Social norms and value statements

A very important class of statements are value statements (e.g., financial statements “present fairly”), and the social norms associated with those value judgments. Social norms are essentially a variety of behaviors, and accompanying expectations, shared by a group of individuals. They can be very much dependent on the context of a situation, e.g., what conditions constitute a valid wedding ceremony.

The role of norms is to help regulate and coordinate behavior within a group, whether the group is a professional body such as ICAS, a student club, or an entire country. An important type of norm is symbols and their meanings. Symbolic thinking such as language, writing, and mathematics seems to be at the heart of human intelligence. For example, the value of paper currency is entirely symbolic and has a meaning independent of its physical characteristics. This symbolic meaning and its related social norms are referred to as “social reality,” and the entities and relationships so created are regarded as “socially constructed.”

For our purposes the relevance of social reality is that it is the basis of the social sciences, including economics and financial reporting (e.g., Shapiro 1998, 653). The problem for auditors is that they need to verify social reality and social constructs such as income. This can be difficult because much of social reality is subjective, and this can lead to alternative social realities which have been the focus of social theory in accounting research. Auditors use norms in the form of suitable criteria such as GAAP to help deal with subjectivity. Part of the challenge of principles-based accounting is to determine what kind of social reality should be included in the principles of financial reporting. In particular, we propose that a key principle be the acceptability of the risks associated with the estimation uncertainties concept of ISA 540 (Auditing Accounting Estimates, Including Fair Value Estimates, and Related Disclosures)—mainly because these uncertainties are a pervasive problem of financial reporting and greatly influence the nature of the social reality reflected in financial reporting.

Both language and social context can have important roles in influencing the strength of all argumentation, including audit of financial statement arguments. These two factors explain why rhetoric is also important to audit argument evaluation. In its broadest sense, the word rhetoric covers the logic, language, and context of argumentation. But it is up to the public accountant to use rhetorical principles in effective argumentation and to expose through skepticism and critical analysis any deception that management and other accountable individuals attempt through their own rhetoric. Some have developed an analysis of rhetoric as an economic transaction, using the analogy of “selling” an idea to selling a good. The gist of the analysis is that when information costs are high (the listeners are uneducated or the information is difficult to understand because it is complex), rhetorical devices, such as appealing to the authority of the speaker or using emotional appeals, become more important (Posner 1995, 501—503).

Young (2003) has suggested that standard setters have improperly used rhetoric to help justify their standard-setting processes. This may help explain the dissatisfaction with current accounting standards and the move to more principles-based accounting standard setting. However, principles-based accounting relies on appropriate identification of the important goals, concepts, and principles of accounting communication; and its implementation requires fluency in good argumentation and accompanying sensitivity to rhetorical issues. Consistent with the ICAS principles above, these are new skills auditors w'ill need to acquire in order to effectively implement principles-based accounting standards.

Soundness of arguments

For an argument to be good, it should be “sound” with respect to its subject matter (its contents) and its form (structure). An argument is sound with respect to its subject matter if all its component statements are true (i.e., the epistemic probability of the premises is 1.00). This is dependent on the knowledge of the field that the argument deals with.

An argument is sound with respect to its form (validity) if its logical structure is appropriate for the burden of proof for the situation (i.e., it has appropriately high inductive probability). This aspect of soundness is the focus of logic. In some cases deductive logic is required (e.g., mathematical or logical theorems). However, in most practical situations, including auditing, inductive proof (that is, an acceptable level of inductive probability below 1.00) is sufficient. Since accounting and auditing deal with a world of uncertainties, inductive argumentation is the dominant one. But how high or low can the epistemic probability of the audit conclusion (opinion) be in order to appropriately meet the auditor’s social role? Audit standards claim that the auditor provides “reasonable” assurance that the financial statements present fairly. From an argument perspective, fair presentation in part means being as precise in the reasoning and statements as the arguer’s knowledge allows. If the arguer is the auditor, this would mean that a fairly presented estimate involving forecasts of future events (these types of estimates pervade GAAP accounting) must have sufficiently high epistemic probability of being true (i.e., being measured accurately, or being achieved, or being realized). For an example using this perspective and assuming the acceptable epistemic probability of future event estimates is 80%, only accounting estimates that are at least 80% sure of being realized should be shown as measurements in the financial statements.

The standard form of an argument as outlined by Barnes (199l)/Toulmin (1958) makes most prominent the major premise or warrant by listing it first. But what if we have more than one warrant that supports a conclusion? If there are several warrants supporting a conclusion, we need to create a structure for the warrants by setting up a hierarchy that most effectively supports the conclusion. This is a very important issue that is implicit in the ISA 200/700 fairness of presentation framework because traditionally there has been a hierarchy of Generally Accepted Accounting Principles (GAAP). The big question is whether any GAAP hierarchy will suffice for fair presentation; or are some hierarchies more logical in supporting a fair presentation opinion than others? For example, principles-based approaches to accounting theory imply that the broader principles take precedence over more detailed rules.