plant and equipment is that the huge amounts of capital that will be required may be hard to come by in a society where the tax structure penalizes savings and rewards consumption. Most companies do not specifically fund their depreciation reserves. There are some industries such as the subsidized steamship companies that do take the cash generated by depreciation and instead of spending it currently, deposit it in a special reserve fund which they set up so the actual cash will be available to replace assets at a future date. In addition to stated depreciation rates, the steamship companies are also able to set aside additional cash, tax free, from earnings on eligible vessels and from the proceeds of their sale. The earnings on the reserve fund, primarily from interest, are likewise tax free. This capital-construction fund can be used only to replace assets.

Unlike the steamship companies, which have special legislation, most companies have made the decision to use the cash generated by depreciation in their current business, and thus the cash is not available for asset replacement. On the other side of the economic coin, companies that spend their depreciation cash flow in this manner do not have to borrow so extensively to finance current operations.

In bringing these points to your attention, I do not mean to imply that our present system is perfect, but I am urgently asking that we do not permit the heavy hand of government to force hasty decisions that could have traumatic side effects upon our whole society. Reasonable people disagree on how best to present financial data on our balance sheets and profit-and-loss statements, which makes it even more important to go slow and think through all the consequences of our actions. Just as war has been said to be too important to be left to the generals, so with great respect I am suggesting that accounting rules are too important to be left only to the accountants.

The FASB process has worked. Exposure drafts have been submitted for comments; FASB has listened to the comments, and it has shown a willingness to change or delay in certain instances. My concern is that the consumers of financial information are not yet making themselves heard. At the moment it is possible that there are too many accountants listening to other accountants discuss technical nuances, and that not enough consideration is being given to the decision-making process for which the numbers are prepared. I urge FASB to reconsider its piecemeal approach toward current-value accounting, by applying the same well-thought-out logic it used in deferring a mandate to report in Units of General Purchasing Power. As you will recall, the Board stated that (1) information is not now sufficiently well understood by preparers and users, (2) the need for it is not now sufficiently well demonstrated, and (3) the Board's conceptual framework project was not completed. Let's decide where we want to be in the future before we continue down a path of making piecemeal decisions on relatively narrow issues that may be leading in a direction we will not want to travel when all the factors have been weighed.

The chairman of the Standards Board has described the present search for a better accounting system as a "democratic process which demands the participation of all concerned." It is urgent that the chief executive officers of American industry get into this dialogue in order to bring their pragmatic, practical insights to the discussion. Out of such a dialogue can emerge an accounting system that is responsive to the information needs of lenders, investors, managers and the general public. This objective is worthy of the best efforts of us all.