Realism in Financial Reporting

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REALISM IN FINANCIAL REPORTING: WHAT’S

REALLY AT STAKE IN THE DISPUTES

Mihaela IONAŞCU

Bucharest Academy of Economic Studies

Piata Romana nr. 6

Bucure şti, sector 1

+40 (0)21 3191900/01

Email: [email protected]

David ALEXANDER

University of Birmingham Birmingham Business School

Edgbaston

Birmingham

B15 2TT

United Kingdom

TEL: +44 121 414 8027/6530

Email: [email protected]

Draft: Please, do not quote without authors’ permission.

mailto:[email protected]










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Abstract

This paper develops the arguments in several recent papers in both the philosophicalliterature and the accounting literature concerning the nature of economic reality and the stake

of preserving realism as an ontological presupposition in financial reporting. We base much

of our analysis on Searle (1965, 1995) as well as on his later works (Searle 2005, 2006a,

2006b) which have not yet been taken into consideration in accounting ontological debates,

and his claims to defend a heavily nuanced (read: watered down) version of external reality.

The analysis is a critical one, as we fear that both the attempts to explain the ontology of

accounting information by means of different philosophical theories, as well as the very

theories chosen for such purposes are subject to inconsistencies which need to be made

explicit in the account.

Our conclusions are as follows. Accounting deals only with institutional reality. Assets like inventory,

equipment or trucks are not physical phenomena. They are artifacts which

would never have existed in the absence of human thought. In addition,

financial statements are not concerned with presenting such items per se, but in

measuring the positive/negative deontic powers of an organization that such

items represent.

In addition, most of the items represented by financial statements are free-

standing Y terms, that is, institutional objects which do not have any physical

realization.

Institutional reality is community-specific, and subject to collective acceptance

within the community. Such reality may be a “given” within the community,

and independent of the views of, or more accurately unable to be influenced

by, any particular individual.

Different conceptual schemes are inevitable, leading to a likely failure of

intertranslatability.

Realism is a necessary condition for achieving normal understanding in

financial reporting. Searle’s (1995) claim that “normal understanding of talk of

both money and mountains requires external reality” could be validly and

helpfully clarified by rewriting it as follows:“ Normal understanding of you and I talking about both money and mountainsrequires the presumption (not the fact) that there is general acceptance within theconceptual scheme of our community (not the human race) that money andmountains exist (whether as brute facts or institutional facts being irrelevant).”



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REALISM IN FINANCIAL REPORTING:

WHAT’S REALLY AT STAKE IN THE DISPUTES

1. Introduction

Ever since the development of interpretative and critical accounting theory the

ontological problem in accounting has been of a controversial nature. The modern

(positivistic/rationalistic) belief in an objective reality – a reality existing out there,

independent of the human subject, waiting to be represented by accounting figures – was

challenged as there were signs that such a narrow perspective would leave many questions

unanswered.

The discussions centered at first on the nature of the reality that is supposed to be

represented by accounting figures, going from a limited ontology of materialism , which

accepts only the existence of physical reality, to social constructivism , which upholds that all

reality is socially constructed.Positions in favour of materialism can be found in Heath (1987):

“Although the accounting concept of income is a model of real-world events,income does not exist in the real world any more than a family with 1.6 childrenexists in the real world. Both exist only in our minds. They are intangible

concepts or abstractions.”

or Schuetze (2001):

“I think that we should account for real things such as trucks, not abstract future

economic benefits.”

In these cases, the authors make an ontological commitment only to physical objects,

such as “trucks”, any other items constructed by human mind, such as “income” or “economic

benefits”, being considered abstractions, not existing “in the real world”, but “in our minds”.

Some of these texts (Schuetze 1993, 2001) contain an incentive for change in accounting

theory in the sense of eliminating abstractions from the accounting sphere, so that the

ontological presuppositions underlying accounting standards could hold.

The opposing position, supported by Hines (1988: 252,253), is that of social

constructivism:

“(...) everyday concepts are a cover -up. Did 'black holes' and 'subatomic particles'

exist, before physicists created the idea of them? Of course they did not! (…)Black holes are an idea, a metaphor, a concept. Like atoms. Like electrons. Likeorganizations!”

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According to this position, “something real” is not “discovered” (Hines, 1988: 253),

but it is created by means of human action (and interaction): “in communicating reality, we

construct reality”. Such approach allows for an explanation of the nature of accounting reality,

as in this perspective, accounting concepts like “revenue” or “profit” can be considered “real”,

although the concept of “real” itself is thought of as a matter of social convention.

The “social constructivism” advanced by Hines (1988) is, however, an extreme

perspective which allows for all reality to be socially constructed. A middle ground position

1 This and the previous two quotations all contain fundamental errors, as we show later in the paper.



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between materialism and social constructivism has been adopted by Mattessich (1991, 1995,

2003), Shapiro (1997, 1998), Alexander and Archer (2003) and Mouck (2004), which

distinguishes between physical reality and social reality. Accordingly, this position does not

support the social construction of reality but only the construction of social reality, and, in

this light, socially constructed objects are real and they should not be excluded from reality,

just because they are dependent on human mind.In support for this idea, Mattessich (1991, 1995, 2003) upholds an original

ontological model – “the onion model of reality” – inspired by ontological theories of

Hartman, Campbell, and Lorenz2::This model depicts reality as a structure of four layers “depended on andinclusive of each other, like those of an onion (…):

1. Physical-chemical reality: consisting of fields of forces, quarks,electrons, etc., and on higher sublevels, atoms, molecules, amino acids, proteins and so on. (...)2. Biological reality: it manifests itself in DNA molecules and thecriteria of life, as well as in its emergent properties, as empiricallyevidenced in modern botany and zoology. (...)3.

Mental reality (of humans): it is characterized by psychological and

quasi-mental phenomena, such as having preferences, intentions, pleasureor pain, etc. (...)

4. Social reality: it exists wherever groups of animals or humansgenerate social properties, which on the higher sub-levels become moral,economic, legalistic and similar properties.” (italic added)

According to this model, socially constructed objects, such as “income”, “liabilities”

or “capital” are not excluded from reality as in this ontological model “[t]he economic and

legal relations of ownership and debt claims are as empirically real on [the social] level as is

an atom on the physical level, or as are pain and preferences on the mental level.” Hence, both

physical and social objects are real, albeit they are different in nature, belonging to differentlayers of reality.

Shapiro (1997, 1998), Alexander and Archer (2003) and Mouck (2004) do not try to

develop their own ontological model, but consider Searle’s (1995) ontological theory in order

to support the reality of socially constructed objects.

Searle’s (1995) theoretic starts by making an ontological commitment to physical

objects (brute facts), and then, based on the concept of “intentionality” explains how social

objects come into being. According to Searle (1995) people have the ability to share beliefs or

desires – termed “collective intentionality” – that in certain conditions can give rise to a

specific type of social facts, namely, institutional facts. More exactly, institutional facts come

into being by ascribing a status function to a physical object (brute fact ) by means of

collective intentionality. This is done by a performative utterance in the form of: “X counts as

Y in the context C” (where X is the brute fact and Y is the institutional fact). For example:

“Bills issued by the Bureau of Engraving and Printing (X) count as money (Y) in the United

States (C)”.

This model can be further developed, as an institutional fact can play th e role of “X”

in creating a new institutional fact. But institutional facts ultimately depend on brute facts, as

there must be a physical object to start the construction of social reality. In Searle’s (1995)

terms, brute facts have logical priority over institutional facts.

This rationale is used in accounting to describe how accounting concepts are socially

constructed:

2 Quoted by Mattessich (2003).



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“By virtue of collective intentionality, ownership claims, income, and other

conceptual objects of accounting can, under appropriate conditions, beinstitutional facts.” (Alexander and Archer, 2003)

According to Mouck (2004), Searle’s (1995) ontological model is preferred to the

one advanced by Mattessich (1991, 1995, 2003) because it identifies very important

characteristics of brute facts and social facts. Namely, whereas brute facts are ontologically

objective – that is, they exist independently of human’s mind; social facts are ontologically

subjective – meaning, they cannot exist in absence of human thought. Moreover, Searle’s

(1995) model explains that institutional facts, although ontologically subjective (as they

require human practices to sustain their existence), are epistemologically objective, meaning

they have an effect that is universally agreed upon. That is because, being inter-subjectively

constructed by means of collective intentionality, institutional facts become objectified; in

other words, they are not dependent on a particular human being’s attitude towards them.

“Mattessich’s <<onion model of reality>>, as presented in Mattessich (1991), isnot adequate because it fails to distinguish between the epistemologicallysubjective and the epistemologically objective aspects of social reality.”(Mouck, 2004)

Macintosh et al. (2000a), adopting a postmodern/antirealist perspective, broke up the

link between accounting representations and reality, explicitly stating that accounting

concepts have no real-world referents, but “instead circulate (…) in a <<hyperreality>> of

self-referential models”. Accordingly, they questioned not only the nature of the reality that is

supposed to be represented by accounting figures (physical reality, socially constructed

reality), but the very existence of a reality to be referred to at all.

Later on, McKernan (2007) did not explicitly relinquish the difference between the

sign and the reference as Macintosh et al. (2000a) did:

The relations between financial accounts and objects and events in thecommercial environment have arguably tended to become progressively lessdirect as the business and technological world has grown in complexity andsophistication (see Macintosh, Shearer, Thornton, & Welker, 2000a) (Mckernan,2000: 159, italic added)

In a plead for a better understanding of the underlying ontological and

epistemological presuppositions of accounting, Lee (2006) reiterates many of the positions

reviewed here (Macintosh et al., 2000a; Alexander and Archer, 2003; Mattessich, 2003;

Mouck, 2004), but he seems unaware of the fact that they are opposing stances advanced from

different philosophical perspectives. Although he relies heavily on Searle’s (1995) theoretic(with a few inaccurate usages of his concepts, which will be addressed further), we find it

hard to define his ontological position.

Among the authors who have addressed the ontological problem in accounting we

have to distinguish between those that have tried to apply a certain ontological theory to the

accounting domain, and those that have only raised question and provided arguments without

relying on any philosophical theories. We have to confess that we do not believe that the latter

approach is suited for such a complex issue, as it can only lead to inconsistencies or to the

revival of some questions that have already received an answer.

A fundamental purpose of this paper is to present a rigorous investigation of the

nature of accounting reality and the stake of preserving realism as an ontological

presupposition in financial reporting. We base much of our analysis on Searle (1965, 1995) as



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well as on his later works (Searle 2005, 2006a, 2006b) which have not yet been taken into

consideration in accounting ontological debates, and his claims to defend a heavily nuanced

(read: watered down) version of external reality. The analysis is a critical one, as we fear that

both the attempts to explain the ontology of accounting information by means of different

philosophical theories, as well as the very theories chosen for such purposes are subject to

inconsistencies which need to be made explicit in the account.We draw on Searle’s theoretic, as it currently has a pervasive impact on the social

sciences domain, and as it has recently become very influential in the accounting, finally

providing us with a reasonable explanation of the nature of accounting reality, after we tried

so long and with so scarce resources to agree on the reality of a bank loan or a stock based

compensation.

2. Searle’s construction of social reality and the ontological status of

accounting objects

Modern ontological theories usually draw on and try to defend two classical

philosophical stances, those of realism and of naturalism , and Searle’s theoretic makes no

exception to this rule.

Realism is the philosophical position according to which reality exists and is not a

mere fiction, or the result of human (collective) imagination. In these systems of thought,

reference is always an important ingredient as there is an extralinguistic (real) object/fact

represented by language. Naturalism upholds that all phenomena can be explained in terms of

natural causes and laws. In this sense, there is just one world, the natural world, and there can

be no class of supernatural phenomena as we cannot give an account of it by means of laws of

physics.

According to Smith (2003), Searle’s challenge is to “develop an ontology of social

reality that is both realistic and naturalistic.” True to these philosophical stances, Searle(1995: 7) defines the bear bones of his ontology as:

“We live in a world made up entirely of physical particles in fields of force.Some of these are organized into systems. Some of these systems are livingsystems and some of these living systems have evolved consciousness. Withconsciousness comes intentionality, the capacity of the organism to represent

objects and states of affairs in the world to itself .” (emphasis added)

Thus, everything that exists is entirely made up of physical particles in fields of

force. Biological systems are also considered a part of nature, and those that have evolved

consciousness (human beings included) have a very important feature, that is, they have the

capacity to represent objects and states of affairs in the world to themselves, termed

intentionality. Intentionality is a key concept in Searle’s ontological system and should not

be confused with intending . According to Searle (1995) intending to do something or having

the desire to do something are just forms of intentionality among others, as in order to have an

intention or a desire we have to intend or desire that such and such be the case, and these

involve human’s ca pacity to represent things. The most conspicuous example of intentional

activity, which is also most relevant for the accounting domain, is having beliefs, because this

implies people representing to themselves (believing) that such and such is the case.



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Having defined all these, Searle’s problem is to accommodate social reality (such as

money, claims, obligations or organizations) to this restrictive realist and naturalist ontology 3.

Because he thinks that:

“[w]e live in exactly one world, not two or three or seventeen … [h]ow can there

be an objective world of money, property, marriage, governments, elections,football games, cocktail parties and law courts in a world that consists entirely of

physical particles in fields of force, and in which some of these particles areorganized into systems that are conscious biological beasts, such as ourselves?”(Searle, 1995: xii, emphasis added)

Searle’s realist and naturalist ontology is summarized by the presupposition of

external reali sm which is defined as the view that "the world (or alternatively, reality, or the

universe) exists independently of our representations of it" (Searle 1995: 150).

2.1. Ontologically objective entities vs. ontologically subjective entities

To start his ontological theory, Searle makes some presuppositions about how the

world is, committing himself ontologically to the existence of physical objects (brute entities).

Physical phenomena are declared to be ontologically objective , that is they exist

independently of human’s mind. Contrariwise, everything else that exists in virtue of human

action or thought is declared to be ontologically subjective.

It is noteworthy to epitomize that this is an ontological distinction reflecting modes

of exi stence 4 :

“In the ontological sense , pains are subjective entities, because their mode of

existence depends on being felt by subjects. But mountains …, in contrast to

pains, are ontologically objective because their mode of existence is independentof any perceiver or any mental state.” (Searle, 1995: 8, emphasis added)

Accounting deals with various kinds of entities such as trucks, buildings, licenses,

cash, receivables, loans, or ownership claims, but there is no consensus reached regarding

their mode of existence. Shapiro (1997) and Mouck (2004) adopt a similar position stating

that financial reporting takes into account both ontologically objective entities and

ontologically subjective entities:

3

In Searle’s (1997) own words: “Why do analytic philosophers push naturalistic theories of reference, belief, knowledge, etc.? I think the answer is that at some point they want a coherent and unifiedaccount of the whole universe. They generally accept some sort of “materialism,” and they wouldlike to give an account of the mind, belief, knowledge, etc., which is consistent with theirmaterialism. They want to treat these things as part of nature, hence as “naturalistic.” I think, in away, the problem is both easier and harder than they realize. It’s harder because given the categoriesthey use, they will not succeed in giving a naturalistic theory of these phenomena. But the problemis also easier, because the simplest way to give a naturalistic theory of, for example, intentionality, isto recognize that intentionality is a biological part of nature. It already is naturalized. The problemthen is to give a logical analysis of its structure, as well as a psychological and neuro-biologicalaccount of how it works causally. Any such account is naturalism enough.”

4 Intentionality itself is considered to be ontologically subjective, because it can only be experienced

by conscious biological systems: “There is no question that intentionality … is ontologicallysubjective. It exists only in human and animal agents.” Seale (2006c: 82)



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“... financial statements include not only values of physical phenomena (e.g.

inventory, equipment, and land), but also values of socially constructed phenomena involving economic, legal, and other features (e.g. cash, receivables,

and debt and ownership claims).” (Shapiro, 1997:168, italic added)

“Land, buildings, equipment, livestock, etc. have an objective physical mode of

existence, but ownership claims, debts, corporations, and money have a subjective mode of existence.” (Mouck, 2004: 534, italic added).

Later on Shapiro (1998), quoting Chua (1986) and Mattessich (1991), restricts his

examples of physical phenomena addressed by financial statements to “coal and hurricanes”,

but he, nevertheless, does not make a formal statement, confessing that he does not consider

“inventory, equipment, and land” as ontologically objective entities anymore.

“...features of the phenomena described in financial statements existindependently of the financial statements. This independence applies no less to socially constructed phenomena (e.g. cash, receivables, and debt and ownership

claims) than to physical phenomena such as coal and hurricanes (cf. Chua, 1986;Mattessich, 1991).” (Shapiro, 1998: 652-653, italic added).

Lee (2006) although reiterates Shapiro’s (1997) and Mouck’s (2004) positions, trying to apply

Searle’s (1995) theory, at some point, he describes “trucks” as being institutional facts:

“the physical particles comprising metal, plastic, and rubber ( X ) constitute atruck (Y ) when constructed in a particular form (C ). If there is general agreementamong humans about this statement, there is effectively a constitutive rule

creating the institutional fact of «truck».” (Lee, 2006: 14)

We shall discuss instititutional facts in much more detail later, but for the moment itis sufficient to say that, according to Searle, their existence is dependent on human’s

collective intentionality, thus, being ontologically subjective.

We believe there is no controversy concerning entities such as cash, receivables,

debt or ownership claims, which have obviously a subjective mode of existence, as they

would never have existed in absence of human thought.

A problem arises for a specific class of entities comprising equipment, buildings,

trucks, or certain inventories, for instance consumables such as fuel, packaging materials or

spare parts; raw materials in the form of pieces of fabrics, nails, paper or flower; work in

progress or all kinds of finished goods. This type of entities are usually called artifacts, that is,

“object[s] which ha[ve] been modified, fashioned, or manufactured according to a set of

humanly imposed attributes, including tools, weapons, ornaments, utensils, houses, buildings,etc.”5

According to Searle (1995: 14):

“In the case of some artifacts, we build the object to serve a function. Chairs,

bathtubs, and computers are obvious examples.”

In this sense, Kroes (2003: 23) notes that technical objects are, just like social

objects, humanly constructed realities that perform certain functions. Following Kroes (2003),

Miller (2005: 54) states more exactly that:

5 "artifact." The Concise Oxford Dictionary of Archaeology. Oxford University Press, 2002, 2003. Answers.com

30 Jan. 2008. http://www.answers.com/topic/artifact

http://www.answers.com/topic/artifact






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“… the designers and users of artefacts impose intentionality on artefacts in thesense, firstly, that the shape, size and other physical properties of an artefact have been intentionally brought about.”

As the act of building artifacts involves human’s intentionality, it follows that they

have a subjective mode of existence. Accordingly, artifacts were mistakenly regarded as

physical phenomena or as ontologically objective entities by Shapiro (1997) and Mouck

(2004). Shapiro’s (1998) limitation of the examples of physical phenomena to just “coal and

hurricanes” may suggest a tacit recognition of this fact.

Although Lee (2006) tried to place “trucks” in the category of socially constructed

objects, he nevertheless, as we shall argue, fallaciously considered “trucks” as being an

institutional fact.

Oddly enough, Searle makes the same mistake as Shapiro (1997) and Mouck (2004)

do in his famous money example, when he considers that a piece of paper is a brute fact:“… all sorts of things can be money, but there has to be some physical

realization, some brute fact – even if it is only a bit of paper or a blip on acomputer disk” (Searle, 1995: 56)

Wisnewski (2005)6 has noticed this shortcoming in Searle’s rationale:

“«a piece of paper» is not part of the furniture of the universe. Rather, it is the product of human needs and purposes.”

As we shall argue, this mistake is generated by the fact that artifacts perform their

function in virtue of their physical properties, hence, becoming very easily associated with

brute objects, rather than with abstract objects such as receivables or debt.

Entities such as hurricanes, earthquakes, land or coal (if it is in its natural state, and

not altered in some form in order to be used as fuel, for instance) can be considered

ontologically objective entities, as their existence does not depend on human’s mental states.

But entities such as hurricanes and earthquakes are not elements of financial statements, so

they do not appear in the financial statements of an enterprise, but they can only be referred to

like that in the notes.

Land or coal, on the other hand, can be enumerated among a company’s assets into

the balance-sheet, but their ontological status will be subject to further discussion.

2.2. Observer-related features of the world and the imposition of functions

The entities described in the previous paragraph, either ontologically objective orontologically subjective, are, according to Searle (1995: 9), the basic features of the world, a

part of our fundamental ontology. But human beings can specify further features of the world,

that is, they can specify further features of the entities described earlier. For instance, we can

describe an object as being made of wood, or as being big, small, beautiful or comfortable. Or

we could describe it as being a chair. Or even that it is worth 100 euros.

Searle (1995) makes a distinction between those features of the world that he calls

intr insic to nature , and those that exist relative to the intentionality of observers, users, etc,

termed observer-relative features . Intrinsic features of the world exist independently of the

6 He, nonetheless, makes the same mistake as Lee (2006) does in considering artifacts as being

institutional facts.



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observers, whereas observer-relative features exist only relative to the attitudes of observers,

that is, they exist only in virtue of human intentionality7.

“It is … an intrinsic feature of the object in front of me that it has a mass and acertain chemical composition. It is made partly of wood, the cells of which are

composed of cellulose fibers, and also partly of metal, which is itself composedof metal alloy molecules. All these features are intrinsic. But it is also true to sayof the very same object that it is a screwdriver. When I describe it as being ascrewdriver, I am specifying a feature of the object that is observer or userrelative.” (Searle, 1995: 9-10)

For reasons we shall detail later, it is important for our discussion concerning the

reality of both subject and predicate expressions to emphasize that “intrinsic” and “observer -

relative” are, as Searle constructs his ontological system, attributes of features of entities.

That is why statements such as those belonging to Lee (2006: 11) are not accurate:

“The existence of ... air and trees is ‘intrinsic’ (i.e., independent of humans and

their mental states) and thus ontologically objective ...”

“Air” and “trees”, stated like that, are entities. But in order for something to be

“intrinsic” it has to be referred to in relation to another entity; as a feature of that entity. Only,

in this sense, something can be understood as naturally occurring within or inherent to

(necessarily) something else. For instance, trees may be regarded as a component of a forest.

Therefore Lee’s (2006: 11) statement is not accurate, unless he refers to air and trees as

features of nature or reality.

As Searle (1995: 8) put it:

“In the ontological sense, ‘objective’ and ‘subjective’ are predicates of entities

and types of entities …” (italic added)

Of course, features of entities may be regarded as entities themselves and

characterized as having an objective or subjective mode of existence. They can also be further

characterized by other features. For example, it is an intrinsic feature of a tree that it is made

of wood. Wood is ontologically objective. It is also an intrinsic feature of wood that it is

composed of cellulose fibers. Cellulose fibers have an objective mode of existence.

So far, based on Searle (1995), we have the following categories: ontologically

objective entities and ontologically subjective entities that can have either intrinsic or

observer-relative features or both (see Table 1 below):

As we discussed previously, accounting information comes in the form of

propositions which refer to both entities and their features. But whereas financial statementsmight name both ontologically objective entities and ontologically subjective entities, none of

their intrinsic features are described within financial statements. Financial statements name

only one observer-relative feature, that is, the value of those entities.

7 Intentionality, if regarded as a feature of conscious biological systems, is an intrinsic feature, as it is a

biological, natural feature of animals and humans. But all other features which are dependent on

intentionality are observer-related. In Searle’s (1995: 12) own words: “Intrinsic features of reality arethose that exist independently of all mental states, except for mental states themselves; which are alsointrinsic features of reality.”



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Table 1: Ontological categories

Intrinsic features Observer-relative features

Ontologically objective entities

(Mountains, molecules, solid ground,

earthquakes, etc.)

Mass, chemicalcomposition

Earthquakes are bad for realestate values.

Ontologically subjective entities

(Trucks, buildings, debt, receivables, etc.)

Mass, chemical

composition

The truck is worth 60,000

euros.

Nevertheless, according to Searle (1995: 14-15), humans do not merely represent

things and their features in a neutral fashion, but they usually do this within a given teleology.

Within such given purposes and values, humans deploy a special feature of intentionality,

namely “the assignment – or impositi on – of function ”. Although Searle (1995: 14) believes

that we live in a world made up entirely of physical particles in fields of force, of which some

are organized into systems, yet he thinks that “we do not experience things as material

objects, much less as collections of molecules. Rather, we experience a world of chairs and

tables, houses and cars, lecture halls, pictures, streets, gardens, houses, and so forth” because

people have the ability to impose functions on both naturally occurring objects (humans

included) and on artifacts. Thus, the function of chairs is to be sat on, the function of

buildings is to be used for dwelling in, the function of policemen is to enforce the law, or a

type of tree can be used for lumber, etc.

Functions are never intrinsic, but always an observer-relative feature of an entity.

And this is because functions are always assigned from outside by conscious observers and

users and, most important, the assignment takes place within a given teleology. According to

Searle (1995: 15), even when people discover a function in nature, as the function of heart of

pumping blood, they do not merely discover a causal process. The discovery of a causal

process comes together with the assignment of a teleology to that causal process:

“Part of what the vocabulary of «functions» adds to the vocabulary of «causes» is a

set of values (including purposes and teleology generally). It is because we take itfor granted in biology that life and survival are values that we can discover that thefunction of the heart is to pump blood. If we thought that the most important valuein the world was to glorify God by making thumping noises, then the function ofthe heart would be to make a thumping noise … If we valued death and extinction

above all, then we would say that the function of cancer is to speed death …”

This rationale is backed by a whole vocabulary of success and failure, which do not

apply to simple brute phenomena. Thus, we can speak of better or worse hearts, but we cannot

speak of better or worse stones, unless a function has been assigned to a stone, as people use itas a weapon or a paperweight. But the imposition of a function always implies the possibility

of failure or malfunction (Searle, 1995: 15).

Searle (1995) summarizes the conditions for the assignment of functions as follows:

1)

“Whenever the function of X is to Y, X and Y are parts of a system , where the

system is in part defined by purposes, goals and values generally.

2)

Whenever the function of X is to Y, then X is supposed to cause or otherwise

result in Y.”

Understanding this feature of intentionality – the imposition of functions – is an

important key to understanding economic reality, but, unfortunately, it has escaped many of

the authors who have tried to apply Searle’s theoretic to accounting.

Trucks, buildings, land or different sorts of inventories disclosed within financial

statements have all agentive functions attached to them within a specific teleology. For



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instance, we can say that the primary function of a piece of bread is to be eaten. That is why

people make bread. But it is also true to say that for a merchandising company, the function of

bread is to be (re)sold. That is why the merchandising company purchased the piece of bread

in the first place, to resale it. Furthermore, for the owners of the merchandising company, the

function of the piece of bread is to bring future economic benefits for the entity, which will

hopefully materialize in dividends distributions.All these agentive functions have been assigned within different sets of values or

purposes. In economic terms, the purpose of goods and services is to satisfy the needs of

consumers, or more exactly, to maximize their utility.

Similarly to:

“The function of the heart (X) is to pump blood (Y) so that people could live

(Teleology).”

We can say that:

“The function of a piece of bread (X) is to be eaten (Y) so that people could

maximize their utility (Teleology)”.

In this example, utility means satisfying one of the basic physiological needs (in

Maslow’s (1943) terms). But as we move further into the financial economy, the purposechanges from “utility maximization” to “wealth maximization”. That is why it is true to say of

the very same object that:

“The function of a stock of bread (X) is to bring future economic benefits to an

entity (Y) so that investors might maximize their wealth (Teleology)”.

Inside the decision usefulness paradigm, financial reporting is oriented towards

helping investors in making economic decisions8, thus “wealth maximization” is the implicit

teleology. The International Accounting Standards Board (IASB, 1989: 49 (a)) explicitly

states that the function of assets is to bring future economic benefits to the entity:

“An asset is a resource controlled by the entity as a result of past events and from

which future economic benefits are expected to flow to the entity.”

The imposition of a function might subsume the assignment of previous functions,

and the IASB (1989: 54) is aware of that:

“An entity usually employs its assets to produce goods or services capable ofsatisfying the wants or needs of customers; because these goods or services cansatisfy these wants or needs, customers are prepared to pay for them and hencecontribute to the cash flow of the entity. Cash itself renders a service to the entity because of its command over other resources.”

But the imposition of the agentive function to assets is made within a giventeleology, namely, wealth maximization, and the IASB tries to make it explicit:

“The objective of financial statements is to provide information ... that is usefulto a wide range of users in making economic decisions (IASB, 1989: 12) [such

as] present and potential investors, employees, lenders, suppliers and other tradecreditors, customers, governments and their agencies and the public ... [Thei]nvestors [are t]he providers of risk capital and their advisers are concerned withthe risk inherent in, and return provided by, their investments. They needinformation to help them determine whether they should buy, hold or sell.

8

It is true that other external parties use the information provided by financial accounting, but they doit only in a rezidual way, as “the main economic actor” – as Zambon and Zan (2000) put it – the onethat induces the logic of the financial reporting system – is the investor/the owner of the company.



13

Shareholders are also interested in information which enables them to assess the

ability of the entity to pay dividends ... As investors are providers of risk capitalto the entity, the provision of financial statements that meet their needs will also

meet most of the needs of other users that financial statements can satisfy (IASB,1989: 9-10).”

In this sense, both the assets and their function have to be understood as parts of a

system which is in part explained by purposes and goals.

According to Searle (1995) the imposition of a function should always imply the

possibility of failure or malfunction, and the IASB makes that also explicit:

“An item that meets the definition of [assets] should be recognised if ... it is probable that any future economic benefit associated with the item will flow to ...the entity ... The concept of probability is used in the recognition criteria to refer tothe degree of uncertainty that the future economic benefits associated with the itemwill flow to or from the entity. The concept is in keeping with the uncertainty that

characterises the environment in which an entity operates ... For a large population

of receivables ... some degree of non-payment is normally considered probable;hence an expense representing the expected reduction in economic benefits isrecognised.” (IASB, 1989: 83, 85)

Accordingly, financial statements do not just represent things, but they do it within a

given teleology and tacking into account the agentive functions assigned to different kind of

entities. Identifying the agentive functions and understanding the set of values and goals within

which they are imposed are necessary conditions for understanding the nature of the economic

reality that financial statements purport to represent.

For instance, sometimes false epistemological problems are put forward, although

the issues are ontological. Alexander and Archer (2003: 8) advance the example of propertiesheld as investments. They could be depreciated and presented at cost or revalued amount less

accumulated depreciation (as all the other items of property), or they could be marked to

market (as all the other investments). According to Alexander and Archer (2003: 8) the

problem is:

“...how one knows that marking to market provides a more faithfulrepresentation than the alternative ... Such knowledge does not seem to be basedon an ability simply to see a correspondence (or lack of it) between arepresentation and what it purports to represent, but on an ability to see

coherence (or lack of it) in the way we construct and use representations.”

On our account, the problem is ontological and not epistemic. The problem is

identifying the reality that we want to depict in words and numbers. The item of property that

we try to describe has already a function, it is held as an investment, it is not held for being

used inside of the company and this is not a matter of accounting judgment or representation.

It is a fact independent of the financial statements which try to represent it.

Thus, we have identified the fact which will make our statement true. If we say „the

value of the item of property is X, where X is computed as cost minus accumulated

de preciation”, then this statement is false. If we depreciate the asset it means that we are

already consuming the economic benefits embodied in it though its use. And this is false. It is

purely a matter of (lack of) correspondence.

In this we agree with Lee (2006: 19) that



14

“… economic reality is an ambiguous concept that requires careful definition

and explanation prior to any decision on how to represent it in terms of truthfulcorrespondence. The FASB would account for a truck at its depreciated

historical cost and Schuetze would prefer a sale value. What is required in thesedisputes over accounting for social reality is agreement with respect tocollective intent about an institutional fact’s status function and the constitutive

rules that create it.”

2.3. Collective intentionality, social facts and institutional facts

Another key concept within Searle’s theoretic, also crucial for understanding

economic reality, is coll ective intentional ity . According to Searle (1995: 23), people do not

experience just singular intentionality, but they have the ability to “share intentional states

such as beliefs, desires, and intentions”, which is termed collective intentionality9. Whenever

collective intentionality is involved, then social facts come into being:“the expression «social fact» … refer[s] to any fact involving collectiveintentionality. So, for example, the fact that two people are going for a walk

together is a social fact” (Searle, 1995: 26)

Accordingly, you cannot have social facts without collective intentionality, and this

is important for explaining economic reality. Unfortunately, Lee (2006: 12) trying to apply

Searle’s (1995) theoretic to accounting failed to understand the concept of social facts:

“Social facts exist because humans mentally assign a «function» to them (Searle1995, 13) — e.g., when a piece of wood is described as a seat. Social facts can

also involve «collective intentionality»” (emphasis added)

If a function is assigned by a singular individual, such as a piece of wood described

as a chair, then we do not deal with a social fact. It is just a mental fact involving singularintentionality (Searle, 1995: 122). However, if humans collectively assign a function to an

object, such as “the function of a chair is to be sat on”, then we do have a social fact. In

Searle’s (1995: 122) own words: “all and only cases of collective intentional facts are social

facts.” But the existence of social facts is not a matter of function imposition (i.e. “Social facts

exist because humans mentally assign a «function» to them”), but a matter of collective

intentionality involvement. Yet, among different kinds of social facts (which involve

collective intentionality), such as we are taking a walk together, or we are playing volleyball

together, there is indeed an (important) social fact, that is, the collective assignment of a

function. But, as we discussed in paragraph 2.1.2, functions are imposed on parts of reality

(both naturally occurring objects (humans included) and artifacts) and not on the social fact

per se. It is true that functions can be further imposed on a social fact in an iterative process

(as we shall discuss later), but basically, a function is assigned to a part of reality; it is that

certain part of reality which performs the function.

When people collectively impose a function to a part of reality, this could lead to the

creation of a subclass of social facts, namely instituti onal f acts . Institutional facts are a

special kind of social facts involving in addition a deontic component. Furthermore, they

occur when people collectively impose a status function to a part of reality, which means that

the part of reality could not perform the function just in virtue of its physical properties.

The creation of institutional reality is the hard core of Searle’s ontological theory

and deserves special attention. Various authors who have tried to establish whether economic

9 This is a feature also manifested already among other animals, for instance, hyenas hunting a lionimplies collective intentionality.



15

reality is institutional have adopted different positions because they interpreted Searle’s

theory in different ways. In addition, as result of criticism, Searle (2005) further developed his

(1995) theory with important implications for the accounting domain. These further

developments of Searle’s theory have not been yet taken into account in the accounting

ontological debate.

According to Searle (2005: 5-11) it is compulsory for the creation of an institutionalfact that some conditions be met:

A. Collective intentionality

The creation of institutional facts has to involve the collective intentionality of two

or more agents.

B. The assignment of status functions

The creation of an institutional fact has to involve the collective imposition of a

function to a part of reality. But it has to be a special kind of function, namely, the object or

person to whom the function is assigned should not be able to perform it just in virtue of its

physical structure. For instance, the function of chairs to be sat on is not a status function, as itcan be performed in virtue of the chairs’ physical properties. Similarly, the function of a piece

of paper to be used for writing is not a status function also, because the paper’s physical

properties are enough for allowing the performance of the function. But when a piece of

green-printed paper (e.g. a twenty dollar bill) performs the function of a medium of exchange,

then such a function cannot be performed just in virtue of the physical properties of the piece

of paper 10, so we do have a status function. Such a function can be performed only because

there is a collective imposition of a certain status to that piece of green-printed paper, and

because people collectively accept that that piece of paper has the requisite status.

The imposition of a status function typically takes the form of a constitu tive ru le :

X counts as Y in the context C,(where X is the brute fact and Y is the institutional fact). For example:

“Bills issued by the Bureau of Engraving and Printing (X) count as money (Y)

in the United States (C)”. (Searle, 1995: 29)

According to Searle (1995: 27-28) there is a difference between regulative rules and

constitutive rules. Whereas regulative rules merely regulate antecedently existing activities,

such as driving, constitutive rules create the very possibility of certain activities, such as

playing chess. Without rules, people could not play chess, and in this sense the rules are

constitutive to this activity. But in absence of rules, people could still drive cars, even if there

were a risk of bumping into each other.So, institutional facts can exist only within a system of constitutive rules (Searle,

1995: 28), by means of which an object or a person receives a status function, which is not

performed in virtue of its physical components, but in virtue of the fact that people

collectively accept the respective part of reality as having the required status.

“The knife will cut just in virtue of its physical structure. But the 20 dollar billwill not buy just in virtue of its physical structure. It can only function as money

if it is recognized, accepted, and acknowledged as valid currency. The knifefunction can exist for anybody capable of exploiting the physics, but the status

10 Gold coins, on the other hand, performed their function as a medium of exchange in virtue of their physical

properties, as the value of money relied on the value of the gold in those coins. (Searle, 1995: 42)



16

function can only exist if there is collective representation of the object as having

the status that carries the function.” (Searle, 2005: 12)

It is important to emphasis that the assignment of a status function can be iterated

upward indefinitely as an institutional fact can play the role of “X” in creating a new

institutional fact. But institutional facts ultimately depend on brute facts, as there must be a physical object to start the construction of social reality. In Searle’s (1995) terms, brute facts

have logical priority over institutional facts.

“... when I make certain sounds through my mouth, making those sounds countsas uttering sentences of English; but uttering those sentences of English counts asmaking a promise; and, in that context, making a promise counts as undertakinga contract. Making that kind of contract in that context counts as getting married,and so on upward. Notice the logical form of this: X 1 counts as Y 1. But Y 1 = X 2counts as Y 2. And Y 2 = X 3 counts as Y 3, and so on upward indefinitely.” (Searle,2005: 8)

C. Deontic powers In order to have an institutional fact, the part of reality to which the status function

was imposed on has to be endowed with some new powers, which are termed deontic11

powers. This special kind of powers are in the form of duties, rights, permissions, obligations,

and are a key ingredient in the construction of institutional reality, because, according to

Searle (2006b: 10), that is the reason why people create institutions, to enable new power

relationships:

“The essential role of human institutions and the purpose of having institutions isnot to constrain people as such, but, rather, to create new sorts of power

relationships. Human institutions are, above all, enabling , because they create

power, but it is a special kind of power. It is the power that is marked by suchterms as: rights, duties, obligations, authorizations, permissions, empowerments,requirements, and certifications. I call all of these deontic powers.”

Generally, the Y term names a power that the X does not have solely in virtue of its

X structure. For instance, George Bush (X) acquired a new status and new deontic powers

when he was inaugurated as President Bush (Y), which he did not have just in virtue of being

George Bush. He now has, for instance, “the right to veto legislation and the responsibility of

delivering a State of the Union address to Congress” (Searle, 1995: 101).

Deontic powers can be classified into two major categories: positive and negative

deontic powers. In case of acquiring positive deontic powers “agents are endowed with

powers such as certification, authorization, entitlement, right, permission, or qualificationgranting the ability to do something they could not otherwise have done” (Searle, 1995: 100).

In case of negative deontic powers, “the agent is required, obligated, in duty bound, penalized,

enjoined, or otherwise compelled to do something he or she would not otherwise have had to

do – or, what amounts to the same thing, prevented from doing something that would

otherwise have been doable.” (Searle, 1995: 100)

As powers can only be employed by persons, whenever a status function is imposed

on an object, the relative deontic powers will go to the user of the object:

11

Deontic = Of, relating to, or concerning duties or obligations Greek deon, deont-, obligation, necessity("deontic." The Oxford Dictionary of Philosophy. Oxford University Press, 1994, 1996, 2005. Answers.com 27

Dec. 2007. http://www.answers.com/topic/deontic)

http://www.answers.com/topic/deontic






17

“In the case where the X term is a person, that person acquires powers that he or

she did not already have. In cases where the X term is an object, the user of thatobject can do things with it that he or she could not do solely in virtue of its X

structure.” (Searle, 1995: 95)

In many cases, institutional facts require official representations, termed status

indicators, because the “institutional facts cannot be read from the brute physical facts of the

situation” (Searle, 1995: 119). Examples of such status indicators are: passports and driver’s

licenses, written signature, wedding rings and uniforms.

Lee (2006) tries to apply Searle’s theory of institutional facts to the realm of

accounting entities, and, at some point, he describes “trucks” as being institutional facts:

“the physical particles comprising metal, plastic, and rubber ( X ) constitute atruck (Y ) when constructed in a particular form (C ). If there is general agreementamong humans about this statement, there is effectively a constitutive rulecreating the institutional fact of «truck».” (Lee, 2006: 14)

Lee’s (2006) account of the creation of the institutional fact of “truck” is notaccurate for the following reasons:

First. A function cannot be imposed on “physical particles comprising metal, plastic, and

rubber” because people do not experience things as physical particles or collections of

molecules. As we discussed in paragraph 2.1.2., functions are imposed either on naturally

occurring objects (humans included) or on artifacts (objects build to perform a function). As

Searle (1995: 126,) put it:

“One person, or perhaps a group of people, invent tools, say, screwdrivers and

hammers, for example. In such a case, they create types of devices on which they

impose a certain function by collective intentionality.” (emphasis added)

So the only valid X that can be extracted from Lee’s statement is “physical particles

comprising metal, plastic, and rubber … constructed in a particular form”, that is, an artifact.

Second. If the rule now takes the form of “the physical particles comprising metal, plastic,

and rubber constructed in a particular form ( X ) constitute a truck (Y )”, it does not meet the

criteria for being a status function. If it were to be a status function, the function of being a

truck (carrier of loads) should not be performed in virtue of the X’s physical properties, and

this is not the case. The truck function can be performed by anybody capable of exploiting the

physics, and only in virtue of its physics. When a piece of green-printed paper (X) counts as

money (Y), the function of being money (medium of exchange) is not performed in virtue ofthe paper’s physical structure. Rather the function is performed in virtue of the fact that the

piece of paper has acquired a collectively accepted status. That is the reason why Searle uses

the expression “count as”, to show that “X” counts as something else, beyond its physical

properties. But Lee (2006) seems to have realized that the ex pression “count as a truck”

cannot be employed in this case, that is why he replaced it with “constitute a truck”.

Furthermore, the Y function needs not only collective intentionality, but continued collective

acceptance of its status. (Searle, 1995: 114). But even if no one thinks that the artifact is a

truck, an individual could still perform its function, because it does not depend on collective

acceptance, but on the X’s physical structure.

Third. The most important feature of an institutional fact is that the status that the X acquires

carries a deontology. But the status of being a truck (Y) does not provide any deontic powers,



18

in terms of rights, duties, permissions etc. The Y term names no power that the X does not

convey solely in virtue of its X structure.

Accordingly, being a truck is not an institutional fact. It is, however, a social fact, as

the function was imposed on an artifact by means of collective intentionality. But the function

does not carry any deontology, nor is it performed in virtue of its collective acceptance.Yet, is a truck per se represented within financial statements? Is financial reporting

concerned with presenting trucks, land, buildings and other similar entities?

2.4. Is economic reality institutional?

In order to give an answer to such a question we have to consider the fact that people

do not merely represent things and their features in a neutral fashion, but they usually do this

within a given teleology, by means of function imposition. As different functions may be

assigned from different systems of goals and values, acknowledging the teleological system in

which financial reporting is performed is an important key to understanding economic reality.

As explained in paragraph 2.2.1.2, the teleology assumed by accountingrepresentations is wealth maximization and the function ascribed to the company’s assets is

bringing economic benefits to the entity. Accordingly, the economic benefits that, for

instance, a truck may bring have to be the foci of financial reporting.

A company may use a truck to render transportation services, thus generating

economic benefits. Moreover, a company may employ the truck for the transportation of its

own raw materials in order to produce goods or services, and thus deriving economic benefits

indirectly. It can be argued that all these activities are centered on the basic function of being

a truck (i.e. an artifact manufactured for carrying loads). But, in addition, an entity might

generate economic benefits by means of selling the truck, and the function of being a truck

(carrier of loads) is not sufficient for performing such an action. Rather the organization may

perform such an action because it was empowered by a status function which was imposed on

the truck, i.e. that of being the organization’s private property.

As private property a truck is indeed an institutional fact, and the status function

carries indeed a deontology: the owner of a truck (i.e. the organization) is enabled with

deontic powers such as the right to use it, to sale it or to lease it out, or to use is as collateral

for borrowings. Accordingly, even the action of using a truck to carry loads is not performed

solely in virtue of the trucks physical structure, as the organization has to be

enabled/authorized to use it; there has to be collectively acceptance that the company has the

right to use it, for instance, the organization cannot use someone else’s truck (i.e. someone

else’s private property).

This is even better understood in the case of land. It is not just raw land, solidground, soil, that it is represented within financial statements, but it is the organization’s

private property, that is, an institutional fact. According to Zaibert (1999: 4):

“… the existence of parcels of real estate is wholly a matter of human institutions:

without humans all that exists is raw land. And what an owner of landed propertyowns is not raw land. The owner owns a land- parcel, or real estate …”

And the same rationale can be applied to buildings, and all sorts of equipment and

inventories. So, financial statements are not about such items (e.g. trucks, land, buildings,

etc.), but about the deontic powers that the institutional status imposed on these items conveys

to the organization. And this is because the inflows of economic benefits are derived in virtue

of these deontic powers and (not merely) in virtue of the items’ physical structure. This idea is

very well explained by the British conceptual framework (ASB, 1999: 4.8):



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“An asset is not an item of property itself , but rather the rights … to some or allof the future economic benefits derived from that item of property*… *The term

‘item of property’ has been used … to differentiate between the control of rights… to future economic benefits (the asset) and the thing from which these futureeconomic benefits are derived (the item of property).” (emphasis added)

Inside the wealth maximization teleology, the function of driver of economic

benefits is actually imposed on top of an institutional fact. That is why defining assets like

“resources”, as the international conceptual framework (IASB, 1997: 49.a) does, means

focusing on a lower level of the social ontology, which does not account for the actual source

of economic benefits, that is, the network of power relationships governing economic reality.

But long before the British conceptual framework (ASB, 1999) was issued, the

French accounting, centered on the civil law concept of patrimony 12 ( patrimoine, Fr.), had

already acknowledged this invisible structure of economic reality. Thus, the balance sheet (le

bilan, Fr.) reflects the patrimony of an organization, that is, its patrimonial rights (droits

patrimoniaux, i.e. actif du patrimoine, Fr.) and obligations (obligations patrimoniaux, i.e.

passif du patrimoine, Fr.). The French accounting, nevertheless, relied exclusively on the

formal legal institutions, accounting being officially understood as the algebra of law (alg èbre

du droit , Fr., Garnier (1947)).

But the formal institutions of law sometimes fail to account for the actual

distribution of deontic (negative or positive) powers within society. And the French

accounting faced this issue in the cases of some complex covenants such as seller financing

contracts (vente avec réserve de propriété, Fr.) and lease contracts (crédit -bail , Fr.). True to

the patrimoniality principle13, the balance-sheet has to exclude items such as leased assets,

because the organization does not hold the property right over them. However, a too rigorous

application of this principle, and the property right behind it, was considered to empty the

balance-sheet of its economic substance (Colasse, 2000: 90).But it was Raybaud-Turrillo (1997) who thoroughly investigated this issue and

exposed the shortcomings of a formal analysis of contracts, pleading for a substance based

interpretation of the patrimoniality principle ( patrimonialité substantielle, Fr.):

“Il apparaît clairement, a l’issue d’une analyse de différents aspects de cescontrats, que les analyses formelles des contrats ne permettent pas decomprendre la nature des opérations, qu’elles sont souvent en contradiction avecla réalité des pouvoirs et des obligations respectifs des parties … Ils est parconséquent impératif de dégager la substance juridique de ces opérations et de proposer de nouvelles qualifications juridiques pour rétablir la cohérence quelque peu perdue de ces contrats …” (Raybaud-Turrillo, 1997: 28, emphasis added)

Her solution consists in seeing the property right as a bundle of rights, and,

following Goyet (1983)14, in dividing the property right into two categories:

12 We are aware of the fact that “patrimony” is not a faithful translation of the French concept of “patrimoine”,

which does not have an equivalent in English, as it is rooted in the civil system of law. In English,“patrimony” means property inherited from one’s father or male ancestor. ( New Oxford Dictionary of English,

The, 2001: 93).13

Viander, A. & Lauzainghein, C. de (1993), Droit comptable, Dallozz, pp. 272-276, quoted by Colasse (2000:

90).14 Goyet, C. (1983). Le louage et la propriété a l’épreuve du crédit -bail et du bail superficiaire, LGDJ quoted by

Raybaud-Turrillo (1997: 146).



20

(1). Warranty property right (propriété d’affectation, Fr.) – the property right that

the lessor acquires in virtue of a lease covenant which serves for ensuring the

receipt of the future lease payments; and

(2). Operating proper ty right (propriété d’exploitation, Fr.) - the property right that

the lessee acquires in virtue of a lease covenant which enables it to use the

asset. Accordingly, the lessee may recognize the leased asset within its balance sheet, as an

operating property right, and this is done not in virtue of some shallow economism (Raybaud-

Turrillo, 1997: 99), but as a consequence of a correct (i.e. substance based) juridical

interpretation of the lease agreement. Raybaud-Turrillo (1997: 262) is reluctant to leave the

institutional level of property rights, as she thinks, drawing on Lagarrigue (1983)15

commenting on British jurisprudence, that the “substance over form” principle is not an

invitation to prefer an economic analysis to a juridical one, but an incentive for a better

understanding of the juridical substance of a transaction or event:“Le principe dit du primat de la réalité sur l’apparence n’est pas interprété par

le ministère du Commerce comme la prétendue prééminence de la réalité

économique sur l’apparence juridique, mais comme la nécessité de rechercherla substance et la portée effective des dispositions juridiques derrière et au-delàde l’habillage formel qui est le leur … On chercherait en vain dans cette position … une quelconque affirmation de l’existence d’une soi-disant réalité

économique dont il est claire qu’elle ne saurait exister par elle-même maisuniquement a travers les institutions de toute nature qui lui permettent des’extérioriser.”

In consequence, Raybaud-Turrillo (1997) is concerned with identifying the correct

distributions of deontic powers between the parties involved in a lease or a seller financing

agreement, and with formally defining new status functions which should properly account

for such a distribution. It is noteworthy to epitomize that Raybaud-Turrillo (1997) uses

concepts such as powers and obligations which are very close to Searle’s deontic (positive or

negative) powers.

At this point in our discussion, it is important to make some further (critical)

comments on Searle’s account of institutional facts. Searle uses the concepts of power

(positive power) as synonym to right, as (positive) powers are described in terms of

authorization, entitlement, right, permission, enabling. But as Zaibert (1999: 4) (drawing on

White16 (1980)), correctly states, rights are not powers and the other way around.

“… someone might have the power to throw a stone, but not the right to throw it.Someone might have more or less power to get his bicycle back, but he couldeither have or fail to have the right to get his bicycle back - rights admit nodegrees. And it is also possible to have the right to vote, without the power tovote, or to have a property right over a thing, without having much power over it … there can be rights without powers, and powers without rights …” (emphasisadded)

In the initial version of his ontology, Searle (1995) stated that, typically, in order to

be recognized, status functions needs status indicators, “because there is nothing in the person

or the object itself that will indicate its status, since the status is only there by collective

acceptance or recognition” (Searle, 2006b: 15). That is the reason why, societies have status

15

Lagarrigue (1983). Réflexions sur l’image fidele: a propos de l’espèce Argyll, Revue française decomptabilité, no. 134, pp. 140, quoted by Raybaud-Turrillo (1997: 262).16 White, A. R. (1980). Rights, Oxford: Oxford University Press quoted by Zaibert (1999).



21

indicators such as wedding rings or driver’s licenses, marriage certificates, policemen’s

uniforms or title deeds. Searle (2006b: 15) goes so far as to say that: “many societies find that

they cannot exist without status indicators, as, for example, the proliferation of identity cards

and driver’s licenses will attest.”

Nevertheless, Searle (2006b: 15) recognized that Hernando De Soto (2000) pointed

out to him an interesting fact, that is, the existence of powers without status indicators.Hernando De Soto (2000) called attention on the fact that in many underdeveloped countries

people own land, although they do not have title deeds to the property. What they lack is

status indicators. In other words, they are squatters , they have powers over a thing, but not the

formal right over it; or, in Smith’s (2003) words, they have informal property rights.

According to Searle (2006b: 15) the lack of status indicators has consequences of

enormous social importance, namely: squatters cannot be required to pay taxes by the

governing authorities, as they are not legally the holders of the property, but they are,

nevertheless, unable to use the land as collateral in order to get loans against it.

It might be argued that in the case of squatters, the analysis should leave the

institutional level, as in their case, there is no institutional reality. The squatters use the land,

just in virtue of its physical structure, and not because they are authorized to do it. However,Searle (2006b: 15) insists on the fact that even in this case there is a collectively accepted

status, which conveys deontic powers:

“The owners of the property are in effect squatters, in the sense that they do notlegally own the property, though they live in a society where their status functionis acknowledged and generally recognized and hence, on my account, continues

to exist and generate deontic powers. But the deontic powers stop at the pointwhere the larger society requires some official proof of the status functions.Thus, without official documentation, they lack full deontic powers. Collectiverecognition is not enough. There has to be official recognition by some agency,

itself supported by collective recognition, and there have to be status indicatorsissued by the official agency.”

This is surely supportive of our account of the institutional nature of economic

reality (e.g. the nature of land, buildings, inventory etc.), as Searle’s thinks that even the case

of using an item of property without the formal status indicators does not preclude the

existence of institutional reality. In other words, being a squatter or being squatted land is

institutional, as there is collective recognition of these statuses. Nevertheless, Searle’s

rationale deserves further explanations with implication for the nature of economic reality that

financial statements purport to represent.

The question is whether being a squatter or being squatted land is really

institutional, as the squatter could use the land, just in virtue of its physical structure. In thecase of chairs, Searle (1995: 44) argued that the function does not necessarily require human

agreement: “if it has a certain kind of shape, we can use it as a chair regardless of anyone else

thinks.” Similarly, in the case of squatted land, if the act of squatting occurs without anyone

knowing, then squatters can use the land for dwelling just in virtue of their being able to

exploit its physics, so we do not deal with an institutional fact. In Searle’s (1995: 44) own

words, the function of being “squatted land” is not a status function, as it does not add

anything but a label. Thus, everything gets down to having powers over a thing without

actually having rights over it. In the reverse situation though, the act of squatting cannot exist

in absence of collective agreement or at least acceptance on the part of the members of that

society. Accordingly we are dealing with an institutional fact, as the squatters may use the

land in virtue of informal authorization.



22

This is relevant for our discussion about the nature of economic reality, as there

might be situations when an organization may draw economic benefits from an asset without

having the formal right to do it, as in the case of an invention which was not yet patented, or

as a piece of know-how kept secret within the organization. It can be argued that in this case

we are not dealing with institutions, as the invention, or the know-how does not perform its

function in virtue of collective agreement. Nonetheless, the organization is not actually in thesame position as a squatter as it does not unlawfully use the invention or the know-how. The

invention or the know-how were generated by the organization which, most probable, is able

to document that. Therefore the organization is entitled to use them (and there is surely

collective acceptance about this), although it does not have an official recognition of its rights.

Accordingly, it is not just an invention or a piece of know-how, but it is the company’s

invention or know-how, that is, institutional reality, although the company does not have the

status indicators, the legal rights over them.

The British conceptual framework (ASB, 1999: 4.12) notices that a company may

have the power to derive economic benefits from an item of property, although not in virtue of

legal rights:

“Access to future economic benefits – and therefore an asset – can also exist inabsence of legal rights. An example may be an unpatented invention.”

Therefore, assets are defined as “rights or other access to future economic benefits”

(ASB, 1999: 4.6, emphasis added).

But drawing on Raybaud-Turrillo’s (1997) analysis, we could point out to Searle the

reverse situation, i.e. having status indicators, but not having the deontic powers that they

denote. In the case of lease agreements, the lessor has the title deed over the asset, but not the

rights that it normally conveys. The lessor, for instance, cannot use its property. This is

because the company which holds the legal title over the asset has acquired a new status by

means of a lease covenant, that is, the status of being a lessor, which conveys different deontic powers. The existence of the title deed was, nevertheless, a prerequisite for acquiring this new

status function, but in order to identify the deontic powers that the organization now has, one

has to draw on a new status indicator, i.e., the lease agreement.

The difficulties that the French accounting faced in the case of lease contracts were

generated by the failure to observe this shift in the status functions. Therefore the French

accounting remained clung to a status indicator which was no longer representing the actual

deontic powers that the organization had, requiring the lessor to present the leased asset into

its balance-sheet, as it was the holder of the formal property right.

As explained above, Raybaud-Turrillo (1997) tried to formally define the new status

functions that the lessee and the lessor acquire in virtue of a lease agreement, by dividing the

property right. But her determination to draw on a former status indicator, i.e. the propertyright, in order to define the new functions, was, on our account, unnecessary and it

demonstrated the fascination that the French accounting has for this status indicator, as goods

were always associated with property rights.

Being a lessor, or a lessee carries a clear deontology which is formally recognized in

a lease contract. Both the lessee and the lessor acquire legal patrimonial rights (and

obligations), in virtue of a lease covenant, and there is no contradiction with the

patrimoniality principle in recognizing these rights into the balance-sheet. The fact that the

lessee does not hold the title deed to the leased asset should not preclude the recognition of

the right that it acquired, which is not a real right, but a personal one, as it does not provide

direct power over the leased asset. Nevertheless, the rights acquired by the lessee and the

lessor are legal rights, and Raybaud-Turrillo’s (1997) reluctance to leave the institutional level



23

of legal rights in the case of lease agreements was, on our account, correct and it was backed

up by the British conceptual framework:

“… les deux propriétés mises en évidence … sont toutes deux des notions juridiques: il ne s’agit pas de faire une distinction entre des droits et des pouvoirs

de fait ” (Raybaud-Turrillo’s, 1997: 147, Fr., emphasis added)

“…legal rights to future economic benefits derived from an item of property can be obtained without having legal ownership of the property itself, as in the case,for example, where property is leased.” (ASB, 1999: 4.10, emphasis added)

As a conclusion we think we are not far from the truth when saying that the

economic reality which financial statements purport to represent is institutional. Financial

reporting is not concerned with items such as buildings or trucks, but with the deontic powers

that the institutional status imposed on these items conveys to the organization. And the only

deontic powers at interest are those by means of which the organization is able to draw

economic benefits so that investors might maximize their wealth. As explained above, deontic

powers should not be necessarily confused with legal rights and much less with legal

ownership.

But some questions still need answers, such as why financial statements do not

present assets in terms of deontic powers which give access to future economic benefits, and

continue to present items such as trucks and buildings. This issue will be further discussed in

the next paragraph.. Furthermore we have only discussed the nature of just one kind of

economic objects disclosed within financial statements. But what about the ontological status

of objects such as licenses, accounts receivable or payable, debts or share capital?

2.5. Further developments in the theory of institutional reality and Searle’s

naturalism. Their implications for the ontology of accounting objects

The common feature that buildings, trucks or land all share is that they fit into

Searle’s (1995) general description of the construction of social reality and in the naturalistic

account that he wants to give. Thus, an artifact made of molecules of iron and rubber (brute

objects) has the function of being a truck (carrier of loads – social object), which, at some

point, counts as someone’s (i.e. the organization’s) private property (institutional object) – see

Figure 2.3 below.



24

In the initial version of his theory, Searle (1995) insisted on the fact that there can be

no institutional reality without brute reality. Institutional facts must eventually bottom up on

brute facts, otherwise one gets infinite regress or circularity:

“It could not be the case, as some antirealists have maintained , that all facts areinstitutional facts, that there are no brute facts, because the analysis of thestructure of institutional facts reveals that they are logically dependent on brute

facts. To suppose that all facts are institutional would produce an infinite regressor circularity in the account of institutional facts. In order that some facts beinstitutional, there must be some other facts that are brute.” (Searle, 1995: 56,emphasis added)

“Chairman of the IASB”

Refers to

I nstitutional object

Chairman of the IASB

Brute object

David Tweedie

“Fixed assets: motor vehicles”

Refers to

I nstitutional object

Private property

Social object

Truck

Brute object

Collection of molecules

Bottoms on

Bottoms on

Counts as

Fig. 1 Searle’s (1995) construction of social reality theory

Counts as

Status indi cator

Title deed

Status indicator

Chairman contract



25

This should be a consequence of Searle’s commitments to realism and naturalism.

But how can social or institutional objects fit into Searle’s realism, as he thinks that all that

exists are physical particles in fields of force? How can the Chairman of the IASB or a

property right exist in a world made up entirely of physical particles in fields of force?

Searle’s answer is that they actually do not exist, because when a function isimposed on a brute object we have no new entity:

“The existence of observer-relative features of the world does not add any new

material objects to reality …” (Searle, 1995: 10, emphasis added)

Thus, the imposition of functions gives us nothing ontological new (Smith, 2003).

David Tweedie is still David Tweedie even when he counts as the Chairman of the IASB.

Paraphrasing Searle (1995), David Tweedie is actually many institutional objects at once: he

is the Chairman of the IASB, a Sir, a British citizen, a chartered accountant, a professor and,

most probably, a licensed driver. But if David Tweedie entered a room, how many “objects”

would be in that room? According to Searle, there would be just one, namely, David Tweedie.Although someone may be tempted to think that the Y term is a new entity, it is actually

identical with the original X. The difference is that the X is treated differently in certain

contexts:

“The open sentence “x is a social object” is not extensional17 with respect tosubstitutability, thus it does not determine a class. This is not a harmlesslogical feature, because we tend to hear the notion “social object” on analogywith, for example, “objects made of iron”. But “objects made of iron” form adistinct class. There is a distinction between objects made of iron and objectsnot made of iron. But there is not in that way a distinction between the class of social objects and the class of non-social objects, because one and the same

thing can be a social object relative to one description, and a non-social objectrelative to another description.” (Smith & Searle, 2003, emphasis added)

Accordingly, Searle seems to have succeded in developing an ontology of social

reality that is both realistic and naturalistic. Everything that exists are physical particles in

fields of force and he has succeded in giving a logical account of the structure of social (and

institutional) reality constructed on that brute reality:

“Our original aim was to explain how the ontology of institutions fits into the

more basic ontology of physics and chemistry and we have now done that: oneand the same phenomenon (object, organism, event, etc.) can satisfy descriptions

under which it is non-institutional (a piece of paper, a human being, a series ofmovements) and descriptions under which it is institutional (a 20 dollar bill, the president of the United States, a football game). An object or other phenomenonis part of an institutional fact, under a certain description of that object or phenomenon.” (Searle, 2005: 10, emphasis added)

This could be the reason why financial statements do not name the institutional

object, but the original X, on which the status function was imposed on, as, ontologically

speaking, we have no new entity. In the case of artifacts, the name of the artifact is employed

17

Extensionality is a property of sentences and other representations by which they pass the following test: iftwo expressions refer to the same object they can be substituted for each other in a sentence without changing

the truth value of the sentence (Searle, 1995: 18).



26

because our primary phenomenological experience precludes us from seeing the objects as a

collection of molecules.

In order for Searle’s naturalism to hold, both the X and the Y terms have to bottom

up on brute objects, “phenomena whose existence is not a matter of human agreement”

(Searle, 1995: 55). However, Searle (2005: 15) admitted that Smith (2003) pointed out to him

that in some cases, this is not happening. Smith (2003) proved that there are some institutionsthat have what he calls „free-standing Y terms”, that is to say, there is a status function

without any brute object on which the status function is imposed.

And Smith (2003) provided two notable examples, i.e. corporations and debit cards.

In the case of corporations, performing the appropriate procedures counts as creating the

corporation, but, once created, the corporation exists although there is no physical object

which is the corporation. Together with the corporation, new status functions are created, such

as the officers or the stockholders, but none of them is the corporation. “There is indeed a

corporation as Y , but there is no person or physical object X that counts as Y ” (Searle, 2005:

16)

Another example is that of money. Searle (2006b: 21/22) admits that currency is not

essential to the existence and functioning of money. In the case of debit cards, Searle agreesthat there is no need of physical realization, as having a system of recorded numerical values

assigned to different persons showing the amount of the money that they have at one moment

in time is enough for the existence of money. A purchase or a sale may be performed just by

decreasing or increasing these numerical values without the actual transfer of pieces of paper

or coins.

This is a quite different position from the one advanced in the initial version of

Searle’s theory, when he stated that:

“… all sorts of things can be money, but there has to be some physical

realization, some brute fact – even if it is only a bit of paper or a blip on a

computer disk ” (Searle, 1995: 56, emphasis added)

But Smith (2003) insisted on the fact that blips in computers are very different from

pieces of paper. Blips on computers cannot be used for buying things, thus the status function

is not actually imposed on them. And Searle confesses his error:

“On at least one point … Smith has shown that the account I gave in [TheConstruction of Social Reality] is mistaken. I say that one form that money takesis magnetic traces on computers disks, and another form is credit cards. Strictlyspeaking neither of these is money, rather, both are different representations ofmoney.” (Smith & Searle, 2003)

So, we need to distinguish between the representation of the institutional

phenomenon and the institutional phenomena represented (Searle, 2006: 23). Thus, magnetic

traces on computers disks merely record money; they do not count as money. Accordingly,

financial statements when presenting the company’s cash at bank deal with a „free-standing Y

term”, that is, an institutional reality that has no physical realization.

But even more important for the financial reporting domain is the ontological status

of different kinds of receivables, payables or debts. Smith (2003) also discussed the issue of

making promises exposing the same confusion between representations and the phenomena

represented.

In the case of promises, according to Searle’s (1995) theory, the construction of

institutional reality should follow an iterative process, specifically: X1 counts as Y1, Y1 = X2counts as Y2:



27

“A certain audio-acoustic blast counts as an utterance.

This utterance counts as making of a promise.” (Smith, 2003)

This should fit into Searle’s (1995) naturalistic account of institutional reality. There

is just an audio-acoustic blast treated in a certain way. Nevertheless, Smith (2003) wonders

how an event which lasts two seconds can be the bearer and the physical foundation ofdeontic powers (such as claims and obligations) which continue to exist for several months:

“When I say «I promise to mow your lawn in three months time», I becomeobliged to you for three months. My obligation survives for three months. Butthe promise only survives for two seconds. Now, what is the physical fact uponwhich the obligation is imposed? Because the air vibrations have ceased to exist.

Deontic powers can exist for several months, events of promising only exist fortwo seconds.” (Smith, 2003, verbatim)

It follows that we are facing the same confusion between objects and their

representations. Just like the blips in computers merely represent money, or a title deed

merely records or registers the existence of a property right, so the acoustic-blast (i.e. theutterance) merely records the existence of a promise.

It can be argued that once the air vibrations cease to exist, then the bearers of the

deontic powers will be some mental acts of the parties involved or of other witnesses. Or, a

document may be written, as memory may fade. But still, all of these will not count as the

promise. They are all records of the promise:

“An IOU records the existence of a debt; it does not count as the debt. …Mentalacts do not count as obligations, any more than blips in computers count asmoney. Rather all of these things belong to the domain of records andregistrations.” (Smith, 2003, emphasis added)

Accordingly, most of the objects which are represented by financial statement are

free-standing Y terms. Bank loans or loans granted to subsidiaries, liabilities towards

suppliers or receivables from customers, advance payments to employees or salaries payable,

taxes payable to the state funds or cash at bank are all institutions without any physical

realization. Furthermore, the organizations themselves, which are the foci of financial

reporting, are a part of this mysterious realm of institutional objects which do not superimpose

on any brute reality.

But this does not fit into Searle’s realist and naturalist ontology. You cannot have a

Y term without an X term, as this would lead to infinite regress or circularity. There must be

some physical reality on which we impose status functions.

As Smith (2003) argues, Searle is aware of this, but he thinks it is not a problem.Searle acknowledges that:

“I promise something on Tuesday, and the act of uttering ceased on Tuesday, butthe obligation of the promise continues to exist over Wednesday, Thursday,Friday, etc. …[but] that is not just an odd feature of speech acts, it is

characteristic of the deontic structure of institutional reality” (Searle (Smith &Searle, 2003, emphasis added)).

“The whole point of institutional facts is that once created they continue to existas long as they are recognized … You do not need the X term once you have

created the Y status function” (Searle (Smith & Searle, 2003, emphasis added)) “[An institution] need not have a physical realization, it may be just a set of

status functions” (Searle (Smith & Searle, 2003, emphasis added))



28

Accordingly, Smith (2003) argued that, without realizing it, Searle has abandoned

his naturalism. “He’s accepted that there are two sorts of social reality: there’s social reality

made of molecules (presidents, churches, driving licenses, dollar bills), and then there’s social

reality which is not made of molecules (debts, licenses, corporations, obligations and claims)”

(Smith, 2003, verbatim). Thus, Searle has adopted a contradictory position: on the one handhe is a naturalist; on the other hand he is committed to the existence of entities which do not

coincide ontologically to any part of physical reality.

Searle (2006b: 23) argued that status functions are matters of deontic powers, and in

such cases, when the X term is missing, “the deontic power goes directly to the individuals in

question”, i.e., to the organization.

In consequence, economic reality that financial statements purport to represent is

comprised of both institutional objects which bottom up on brute (physical) objects, but also

of abstract enti ties , such as rights, obligations and debts, which have no physical realization.

This is puzzling for a realist ontology and it seems to have already started to trouble

the accounting standards setters. In a recent discussion paper on a new converged conceptual

framework it is stated that:

“The phrase real-world economic phenomena deserves emphasis because itsimplications have often been overlooked. The phenomena depicted in financialreports are real-world because they exist now or have already occurred. Forexample, a stamping-machine exists in the real world. In contrast, an accountingconstruct such as a ‘deferred charge’ (that is not an economic resource) or a‘deferred credit’ (that is not an economic obligation) is a creation of accountants.Because such deferred charges and deferred credits do not exist in the real

world outside financial reporting, they cannot be faithfully represented as theterm is used in the framework. (IASB & FASB, 2006: QC18, emphasis added)

2.6. The mystery of capital and the abstract realm of deontic powers

Smith (2003) drawing on De Soto (2000) emphasized the role of institutional reality,

and even more the role of the institutions which have no physical realization but exist because

of records and registrations. De Soto’s (2000) thesis is no less than the existence of records

and registrations which give birth to institutional reality with full deontic powers makes all

the difference between wealth and poverty. The reason why “capitalism triumphs in the west

and fails everywhere else” is because of such pieces of paper which records the existence of

institutional reality.

According to De Soto (2000), in the economic domain, this abstract realm of

institutional reality is actually the universe of capital :

“Capital is born by representing in writing – in a title, a security, a title, and othersuch records – the most economically and socially useful qualities [of a givenasset].” (De Soto, 2000)

“The moment you f ocus your attention on the title of a house, for example, andnot on the house itself, you have automatically stepped from the material worldinto the [non- physical] universe where capital lives.” De Soto (2000)

Thus, the “mystery of capital” is the invisible structure conveyed by records and

registrations which capture “what is economically meaningful about the corresponding assets”

De Soto, (2000). Nevertheless, the formal property system that breaks down assets into capitalis, according to De Soto, (2000), extremely difficult to visualize and this is because, Smith



29

(2003) argues, capital/equity is not made of molecules (such as buildings and trucks), it

cannot be put under a microscope, as it belongs to an abstract realm. In Smith’s (2003) terms

“we are dealing with the domain of free-standing Y terms = the domain of what exists in

virtue of representations”.

In light of Smith’s (2003) argument, it could be inferred that it should not really

matter whether the institutional objects are constructed on brute reality or not, as once we stopconcentrating on the physical objects and focus on the institutional level we have

automatically entered into the abstract domain of the Y terms, that is, into the realm of capital.

But according to Smith (2003), it is because of their abstract nature, that they are so

important. As we can take advantage of that and manipulate them into “quasi -mathematical

ways”: “… the Mystery of Capital is that we can take advantage of free -standing Y

terms. Because they’re not made by molecules we can do all sorts of thingswith them we can’t do with physical stuff. We can manipulate them in quasi-

mathematical ways: we can pool and collateralize assets, we can securitizeloans, we can consolidate debts, shareholders can buy and sale their property

rights in factory without affecting the integrity of the physical asset. You can’tdo that with physical things. Physical things are not divisible mathematically. Not even [a dollar bill] is divisible mathematically. But the money which [it]

represents is divisible mathematically.” (Smith, 2003, verbatim)

This is also relevant for financial reporting, as we tend to see assets in terms of their

ontologically corresponding brute objects, such as buildings or trucks, and not in terms of

deontic powers to access economic benefits. And sometimes, it might be the case that the Y

terms have been manipulated mathematically by means of covenants or agreements, and

accountants will find it hard to account for such covenants as they cannot identify the

ontologically corresponding physical entities. For instance, in the case of lease agreements,

the lessee acquires the right to use the assets, that is, it acquires powers to access a part or allof the economic benefits related to the leased assets. As accountants and users of accounting

information are accustomed to see the physical thing into the balance sheet, only assets

acquired as a result of a finance lease covenant will be presented in the balance-sheet, as in

this case, the lessee has acquired access to the majority of the economic benefits of the leased

asset. But in the case of an operating lease, the lessee will record nothing into its balance-

sheet, although it has the right to access a part of the economic benefits of the leased asset.

What really happens in the case of an operating lease is a quasi-mathematical

manipulation of the Y term (i.e. property right), both parties, the lessee and the lessor, having

rights to access future economic benefits of the corresponding asset, but neither of them

having access to approximately all the economic benefits that it could provide. Accordingly,

they should both recognize their (deontic) powers as assets. This is not that puzzling. Themost conspicuous example of quasi-mathematical manipulation of a Y term is dividing a

corporation into a finite number of shares. But economic benefits embodied in an asset may

also be shared by different parties.

G4+1’1996 Discussion Paper 18 advocated such an approach, arguing that under both

finance and operating leases, “the lessee acquires a contractual right to enjoy the future

economic benefits embodied in the leased property and incurs a contractual obligation to

compensate the lessor for the use of the leased property over the lease term.” Nevertheless,

18 Australian Accounting Standards Board; Canadian Accounting Standards Board; International Accounting

Standards Committee; New Zealand Financial Reporting Standards Board, United Kingdom AccountingStandards Board; United States Financial Accounting Standards Board (G4+1) (1996). Discussion paper:

Accounting for leases: a new approach, quoted by Bonham et al. (2004).



30

the G4+1’1999 Discussion Paper 19 recommended the recognition of a tangible asset and a

corresponding liability in the financial statements of the lessee. Bonham et al. (2004: 1253)

argued against this approach, as in their opinion:

“[the lessee has] acquired an intangible asset in the form of the right to use the

asset. The fair value of the liability represents the cost of an intangible asset, notthe fair value of a tangible asset. ... It would be misleading to describe, forexample, a short term non-assignable property lease in the balance sheet astangible fixed asset land and buildings; in our view, both in terms of economicsubstance and legal form, this is an intangible right to use an asset for a specific period and we believe that it should be described and presented as such in theaccounts.”

All these difficulties are triggered by the fact that financial reporting uses

conventional devices which name a lower level of the social ontology (truck, buildings,

tangible, intangible assets), hence it is actually the signs employed in the representations that

cause problems.

3. Realism in financial reporting

As we have already explained, Searle believes that the world is made up entirely of

physical particles in fields of force, and he is committed to the presupposition of external

realism (or realism ). According to Searle (1995: 155):

“Realism is the view that there is a way that things are that is logicallyindependent of all human representations.” (emphasis added)

But as we found out in the previous paragraph, economic reality is pervasively

institutional. Although financial statements make reference to buildings, land or trucks, they

are not actually concerned with such items, but with the deontic powers that the institutional

statuses imposed on these items convey to the organization.

Yet institutional reality is constructed by means of language, and therefore it is not

independent of all our representations:

“… marriages and money, unlike mountains and atoms, do not existindependently of all representations” (Searle, 1995: 190)

An apparent solution to this problem could be the fact that, institutional reality is

constructed on physical reality and that both the X and the Y terms have to bottom up on

brute objects, namely phenomena whose existence is not dependent on any of ourrepresentation. Thus according to Searle (1995), all institutional objects correspond

ontologically to a piece of brute reality. And “Physically X and Y are exactly the same thing.

… [and] empirically speaking,” the Y term does not exist (Sear le, 1995: 69).

But it cannot be argued that our statements refer only to brute reality. When we are

talking about money and marriages we are referring to institutional facts (Y terms), and not

to their physical ontological support.

19 Australian Accounting Standards Board; Canadian Accounting Standards Board; International Accounting

Standards Committee; New Zealand Financial Reporting Standards Board, United Kingdom AccountingStandards Board; United States Financial Accounting Standards Board (G4+1) (1996). Discussion paper:

Leases: implementation of a new approach, quoted by Bonham et al. (2004).



31

Furthermore, as we have already discussed, most of the items disclosed within

financial statements such as rights, obligations and debts, are free-standing Y terms, which

have no physical realization. So, there isn’t in fact any X term to be referred to by financial

statements.

So, what could possibly be the role played by external realism in financial

accounting reporting, as financial statements purport to make references only to institutionalfacts, which are not independent of all representations? Is such a presupposition suited for

the accounting domain?

3.1. Internal vs. external realism debate in accounting

We do not know whether Shapiro (1997), who was the first author to apply Searle’s

(1995) theory to accounting, was aware of the issues discussed above. But he, nevertheless,

without realizing it, or just without explicitly saying it, defined a different (weaker) version of

external realism as an ontological presupposition of accounting. According to Shapiro (1997:

167):

“External reality exists independently of the financial statements that attempt torepresent it. Social phenomena are ontologically subjective but just as real asontologically objective physical phenomena.”

In doing so, Shapiro (1997) not only makes an ontological commitment to socially

constructed objects, but furthermore he describes reality as being independent of the financial

statements that try to represent it. In other words, there is a non-linguistic (that is, independent

of a particular speech act) object that is referred to by accounting signs. But Shapiro’s (1997)

external realism is not equivalent to the one advanced by Searle (1995), as he is only saying

that reality is independent of the financial statements that attempt to represent it , and not

independent of all representations.This presupposition is attacked by Alexander and Archer (2003), who argue that

socially constructed objects are not externally real. Here is Alexander and Archer (2003: 6)

rationale:

“Searle's position is that (a) under appropriate conditions a firm's profit becomes (is objectified as) an <<institutional fact>>, but also (b) this does notmean that profit is real, or has a realworld referent, in the external realist sense

of existing independently of the collective representations which lead underappropriate conditions to its objectification. (…) Searle does not consider<<institutional facts>> to be <<externally real>>”

And because “social (and economic) reality does not exist independently of our

collective representations of it (...) then (...) an ER [external realism] position on the economic

reality that accounting (among other discursive practices) seeks to represent is not tenable.”

Accordingly it follows that (...) “ER is rejected as an ontological basis for accounting”.

(Alexander and Archer, 2003: 6)

Thus, Alexander and Archer (2003) refute external realism as being a suited

ontological presupposition for accounting and financial reporting, drawing on Putnam (1981)

in order to define a new ontological presupposition that they advance for financial reporting,

terming it internal realism:

“[T]he objects of accounting do not exist independently of a conceptual schemethat relates accounting concepts to each other and to their empirical referents.

But this does not mean that such objects are not real. The objects of accounting



32

are part of an economic reality that is socially (i.e. intersubjectively)

constructed and objectified by virtue of collective intentionality.”

In doing this, Alexander and Archer (2003) argue not with Shapiro (1997), but

actually with Searle (1995), albeit they don’t seem to realize it, as they use Searle’s theoretic

in order to support internal realism, while Searle explicitly supports external realism as the background premise of a “chunk of discursive practices”.

But actually Searle (1995) addresses such criticism as those advocated by Putnam

(1981). These kinds of criticisms are advanced from a conceptual relativity stance, according

to which “[a]ll representations of reality are made relative to some more or less arbitrary

selected set of concepts.” (Searle, 1995: 161)

Searle (1995) accepts the validity of conceptual relativity, as the same piece of

reality can be represented differently depending on the conceptual schemes involved; for

instance a person may weight 160 in pounds and 73 in kilograms (Searle, 1995: 165), or the

company’s building may be valued in euros or in US dollars (functional currency or

presentation currency, for instance).

But Searle (1995: 165) does not accept that conceptual relativity can refute externalrealism:

“… if conceptual relativity is to be used as an argument against realism, it seemsto presuppose realism, because it presupposes a language-independent realitythat can be carved up or divided up in different ways, by different vocabularies.”(italic added)

Accordingly,“From the fact that a description can only be made relative to a set of linguisticcategories, it does not follow that the facts/objects/states of affairs,/etc.,described can only exist relative to a set of categories.” (Searle, 1995: 166)

However, Alexander and Archer (2003) did not follow the latter syllogism (i.e. a

description can only be made relative to a conceptual scheme, it follows that the facts

described can only exist relative to a conceptual scheme). But their rationale was quite the

opposite. They know that economic reality that accounting purports to represent (objects of

accounting, as they call it) requires human representations for its existence, and they refute

external realism on these grounds; but because they wanted to fit Putnam’s conception, they

said that economic reality (“objects of accounting”) does not exist independently of a

conceptual scheme that relates accounting concepts to each other and to their empirical

referents.

Having in mind the starting premise of the conceptual relativity argument - a

description can only be made relative to a set of linguistic categories, or arbitrary selected

set of concepts – it could be inferred that by “conceptual scheme” Alexander & Archer(2003) mean an accounting conceptual scheme, that is accounting rules such as GAAP (and

it makes sense to think that accounting rules such as GAAP relate accounting concepts to

each other and to their empirical referents).

Nevertheless, we also have to bear in mind the fact that they refuted external

realism on the grounds that economic reality is not independent of our representations,

accordingly, when they say that the “objects/empirical referents are socially constructed,

being dependent on collective representations”, they surely mean more than accounting rules,

but because of the conceptual relativity position they embraced, they necessarily involve

accounting conceptual schemes. It follows that the ontological presupposition advanced by

Alexander and Archer (2003) states that economic reality is not just depended on our

collective representations, but is now also depended on accounting rules. In other words, areceivable presented within financial statements is not dependent only on the collective



33

intentionality of the parties involved in the transaction and on acceptance from the members

of society of the existence of this status, but it is also dependent on accounting conceptual

schemes. This rationale is supported by Alexander and Archer (2003: 6) themselves, as they

state that: “[a] key issue ... is the part played by accounting rules in this process of

intersubjective construction.”

So, in fact, Alexander and Archer (2003) do not refute external realism, at least notthe weak version advanced by Shapiro (1997). They are not, so to speak, antirealists, as they

stress that their position does not imply that “objects [of accounting] are not real”. Thus

financial statements do purport to make reference to a reality beyond themselves. It is only

that this reality is socially (inter-subjectively) constructed and that accounting rules play a role

in this construction.

It is not certain whether Alexander and Archer (2003) think that accounting rules

play a role in the creation of all economic reality, or that they believe there are only some

occasions when accounting conceptual schemes are involved. The conceptual relativism

position will definitely entail the former. But a conceptual relativism position will also extend

to brute reality, but Alexander and Archer (2003: 6) do not want to assume this position as

they say:“Putnam ... argue[s] for IR [internal realism] as an ontological basis for all reality[but w]e do not need to follow Putnam … in this. It is sufficient for our purpose tohave established that ER is not a suitable ontological theory for accounting andfinancial reporting (or for any other discursive practices implicated in the socialconstruction of economic reality), and that IR is a suitable alternative.”

Accordingly, Alexander and Archer’s (2003) position is not far from the one adopted

by Shapiro (1997, 1998), as they also commit ontologically to both socially constructed reality

(ontologically subjective facts) and brute reality (ontologically objective facts), and they seem

aware of that:

“In as much as Shapiro's reconstructed version of ER [external realism] is in fact aform of IR [internal realism], there is no significant disagreement between Shapiroand ourselves regarding ontological issues in accounting.” (Alexander andArcher’s, 2003: 7)

Nevertheless, as explained previously, Shapiro (1997: 653) tends to believe that the

economic reality which is subject to financial representations is comprised of both social and

brute facts, although he thinks that most of the phenomena that financial statements purport to

represent are socially constructed. And we have proved this position wrong. Financial

statements are only concerned with institutional reality, not with brute reality such as land or

coal. Alexander and Archer’s (2003: 6) make a clear statement to say that economic reality is

socially constructed, although they do not provide any evidence to support their belief:

“The objects of accounting are part of an economic reality that is socially (i.e.intersubjectively) constructed and objectified by virtue of collectiveintentionality.”

Shapiro (1998: 654) quoting Burchell et al. (1985) and Tinker and Ghicas (1993, p.

363) adopts a similar position to Alexander and Archer’s (2003) in respect of the role played

by accounting in creating the economic reality that financial statements purport to represent,

but they think that this happens only occasionally:“... external realism advanced here does not deny that financial reporting mayalso produce economic consequences, nor does it deny that accounting practices

might encourage or promote the social institutions on which they report. Indeed,sometimes accounting is asked to constitute the very things it is supposed to



34

reflect (Burchell et al., 1985). But as Tinker and Ghicas (1993, p. 363) quite

rightly put it in a different context. This is not to suggest that accounting fullyconstitutes reality and is solely responsible for the outcome.”

Accordingly, we can safely conclude that their positions are very similar, although

their original formulations stress different things. That is, while Alexander and Archer (2003)

underline the fact that economic reality is socially constructed, Shapiro (1997) emphasizes

that it is, nonetheless, independent of the financial statements that purport to represent it. But

it seems that both reject external realism, as it was initially formulated by Searle (1995), i.e.

reality exists independently of all representations.

3.2. External realism as an intelligibility criterion: a way further

Can external realism be rejected? According to Searle (1995) it cannot. And this is

because external realism is neither a thesis nor a hypothesis, but a presupposition , and

presuppositions cannot be rejected or falsified.

“External Realism is (…) not a thesis nor an hypothesis but the condition of

having certain sorts of theses or hypotheses” (Searle, 1995: 178)

External realism, as Searle (1995) argues, is a necessary condition for intell igibil ity .

It is a part of what he calls the Background, which consists of “nonintentional or

preintentional capacities that enable intentional states of function” (Searle, 1995; 129). The

Background contains all sorts of presuppositions that we normally take for granted in order to

understand a sentence. They are usually not explicit in the semantic content of the sentence

but they are automatically taken for granted so that we can understand the sentence (Searle,

1995: 184). And Searle argues that external realism is such a Background presupposition, but

contrary to other presuppositions, it is pervasive, that is, it applies to a very large class ofutterances, and essential , in the sense that we cannot preserve normal understanding of these

utterances without it. Thus, external realism is a necessary condition for achieving normal

understanding: “The claim I make here is that ER [external realism] functions as a taken-for-granted part of the Background. Unless we take ER for granted, we cannotunderstand utterances the way we normally do.” (Searle, 1995: 182-183)

And he warns that the abandonment of external realism means the abandonment of

normal understanding:“The price of the abandonment of realism is the abandonment of normalunderstanding. If someone wishes to abandon normal understanding, he or sheowes us an account of what sort of understanding is possible.” (Searle, 1995:189)

External realism allows us to communicate meaningfully with one another, because

in order to understand each other, in order to have the sameness of understanding of our

words, we have to assume that our statements refer beyond themselves to a publicly

accessible reality. If our statements were merely private representations, we wouldn’t

understand one other.“Normal understanding requires sameness of understanding by both speaker andhearer, and sameness of understanding in these cases requires that utterances ofthe referring expressions purport to make reference to publicly accessible reality,

to a reality that is ontologically objective. But the condition on public



35

accessibility to the sorts of phenomena in these examples is that the way that

things are does not depend on your or my representations.” (Searle, 1995: 186).

Although Searle tries to make a clear case in respect to ontologically objective

reality, he does not succeed, because “your or my representations” is not equivalent to “all

representations” and “publicly accessible reality” is not equivalent to “a reality that isontologically objective”. He argues that even institutional facts like “money” or “marriages”

are independently existing reality. That is, although institutional facts are not independent of

all representations, they are independent of any particular speech act , as they were objectified

by means of collective intentionality.

“Talk of money and marriages is talk of publicly accessible reality, and such phenomena are <<representation independent >> in the sense that this twenty

dollar bill or this marriage between Sam and Sally exists independently of youror my representations of it. (…) <<You owe me five dollars>> presupposes an

independently existing reality as much as does <<Mt. Everest has snow and icenear the summit.” (Searle, 1995: 190, Italic added)

Accordingly, his argument – a public language presupposes a public world - doesn’t

necessary lead to a reality that is independent of all representations. Thus, the logical

conclusion would be that “normal understanding” for sentences of a public language does not

require a reality independent of all representations, but just independent of the speaker and

the hearer and their particular r epresentations .

It doesn’t matter that institutional reality is created by means of representations,

because after it is created, we refer to it in the same way we do for brute reality.

“Typically the <<stands for>> relation requires the existence of some objects

that exists independently of the symbol that stands for it, but in the case of

institutional reality at the lowest level, the practice of attaching a sense to anobject according to the constitutive rules creates the very category of potentialreferents, Symbols do not create cats and dogs and evening stars; they createonly the possibility of referring to cats, dogs, and evening stars in a publicly

accessible way. But symbolization creates the very ontological categories ofmoney, property, points scored in games and political offices, as well thecategories of words, and speech acts. Once the categories are created, we can

have the same sense/reference distinctions that we have for evening stars etc. (Searle, 1995: 75, emphasis added)

But Searle (1995: 190-194) insists that even in the case of institutional facts, external

realism, as he defines it, plays a role in achieving normal understanding. And for that he isadvancing a “transcendental argument”: “a socially constructed reality presupposes a

nonsocially constructed r eality … you cannot have institutional facts without brute facts …

[o]therwise you would get infinite regress or circularity” (Searle, 1995, p. 191).”

But what about free-standing Y terms such as debts and claims, which do not bottom

up on any brute reality? Searle has not given an answer to that yet. However, it might be

argued that although such items do not have a physical realization, nevertheless their creation

requires some brute reality, an audio-acoustic blast, records and registrations, which

eventually bottom up on brute reality. A record does not count as the debt, it merely records

the debts, but still the debt exists because of the record.

So, in that sense, a socially constructed reality presupposes a nonsocially constructed

reality. Accordingly, the existence of a reality independent of all representations plays a rolein achieving normal understanding of talk about institutional reality. But this presupposition is



36

not enough for achieving normal understanding, because institutional reality is socially

constructed, and for that we need representations.

Searle (1997: 193) acknowledges this fact and he says that “statements … [which]

purport to be about representation-dependent features of the world … require the existence of

representations as part of the conditions of their normal intelligibility.” And this is where his

rationale stops, as he was only interested in proving that normal intelligibility of bothinstitutional reality and brute reality requires external realism as he defined it, but only talk

about institutional reality requires the existence of representations. And we have no issue with

that. Besides, we think that neither Shapiro (1997, 1998) nor Alexander and Archer (2003)

reject this kind of external realism understood as an intelligibility criterion.

But in the case of socially constructed reality, the presupposition of a reality

independent of all representations and the presupposition of the existence of humans’

representations are not enough for achieving normal understanding. What we lack is

something essential , in Searle’s terms, in the sense that we cannot preserve normal

understanding of these utterances without it.

In the case of representation-dependent reality our statements might be just private

representations, or they might be self-referential. That is why in the case of these statementswe have to go back to our formulation of “normal understanding” that is, normal

understanding presupposes a reali ty independent of the speaker and the hearer and their

particular representations , and this is just the weak version of external realism which was put

forward by Shapiro (1997, 1998). Or we could substantiate Alexander and Archer’s (2003)

presupposition of an inter-subjective construction and we would get to the same normal

understanding condition: statements which purport to be about representation-dependent

features of the world require the belief in the existence of a reality independent of your or my

private representations.

Accordingly, on our account, both Shapiro (1997, 1998) and Alexander and Archer

(2003) advancing different ontological presuppositions for accounting tried to make explicit

an essential presupposition of the Background which would help us preserve normal

understanding of financial statements, and prevent us from slipping into a self-referentiality

conundrum or in a crisis of representation as the one claimed by postmodern theories.

Searle’s (2006a) upholds that the word-to-world direction of fit and the

commitments to states of affairs in the world, at least for a very important class of speech acts,

that is assertive utterances or statements (of which financial statements are an example) are

built in the very structure of language. In other words, according to Searle’s (2006a) analysis,

the institution of language was socially constructed as directed towards the world . So any

statement is a representation and in order to be understood as a statement must be understood

as a representation (Searle, 1995: 193), but furthermore, in order to succeed in communicating

with others we have to assume that there is something outside of our statements, a publicworld, which is independent of our particular representations.

And in the case of statements purporting to make reference to institutional reality

(such as financial statements), this presupposition is the weak version of external realism

advanced by Shapiro (1997, 1998). External realism so construed is not about truth

conditions, but it is about conditions of intelligibility.

All forms of intentionality have their own constitutive conditions of success or

failure. But when a mental state (e.g. beliefs, desires, intentions) with conditions of

satisfaction is communicated by means of an utterance, then the same conditions of

satisfaction are imposed on the utterance. Thus an (assertive) utterance which is the

expression of a belief has to fit the states of affairs in the world, just like the belief in the mind

has. Depending on whether it fails or not to fit the states of affairs in the world, it is said to betrue or false. Accordingly the truth condition for any statement is the existence of the fact



37

being referred to. For instance if the balance-sheet states “Long term bank loans €100.000)

(i.e. the company owes 100.000 euros to a credit institution) then the truth condition of this

statement is the existence of the stated obligation. But prior to instantiating the truth

conditions we have to assume that the statements refer to something beyond themselves. The

statement only makes the kind of sense that it does, we only understand it the way we do,

against the presupposition of the existence of obligations. In this way, external realismarticulates a space of possibilities (Searle, 1983: 183). Even if it turns out that the company

doesn’t have any obligation, we would still understand the statement in virtue of the external

realism presupposition.

Thus external realism is not a truth condition but a condition of intelligibility:

“The point is not epistemic. It is about conditions of intelligibility and notconditions of knowledge, because the point applies whether or not ourstatements are known or unknown, and whether they are true or false, and evenwhether the objects purportedly referred to exist or not. The point is simply thatwhen we understand an utterance … we understand it as presupposing a publiclyaccessible reality” (Searle, 1995: 187)

“Once we start talking to our interlocutors we have already presupposed theexistence of the real world.” (Searle, 1995: 196)

If realism is abandoned, than a fundamental feature of language is annulled, that of

being representational (referring to something external), and all we get is self-referentiality,

and the question of what sort of understanding is possible. Thus, the stake of maintaining (at

least the weak version) of external realism as an ontological commitment for financial

reporting is preserving our normal understanding.

3.3. Attacks on realism in financial reporting

Macintosh et al. (2000a), adopting a postmodern perspective, advanced the most

virulent attacks on realism, explicitly stating that accounting concepts have no real-world

referents, but “instead circulate (…) in a <<hyperreality>> of self -referential models”.

Accordingly, they questioned not only the nature of the reality that is supposed to be

represented by accounting figures (physical reality, socially constructed reality), but the very

existence of a reality to be referred to at all.

Macintosh et al. (2000a) exposed this crisis in representation in accounting for

financial instruments:

“(...) neither the accounting sign nor the financial market sign appear to begrounded in any external reality. Instead, each model appeals to the other

model for the only <<reality check>> available. Accounting signs modelmarket signs, which in turn model accounting signs. Thus, in the hyperreal

financial economy of simulation, the difference between the sign and thereferent implodes. The signs become images of themselves in an imbroglio of

ungrounded, self-referential simulation (…)” (emphasis added)

Contradictions inside the financial accounting valuation model, such as those

identified by Macintosh et al. (2000a) reveal themselves once we provide a trivial account of

financial accounting reporting. So the first question is: what is the purpose of valuation in

financial accounting? or why employing the term financial ?

The answers are trivial as they rely on our common knowledge of accountinghistory, as we know that financial accounting came into being when the enterprise became



38

independent of its owners. More exactly, financial accounting came into being when the

economic activities required funding that exceeded the financial resources of just one investor

(or of a small group). This is the moment when anonymous companies appeared – companies

owned by a large number of investors which, for this reason, had to abandon the management

of their resources. Nevertheless, although estranged from the company they owned, they were

entitled to know whether their resources were managed efficiently in order to decide whetherthey should maintain their investment and claim a part of the profit, or whether they should

relinquish it and invest in a more profitable company.

Accordingly, the term financial is employed because the purpose of organizing this

type of information system (i.e. financial accounting) is to supply information in order to

assist decision-making on the financial market20. Thus, the implicit presupposition that

underlines accounting standards is that financial accounting intermediates between the

enterprise and the financial market; managers communicate with investors via financial

statements.

In order to understand better how financial accounting is perceived, we shall focus

on these two levels of analysis: the financial market level, on the one hand, and the business

organizations level, on the other.

Firstly, the financial market is the market where all sorts of financial instruments

(generally termed: money) can be traded. According to finance theory, people engage in

transactions on financial markets in order to maximize their wealth, in contrast to the marketfor goods and services, where people enter in order to satisfy their needs, in economic terms:

to maximize their utility.

Although the two markets are given different purposes, McGoun (1997) argues that

the notions of wealth and utility become equivalent once we accept that money (wealth) can

buy happiness (utility). This statement is justified as by use of money people can buy things in

order to satisfy their needs, thus wealth maximization means utility maximization.

Following this rationale, the next step would be to acknowledge that money (wealth)

is needed only to ensure satisfying needs by means of goods and services, except for cases

20

It is true that other external parties use the information provided by financial accounting, but they doit only in a residual way, as “the main economic actor” – as Zambon (2000) put it – the one thatinduces the logic of this type of information system – is the investor/the owner of the company.

Financial

accountingGoods and

Services Market

BOi

“Real Economy” “Financial Economy”

Ii

Financial

Market

Investments

BOi: Business Organizations - assumed to be operating on the market for goods and services.

Ii: Investors - assumed to be operating on the financial market.

Fig. 2 Financial accounting as a link between “real” and “financial” economy



39

when money itself is the source of happiness, but these behaviours are considered aberrant in

finance theory. (Money does not offer direct, but indirect utility by means of goods and

services). Accordingly, as McGoun (1997) put it:

“In both our scholarship and our society, we are wedded to the no tion that the

financial economy (of money) exists for, refers to, and is meaningless withoutthe so-called real economy (of things).”

Secondly, in what business organizations are concerned, a common presupposition is

that they operate in the real economy, in that they came into being in order to provide goods

and services that will satisfy the needs of different consumers. As financial economy cannot

exist without the real economy, valuation of money will need reference to the market for

goods and services. Thus, financial accounting will be the link between the real and the

financial economy. Financial accounting will supply information in order to support securities

valuation on stock exchanges.

In this rationale we are privileging the real economy to financial economy: first we

have business organizations operating in the real economy, then we have the stock exchange,where securities need to be valued (represented in terms of money); we assume that there is

something real (the companies’ performance on the market for goods and services) which will

be referred to by stock prices.

But the description we provided is quite a rough representation of what really

happens, as business organizations do not operate only in the real economy, but they intervene

substantially on financial markets. This happens, for example, when companies act like

investors on the securities market purchasing stock as short term or long term investment. In

these cases, the accounting valuation model becomes self-referential: in order to value

securities on the financial market, accounting valuation (the valuation of company’s

performance) is taken into account; but accounting valuation was previously influenced by

financial market valuations, as securities prices were taken into account when company’s performance was assessed.

But, nobody can determine a market price by themselves – a market requires

multiple players, and collective acceptance of the outcome of the market process. It would be

mistaken to think otherwise. Macintosh et al. (2000a: 36) ignored this rationale when

exposing the valuation of financial instruments as being self-referential. There is no reason to

say that the difference between the sign and the referent implodes, because the companies'

earnings do not determine the security prices alone. There are multiple players operating on

the market, and the security prices are the result of the collective intentionality of these

players. The security prices are objectified by means of collective intentionality, and are not

subjectively determined by the company’s performance. In Searle’s (1995) own words, self -

referentiality does not result in circularity. So, once you have accepted collectiveintentionality you have accepted the existence of a social fact.

In addition, even if the valuation model is self-referential, there is still no reason to

assume that there is no reality to refer to at all. The signs of capital and income, exposed by

Macintosh et al. (2000a) to have no reference in reality, reflect the company’s obligations

towards the owners, and even if we fail to measure them, or we measure them subjectively, it

doesn’t mean that they are not real.

Thus, the point made by Macintosh et al. (2000a) is epistemic and not ontological.

They don’t deny the existence of reality, but just the fact that we cannot acquire “true”

knowledge about it. This argument is usually called the “Ding an Sich” (the thing in itself)

argument. According to it, as Searle (1995: 173/174) describes it, when we deal with the

world, we are always working within a conceptual scheme. And there is no God’s eye view

from which we can survey the relationship between our representations and reality. “Because



40

we can’t get outside the set of our representations to scrutinize reality directly, because there

is no nonrepresentational standpoint from which we can survey the relations between

representation and reality, and because there is not even the possibility of addressing the

adequacy of our representations by measuring them against things in themselves, talk of a

transcendent reality must be just so much nonsense … What external realism offers us is an

unthinkable something, indescribable, inaccessible, unknowable, unspeakable, ultimatelynonsensical. The real problem with such a realism is not that it is false, but that it is ultimately

unintelligible.”

Paraphrasing Searle, we can state the premise and conclusion of the argument as

follows:

Premise: Any representation occurs as a part of a system of representations.

Conclusion 1: It is impossible to get outside of all representations to survey the relationships

between them and the reality they are used to represent.

Conclusion 2: There can be no representation of a reality that exists independently of the

systems of representations.

Searle (1995: 174) agrees that the first conclusion follows from the premise. As all

representations occur within a set of representations and within some representational system(Premise) it follows that you cannot get outside of all representations to survey the

relationship between representation and reality (Conclusion 1). But from this conclusion, it

follows that any representation of the relationship between the set of representations and

reality occurs within a representational system. So Conclusion 2 does not follow from

Conclusion 1. There can be representations of a reality independent of all representations,

although we don’t have a God’s eye view to assess it. So, the point is epistemic and not

ontological. It’s about knowledge and not about reality.

Macintosh (2006) came back on his allegations and explained that what he was

actually saying was not that there wasn’t any reality out there, but only that we cannot get to

know it:“Most of us are pretty sure that things are out there (stones, mountains, atoms,animals, etc.) that are not just a creation of human minds and language and thatthey do exist as things-in-themselves, as Nietzsche calls them. We believe thatwhen a tree falls in the forest it does make a physical sound in the scientificsense even if no one is within earshot. The vital point is that the physical worldis out there but the truth or falseness about it, its essential meaning, is not.”(Macintosh 2006: 30)

However, this is not what someone understands when reading their seminal paper

where they were advancing a virulent attack on realism in financial accounting reporting:

“Our major thesis is that many accounting signs no longer refer to r eal objects and events and accounting no longer functions according to the logic of trans- parent representation, stewardship or information economics. Instead,accounting increasingly models only that which is itself a model.” (Macintosh etal., 2000a: 13, emphasis added)

This happened to Derrida, a prominent figure of postmodernism, when his

expression “there is nothing outside of the text” was interpreted literally. He replied vaguely

that he was misunderstood, and that he actually meant that “there is nothing outside of the

context”.

So there is no serious challenge to realism, as the arguments are truly epistemic.

Searle (1995: 175) explains that what happens with philosophers who attack realism is that

when they despair of “achieving an exact isomorphism between the structure of reality and



41

the structure of true representations, the temptation is to think that somehow or other our

naïve notions of truth and reality have been discredited. But they have not been discredited.

What has been discredited is a certain misconception of the relationship between truth and

reality.”

In face of these arguments, Rorty (1997: 160) claims that this kind of realism has

never been under attack. However, reading Derrida’s or Macinotsh’s allegations this isexactly the meaning of their words.

McKernan (2006: 158) drew on Davidson’s view, who tried to avoid this mistake,

adopting an antirepresentationalist perspective. That is, he doesn’t claim that reality does not

exist, but only that financial statements cannot represent it:

“This Davidsonian view is antirepresentationalist but not antirealist. Davidsonclearly accepts the world as “out there” and does not doubt that most things inthe world are causally independent of us.”

4. Subjective ontology and the “intertranslatability issue”

As we discussed in the second paragraph, economic reality is ontologicallysubjective, being constructed within a social context, and being dependent on that particular

social context. But a social context can be different than another, which may lead to opposing

views and intertranslatability issues from one context to another.

Regarding the fact that social reality is constructed within a social context Barry

Smith brought up to Searle the following example: (Smith and Searle, 2003) „Consider an

area of territory X in, say, Kashmir, an area which India claims as part of India and Pakistan

claims as part of Pakistan. X counts as Indian territory in India-friendly contexts, and as

Pakistani territory in Pakistan-friendly contexts.” And he wondered about the correct account

of the ontology of such a piece of territory and of the institutional facts in which it

participated. Searle argued that such „ problems were to be settled by judges and lawyers, andin the end perhaps by armies and political movements.” The relevant conclusion would be

that, according to Searle, issues such as X counts as Y1 in context C1 and X counts as Y2 in

context C2 can be solved in placing the issue in context C3, which both communities would

accept. If C3 can only be achieved by „armies and political movements” then it doesn’t seem

to say much for the rational intertranslatability of different conceptual schemes. But more

fundamentally, if the only way to resolve the conflict between Y1 (from C1) and Y2 (from

C2) is to depart from both C1 and C2 altogether (creating C3), then this surely demonstrates

conclusively the non-intertranslatability of Y1 and Y2.

But accounting is itself an institutional reality, being a set of status functions

(meaning attached to conventional devices) which are performed in virtue of collective

intentionality. Accordingly, the model described above could be suggested to closely mirrorthe situation in financial reporting. The purpose of, and therefore appropriate methodology

for, financial statements in country A is different from the purpose of, and therefore

appropriate methodology for, financial statements in country B. Given the non-

intertranslatability between A and B (as witness the failure of the Fourth EU Directive to

achieve significant harmonisation in Europe), the suggested solution is to invent Y3 (IFRSs)

in a newly created C3 (the international context).21

Another accounting example is the concept of fair value, as Alexander and Eierle

(2007) illustrate in detail regarding the very different connotations of fair value and

beizulegender Zeitwert (the Italian, valore equo, is different again).

21 This is not to deny the possibility that the move towards C3 is not always voluntary, nor to argue that C3 is in

any way guaranteed to be successful.



42

As a more detailed example, we instance a problem between French and German,

not involving the English language at all. The extract below is from the advice of the “avocat

général” presented to the European Court of Justice on 26 November 1998 in relation to case

number C-275/97, as a ‘preliminary opinion’. The opinion relates to a case of German origin,

was prepared in French, and exists also in official German (and Spanish, apparently)

translations but not in English. Paragraph 11, reproduced absolutely verbatim, reads asfollows.

La quatrième directive a été transposée en droit allemand par le Bilanzrichtliniengesetz (loi surle plan comptable général) du 19 décembre 1985. Cette loi a été incorporée dans le trosièmelivre (articles 238 à 342) du Handelsgesetzbuch (code de commerce, ci-après le <<HGB>>) du10 mai 1897.

The author has seen fit to explain Bilanzrichtliniengesetz, in French, as loi sur le

plan comptable général. This is absolute nonsense. A literal translation of

Bilanzrichtliniengesetz would be accounting guidelines law. But Richtliene is the formal

translation of directive (as in fourth Directive), so a proper translation would be “accountingdirectives law”.22 But what has this to do with the plan comptable général? The answer is:

absolutely nothing. Germany has no plan comptable, which is an internally specific French

concept with a unique and context-specific ethos. It represents a conceptual scheme

automatically understood in the French context, but alien, foreign, and incomprehensible in

the German situation, which is the context about which communication is intended.23 The two

conceptual schemes here are fundamentally different, and have been found to be not

“intertranslatable”.

Our conclusion on the intertranslatability question is clearcut. This is that

intertranslatability cannot be assumed. This is not just true in itself as a language issue,

despite the significant implications (problems?) for conceptual relativism and the existence of

different conceptual schemes. It is true because of conceptual relativism and the existence ofdifferent schemes.

These are important issues in financial reporting once accepting that all economic

reality and even accounting itself are institutional. However are these issues a menace for

realism in financial reporting? Reference to Searle is once again problematic, as he is only

interested in brute facts. Searle (1995: 176) argues that conceptual relativity doesn’t refute

external realism (as he define it) as it is only from a point of view that we represent reality,

but ontologically objective reality doesn’t have a point of view.

McKernan (2006) recently attacked Shapiro(1997)’s weak version of external

realism arguing that “ontologically subjective reality exists under representations, it exists

only by virtue of our beliefs and practices: it has <<a point of view>>”.

However, different degrees of subjectivity have to be taken into account at this point. If the “ point of view” is collectively accepted, than we deal with an ontologically

subjective reality which is independent of the financial statements representing it. And the

same piece of ontologically subjective reality may be represented differently by different

conceptual systems without having a “point of view” (e.g. a lease covenant is still a lease

covenant regardless of whether it is capitalized or not). Thus conceptual relativity does not

refute the weak version of external realism advocated by Shapiro (1997). As we argued in the

22 This is supported in that the first draft of this law was anticipated to transpose the fourth Directive only, and

was labelled Bilanzrichtlieniegesetz (i.e. single directive). The eventual law incorporated three directives at once,

hence the plural (lienien, not lienie in the middle of the composite word).23

This is true, notwithstanding the fact that the plan comptable system was refined by Reichsmarschal Goering,and introduced into France at the point of a gun in 1940. This of course demonstrates its logical independence

from European Union Directives.



43

third paragraph, external realism cannot be refuted, as it is a necessary condition for achieving

normal understanding. But in the case of ontologically subjective reality, normal

understanding will necessarily be achieved within a specific social context.

5. Summary and conclusions

We have essentially said what we feel needs to be said. We draw the strands together

at three levels. The paper showed for the first time in the literature that the nature of

accounting reality is institutional, and it is not comprised of brute facts. It also draws on the

later developments in the theory of institutional reality and exposes that most of the items

represented by financial statements are free-standing Y terms, that is, institutional objects

which do not have any physical realization.

The second level relates to the philosophical issues per se. We suggested earlier in

the paper that Searle’s (1995) claim that “normal understanding of talk of both money and

mountains requires external reality” could be validly and helpfully clarified by rewriting it as

follows.

“ Normal understanding of you and I talking about both money and mountains requires the presumption (not the fact) that there is general acceptance within the conceptual scheme of ourcommunity (not the human race) that money and mountains exist (whether as brute facts orinstitutional facts being irrelevant).”

We submit that our later analysis of Searle (2006b) and other related views supports

the validity of this rewritten proposition. It is an open question whether this nuanced

proposition should be linked with external reality (this being, of course, a matter of definition

which would require collective acceptance). It might be argued that it is unhelpful so to link

it, as the phrase carries overtones which are arguably false, and certainly misleading. The

distinction between a brute fact and an institutional fact is a fundamental one, and it might be preferred to restrict the context of external reality to brute facts, thereby regarding

institutional facts to lie within the internal reality dimension. But such questions of

appropriate labels are issues of convenience not principle. Normal understanding of talk of

both money and mountains requires collective acceptance between those doing the talking.

Full stop. Searle’s failure to achieve a meaningful defense of external realism as a necessary

condition for achieving normal understanding is indeed, as we suggested, inevitable.

The third level dealt with the “intertranslatability issue” acknowledged once

accepting that all economic reality and even accounting itself are institutional. However,

although significant, such issues represent no menace for realism in financial reporting as in

the case of institutional reality realism plays the same role as it does in the case of brute

reality, being a necessary condition for intelligibility.

In a recent draft Searle (2006a) has given an innovative account of language which

goes beyond the standard approach provided by philosophy of language, linguistics or

sociology, describing language as an institutional fact. He tries to give a naturalistic account

to language, that is, to explain how language is a natural development of prelinguistic

biological capacities. He tries to show how language has evolved from fundamental forms of

intentionality, such as beliefs, desire and intention, which have also developed from even

more fundamental forms of intentionality, especially, perception and intentional action.

In his account he showed that the word-to-world direction of fit and the

commitments to states of affairs in the world, at least for a very important class of speech acts,

that is assertive utterances or statements (of which financial statements are an example), are built in the very structure of language. In other words, according to Searle’s (2006a) analysis,



44

the institution of language was socially constructed in this way, namely as directed towards

the world . And accounting shares this feature with the natural language as financial

statements purport to represent the world (i.e. the economic reality).

The main thesis of the paper was that if this fundamental constitutive presupposition

(realism) of accounting is attacked, we might end up with an unintelligible and useless

instrument. Any institutional fact was created by means of constitutive rules, and the set ofstatus functions exist because of those rules, just like in the game of chess:

“Once you play chess then the queen has to be able to move both diagonallyand rectilinearly, that’s just the logical fact about chess. … If you move yourqueen in some other way, you’re not playing chess, you’re playing somethingelse. … It doesn’t make sense to say: why do you move your bishop diagonallywhen you’re playing chess? Anyone who asks that question just has not

understood the concepts of chess, and bishop and moves.” (Smith, 2003,verbatim)

Violate the essential rules of language, and the issue you get is: What sort of

understanding is possible? (Searle, 1995):

“If someone decides to break the rules of language, that person will soon findout that communication with others becomes impossible.” (Sánchez-Cuenca,2007)

However, someone might argue that, after all, accounting is a “constructed”

language and we can make it any way we want it to be … but shall we be able to speak it?

Acknowledgements

The authors tank the participants to the Interdisciplinary Perspectives on Accounting

Conference (Innsbruck, 2009) and to the 34th Annual Congress of the European Accounting

Association (Rome, 2011), in particular Prof J. Mckernan, for their helpful comments and

suggestions.



45

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Realism in Financial Reporting