Here, at last, was legislation with teeth. But as Tedlow (1981) observed, after an initial zeal on the part of the commission, its interest in advertising regulation degenerated for a variety of reasons.
The advertising industry’s attempts to secure legislation, combined with the industry’s publicity of its codes of ethics, slogans, and emblems, had the public clamoring for truthful advertising by the 1920s. The version of truth adopted by the industry was one based on the correspondence between advertised claims and the facts or actual products and prices offered by advertisers. When the AACA and others during this era used the term truth, they usually had a fairly broad concept in mind. Their targets included ads described variously as fraudulent, false, misleading, and deceitful. Even puffery, which is legal today and has been for centuries, would have been stopped by some participants in the “truth in advertising” movement.
Puffery is “advertising which praises the item sold with subjective opinions, superlatives, or exaggerations, vaguely and generally, stating no specific facts” (Preston 1975, 17). It is legal because the law holds that “reasonable” people will automatically distrust it and therefore not be deceived by it. In other words, it is considered by the law to be false but not deceptive. Puffery can coexist with a correspondence version of the truth because the correspondence criterion leaves subjective opinion and exaggerations outside the realm of truth claims. Statements of puffery are not subject to truth claims because they state “no specific facts”; that is, they make no reference to an objective object world. It is less clear that puffery would be consistent with truth claims anchored in pragmatism or coherence theory.
An advertisement goes beyond puffery when deception occurs. An advertisement is regarded as deceptive when an individual is injured (materially or physically) by acting on the claims stated in the advertisement. That stricter interpretation of truthful was clearly the intention of most of the early legislation in both the United States and Canada. It was true with the Food and Drug Administration in 1906 and still so in 1938 with the Wheeler-Lea Act cited above. Nevertheless, all false advertising was considered by most in the truth movement to be harmful to their aspirations of professional status. Their reliance on a strict correspondence between advertised claims and the facts left them no room for error, as this 1927 Canadian trade journal commentary pointed out:
Honesty may be the best policy, but has anyone fully tried it? I admit that many have, up to a certain point, and that they have found it profitable. But can 75 per cent of the truth be called complete honesty? And if 75 per cent honesty is profitable would not 100 per cent be more so? Is the troth, the whole truth, and nothing but the truth in advertising impracticable?… Can you think of any greater business asset than to have people believe implicitly, without modification, everything you say in your advertising? (Smith 1927, 431)
Despite the extreme position adopted by many, the advertising industry still had untruthful advertising, and it was no closer to becoming a profession.
TRUE AND FAIR (FINANCIAL STATEMENTS)
The history of truth in accounting is most clearly played out in the evolution of the auditor’s certificate. The auditor’s certificate specifies the standards to which the auditor may be held responsible and, derivatively, the extent to which others should rely on the contents of the financial statements that have been audited. F. Whinney (1894, 558-59), founder of one of the major accounting firms, held that “no auditor should sign any balance sheet unless he believed it was true, and he must take all reasonable means to satisfy himself that it is true.” The truth was to be determined by checking “the facts.” “An auditor should be sure that the figures represent facts, because the whole object of an audit was to ascertain whether figures were facts.” Whinney clearly subscribed to a correspondence version of truth.
The importance to the profession of seeking the truth was reinforced in an editorial in the Canadian Chartered Accountant. The editorial proposed “truth” as the essential attribute of the auditor:
The truth is the only thing that should concern him and on all questions of fact he should be unwavering …. Confront the accountant with a requirement to present facts in a light solely or chiefly favourable to a client and you take away from him the very foundation upon which the growth of the profession and its value to the community are built. (”Editorial” 1919, 105-6)
The version of the truth suggested by Whinney and others early in the profession’s history was not widely accepted. The difficulty was that while a check of the consistency of the balance sheet to the books was possible, two further issues arose: (1) were the entries in the books “real”? and (2) were the results reflective of the expectations of the public regarding their use of the statements? While the auditors of the day could reject the suggestion that “figures should be fictions” (Whinney 1894, 962), they also argued that the need to use estimates of asset values, the useful lives of assets, and probability of successful sales of inventories meant that any auditor’s certificate was an opinion and not necessarily “true.”
Authors such as Parton (1917) noted the impossibility of auditors attesting to the correspondence between financial statements and the underlying reality of the firm. His recommendation is that the auditors limit themselves to those historical facts that could be verified by the auditors:
The Auditor is advised to “select a few items of importance and compare with the things themselves.” Unfortunately, however, we are none of us possessed of sufficient knowledge to make such an examination effective… an appraisal being always the result of an individual opinion while original cost is an undeniable fact. (Parton 1917, 95)
In practice, accountants and auditors routinely prepared financial statements that varied from a commonsense or correspondence version of truth. There are two major financial statements: the balance sheet and the income statement. The balance sheet reports on the assets and liabilities of the company; it is a representation of the stock of wealth at a particular point in time. The income statement reports on the change in wealth between two points in time. The generally accepted accounting principles that are used to create these statements require the use of historic costs (original costs). There are exceptions to this rule. Current assets, assets that can be liquidated within a year, for example, are reported at the lower of cost or market, and long-term assets that have suffered a permanent loss of value are also “written down” to reflect this loss. These exceptions reflected a principle of conservatism that requires that all losses be recognized but no gains until they are realized. The use of historic cost and conservative valuation principles results in a distinction between the intended truth value of accounting reports and the actual truth value of those reports.
Hatfield (1913, 83), the first professor of accounting in the United States, talks at length about the economic uses of accounting information but then cautions that
in all the foregoing discussion it has been assumed that the purpose of accounting is to present facts fully and without reservation; but argument is sometimes made that the statement set forth in the balance sheet does not even profess to be true; indeed, that a variation from truth, provided only that it understates the wealth of the concern, is really a merit rather than a fault.
There are alternatives to the commonly accepted approach to reporting financial information. For example, if the balance sheet is meant to provide a measure of the value of a company at a particular time, then all numbers can be restated in terms of the present or market value of assets and liabilities, or when no market exists, the cost to replace assets can be used. MacNeal ([1939] 1970) was an early proponent of a present value approach to accounting. He claimed that
financial statements are undoubtedly the principal means by which investors are informed. They are relied upon by millions of investors. But they can never become the key to the solution of the basic problem of protecting the small investor until the faulty accounting principles underlying their preparation are changed to permit a presentation of truth as it is instinctively understood by laymen everywhere. (P. 57)
MacNeal ([1939] 1970, 39) held that truth “in an economic sense” was the key to the success of the profession and that the failure of the profession to adopt this version of truth put the future social standing of auditors at risk. He recognized, however, that the adoption of present-value accounting or replacement cost accounting requires skills that the accountant does not possess and opens up the field of auditing and financial statement preparation to competition from appraisers and engineers, respectively.
While Hatfield and MacNeal were critical of the principles underlying financial reporting on theoretical grounds, others were concerned about any attempt to define a set of rules for accounting. The call for a science of auditing was equated with the de-skilling of the profession and the replacement of professional judgment with rules. This view was also reflected in comments in the Canadian Chartered Accountant:
As the desire for health justifies the existence of the medical profession, the desire for truth or accuracy in accounts justifies the existence of the accounting profession …. This truth is so obvious that it is in danger of being overlooked, yet I suggest that until one has fairly gripped it the whole practice of auditing may degenerate into the mere observance of certain rules which are sometimes called the principles of auditing and which have produced so many inferior auditors. (McCall 1924, 105-6)
These criticisms deny the ability of any set of rules and procedures to grasp the reality of a firm’s financial position. These concerns become even more pronounced as financial statements became more important in the operation of the capital markets.
During the speculative boom of the late 1920s, concern was raised about auditors’ certificates becoming associated with public offerings of shares and hence being relied on as an indication of future performance rather than just as a report on the firms’ past stewardship of resources. The change in focus required that auditors become concerned with the reliance of third parties on their certificates and hence with a pragmatic test of truth.
The self-respecting accountant should constantly apply this touchstone to the circular [prospectus] and every part of it. Is the picture not only true to the facts but is it drawn in such a way as to convey a true and reasonably understood story to the prospective investor? (Dilworth 1928, 146)
The discussions reviewed above exhibit a curious tension between a desire to claim that auditors presented the truth behind the financial statements and recognition that they could not claim to present truth as understood by the layman. Moreover, the tendency of third parties to impose a pragmatic criterion of truth on the audit certificate threatened to expose the auditor to legal risks. The need to resolve this tension was finally brought to a head in the aftermath of the Great Depression. The accounting profession was called on to help shore up the capital markets by restoring faith in corporate reporting. The vehicle by which this was to occur was the auditor’s certificate.
Prior to the U.S. Securities Act of 1933, the auditor’s certificate was not standardized. In negotiations surrounding that act, the profession found itself in the uncomfortable position of lobbying to ensure that auditors were not required to attest to the “truth” of financial statements. The FTC was empowered under the act to regulate the standards of financial reporting and issued a statement requiring auditors to attest to the truth of the financial statements. Auditors were successful in lobbying against this construction of their responsibilities, and on April 7, 1934, the commission announced a change in the wording of the auditor’s certificate. The form adopted, which continues to the present, is a legally weaker statement that the financial statements “truly and fairly reflect the application of accepted accounting principles to the facts disclosed.” Note that there are two caveats in this statement: (1) the truth is defined by a set of rules on which there has been previous agreement, and (2) the truth is limited to that which has been disclosed by management.
A report to the U.S. Department of Commerce, dated August 2, 1934, captures the essence of the position adopted:
Regardless of how conscientiously the statements have been prepared, it will still remain true that no reader can fully understand them who has not informed himself of the accounting principles which underlie them. (Gifford, duPont, and Harriman 1934, 112)
The truth criterion adopted by the profession was thus coherence with a network of a priori beliefs. The audit profession was in the enviable position of both defining truth and certifying its presence. Rather than conforming accounting to the expectations of the public, the version of truth adopted committed the profession to training the public to understand the truth of financial statements. The potential gap between naive expectations and the coherence version of truth adopted in financial statements has resurfaced repeatedly in the history of the profession, most recently during the recession of the late 1980s.
Although the coherence version of the truth in accounting was enshrined in the U.S. Securities Acts of 1934, other approaches continue to appear in the literature. One construction of that debate is as a conflict between views of auditing as a science or an art (e.g., Green 1966). The attempt to construct auditing as an art, however, leaves the truth claims of auditors’ reports in a precarious position. As Previts and Merino (1979, 163) note, “The artist does not seek fundamental truths but relies instead upon the independent, informed judgment of the individual in the interpretation of the phenomenon.” Deutsch (1979) argues that artistic truth (i.e., to recognize a true work of art) is not based in a correspondence theory of truth. A work of art is not simply a copy or representation of some other object or event. Rather, art is recognized as true when it is an authentic expression of its own intentionality (Deutsch 1979, 38). In other words, a true work of art is recognized by its unique expression of a particular vision; it is judged existentially. Applying this view of artistic truth to audits would require that the audit be judged as a performance with intrinsic value and not subject to external norms. Perhaps the artistic concept of an audit’s truth value reflects White’s (1970, 118) observation: “A particular statement (or artwork) could be perfectly true without containing more than a minute proportion of the whole truth even about a single topic. Being wholly true is not the same as being the whole truth.”
By the end of the Progressive Era, auditors were well established as one of the modern professions in North America. In their literature, they wrestled with the truth of their communications, often using the rhetoric of correspondence theory in claiming to present nothing but the facts while clearly recognizing that such claims were not defensible. The literature suggests that accountants believed that a “true financial state of the firm” existed and could be apprehended by a professional auditor. In practical terms, however, the auditor could only rely on a set of common beliefs about the measurement and disclosure processes (i.e., accounting and auditing principles) that, if followed, would most likely reveal this true state of affairs. The true professional achievement of the auditors in this period was to take control of the process by which these principles would be set and resist legislation that would have locked them into a version of the truth easily accessible to lay interpretation.
DISCUSSION
Why did advertisers and auditors take different approaches to “truth”? Several factors appear relevant. First, the audiences for advertisers’ and auditors’ truth claims were different. Advertisers faced an audience of mass consumers. Compared with auditors, advertisers had little direct contact with their audience by which to educate and negotiate a definition of troth. Advertisers were then constrained to use criteria that had broad intuitive appeal. In addition, false advertising, which misled or deceived consumers, could and often did lead to serious consequences for those consumers, creating not only bad press for the advertiser in question but also negative impressions of the advertising industry in general. That is why truth in advertising was so often justified on economic grounds. Deception could hurt consumers and thus indirectly hurt the advertising industry, or so the reasoning went. Legislators were never interested in truth in advertising for the same masons as advertisers. As Preston (1975, 11) puts it, the law was not really regulating the message but rather the fate of the consumer, but in so doing it became an ally for the truth in advertising movement.