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Journal of Education for Business

ISSN: 0883-2323 (Print) 1940-3356 (Online) Journal homepage: http://www.tandfonline.com/loi/vjeb20

Back to the Future: Implementing a Broad
Economic, Inquiry-Based Approach to Accounting
Education
Thomas J. Frecka , Michael H. Morris & Ramachandran Ramanan
To cite this article: Thomas J. Frecka , Michael H. Morris & Ramachandran Ramanan (2004)
Back to the Future: Implementing a Broad Economic, Inquiry-Based Approach to Accounting
Education, Journal of Education for Business, 80:2, 69-74, DOI: 10.3200/JOEB.80.2.69-74
To link to this article: http://dx.doi.org/10.3200/JOEB.80.2.69-74

Published online: 07 Aug 2010.

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Back to the Future: Implementing a
Broad Economic, Inquiry-Based
Approach to Accounting Education
THOMAS J. FRECKA
MICHAEL H. MORRIS
RAMACHANDRAN RAMANAN
University of Notre Dame
Notre Dame, Indiana

I

n this article, we argue for a broad
economics framework and an
inquiry-based approach to accounting
education and illustrate how such an
approach has been implemented successfully in the curricula at two universities. We included the following major
features in the project: (a) a focus on
inquiry or discovery-based learning, (b)
the use of a broad economics framework that includes contracting notions
and information concepts to motivate
the demand for accounting information
and to supplement a decision-usefulness framework, and (c) the elimination
of a “silo” approach to accounting education through an integration of financial and managerial topics, together
with auditing, tax, not-for-profit, and
international topics.
Our primary objective in this article
is to motivate accounting educators to
consider and implement revisions to
their undergraduate accounting curricula at a time when there is substantial
evidence that the accounting education

model used at most schools is broken or
obsolete. With this objective in mind,
we describe an initiative undertaken at
the University of Notre Dame and the
University of Illinois with the hope that
it may stimulate accounting education
innovation at other institutions.
Citing a growing gap between what
accountants do and what accounting

ABSTRACT. Motivated by concerns
about the quality of accounting education and calls for a broader, more
active approach to learning by numerous accounting educators and practitioners over the past 2 decades, the
authors of this article sought to provide a framework and example materials to address those issues. The framework makes use of broad, economic
contracting notions to supplement the
traditional decision-usefulness approach to accounting. The contracting
perspective more explicitly considers
the incentives of all parties to the various contracts with the entity and the
information environment in which
decisions are made. The approach,

which can be applied with any textbook in multiple settings, supports a
“discovery” mode of learning focusing on the methods and skills of
inquiry, analysis, judgment, and decision making.

educators teach, the Bedford Committee
(1986) called for a complete reorientation of accounting education toward
breadth at the undergraduate level and
specialization at the graduate level.
Later, the then Big Eight (1989) firms
endorsed the Bedford Committee and
offered their own criticisms of accounting education, including concerns about
a passive learning environment and the
lack of integration.
A 20%–25% decline in the number of
accounting graduates in the late 1990s
and concerns about the overall quality of

the remaining accounting students led
the American Accounting Association
(AAA), the American Institute of Certified Public Accountants (AICPA), the

Institute of Management Accountants
(IMA), and the then Big Five accounting
firms to commission a study by Albrecht
and Sack (2000) to determine causes.
The strong conclusion of the study, as
evidenced by practitioner views, is that
our current accounting education model
is still broken and obsolete.
The Call for Discovery-Based or
Inquiry-Based Learning
Calls for inquiry-based, discoverybased, or similar conceptual approaches
to learning are pervasive in educational
literature. For example, the Accounting
Education
Change
Commission
(AECC, 1990), Boyer (1990), and the
Boyer Commission on Educating
Undergraduates in the Research University (1998) have focused on “learning to
learn.” Eleven AECC grants responded

to the call for experimentation with a
focus on undergraduate accounting education. The two major thrusts of change
resulting from the grants are (a) a movement away from a preparer’s emphasis
and toward a user’s emphasis and (b) an
increased attention on the development
of professional skills (e.g., critical
thinking, lifelong learning, listening,
November/December 2004

69

speaking, and writing). Although both
of these directions of change are important, they do not provide a change in the
conceptual paradigm for accounting
education, nor do they address the concerns about lack of breadth that are at
the heart of most of the criticisms of
accounting education.

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Supplementing the Traditional
Decision-Usefulness Approach
With a Contracting and
Information Framework
From a financial reporting standpoint, the basis for the conceptual
framework used by the Financial
Accounting Standards Board (FASB)
is a decision-usefulness approach in
which the primary focus is on the characteristics of useful information (e.g.,
relevance and reliability) for investors
and creditors. In this article, we expand
the decision-usefulness model to include the building of accounting understanding on a foundation of standard
economic and contracting notions that
are not normally addressed within the
traditional decision-usefulness paradigm. Beaver (1998) noted that the two
primary concerns of economics are
efficiency and equity. Accounting
plays an important role in providing
information relevant for addressing
these two concerns.

Focusing first on the efficiency perspective, we see that economic theory is
developed based on perfect market
assumptions, including the assumption
that all information is free and known
to everyone. However, perfect market
assumptions do not hold in the real world.
A constraint on efficient contracting is
that one party to the contract usually has
superior information, knowledge, or ability to process information relative to the
other party. Thus, the usual information
environment provides an unlevel playing
field. Information asymmetry is a fundamental notion in the information economics literature and a pervasive problem
throughout the economy. Information
asymmetry arises in both precontracting
(adverse selection) and postcontracting
(moral hazard) settings. The demand for
accounting arises in this asymmetric
environment because of the need for
facilitating efficient contracting. Without
70

Journal of Education for Business

such market imperfections, there would
be no demand for accounting.
In addition to providing more accounting disclosures that level the information
playing field, parties can also mitigate
postcontractual opportunism by entering
into incentive-compatible contracts.
Given that all economic agents seek economic gain while having incentives to
behave opportunistically, their challenge
is to structure contracts that are fair and
that create incentives for efficient economic activity.
The second primary concern of economics, equity, generally leads to a discussion of regulatory considerations.
Although one could advance a “litany of
abuse” argument to support the need for
regulating accounting information,
Beaver (1998) noted that a more elegant
argument can be developed based on
market failures. Given an accounting

free-rider problem in which users do not
pay for financial accounting information, the price system cannot be used for
determination of an optimal supply of
information. The free-rider problem
potentially leads to an undersupply of
information and can be used to justify
regulation to support not only equity but
also the efficiency objective. Again, the
economic framework provides a much
richer setting for considering accounting issues and principles such as full
disclosure.
Supplementing DecisionUsefulness With Accountability
and Stewardship Notions
Laughlin and Puxty (1981), Gray,
Owen, and Adams (1996), and others
have criticized the decision-usefulness
framework for undermining the stewardship function, for giving priority to
financial stakeholders instead of society
as a whole, and for giving little consideration to the role of preparers and the
goals of the entity. Stewardship and

accountability notions have taken on
increasing importance in the wake of
the Enron, WorldCom, and other recent
accounting failures and are at the heart
of new regulatory controls such as the
Sarbanes-Oxley Act.
A contracting framework facilitates a
discussion of such accountability
notions. Ijiri (1983) noted that an

accountability-based framework focuses
on the relation between the accountor
(supplier of accounting information) and
the accountee (user of the accounting
information). In this framework, the
user is not the only driver of the information generated; rather, the objective
is to provide a fair system of information flow between the accountor and
accountee. What is “fair” is determined
as a result of negotiations between the
accountor and accountee. In this context, Ijiri noted the importance of the
accounting information qualities of
objectivity and verifiability. These qualities protect both parties by assuring that
the information is not biased or misleading. Also, when contracts are silent
about information requirements, Ijiri
noted that other qualities become
important, including relevance, usefulness, or representational faithfulness of
economic reality.
Although the contracting approach is
probably most consistent with a stakeholder theory of the firm, stakeholder
theory is a subset of contracting. For
example, a competitor generally would
not be considered a stakeholder in the
firm, but management may enter into
contracts with competitors to expand
the market over which they are competing. Competitors may contract to put on
a trade show to expand the market, thus
becoming parties to an expansion contract without becoming stakeholders in
each other’s firms. Another more recent
example of competitors contracting
with each other has occurred in the
automobile insurance industry. Insurance companies recently have combined
their resources to address the problems
at the most dangerous intersections in
the country. By entering into contracts
to make some intersections safer, the
competitors are preserving lives and
reducing costs for the entire industry,
without directly becoming stakeholders
in each other’s firms. Thus, the contracting approach easily can accommodate a
variety of accountability notions in
these situations.
Contracting Framework
and Discovery Learning
Building on the above discussion, we
used the following contracting ques-

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tions to systematically direct student
attention, initiate discussion, and organize the analysis of any accounting
topic or business situation:
• Who are the parties (entities)
involved in the transaction or business
situation?
• What is the primary interest (incentive) of each party?
• What are the primary risks and
rewards to each party to the contract?
• What major decisions are to be
made by each party?
• What information could be provided
to assist in the negotiated settlement of
each contract?
• How will performance be measured, and what mechanisms will ensure
accountability, enforcement, and incentive compatibility for each party?
• What role does accounting play in
this business setting, and what qualities
of the information are most important to
each contracting party?
Answers to these questions provide a
frame of reference for constructing an
entity diagram that details the parties
and the resource flows arising from
each contract (see Figure 1). This diagram leads to a discussion of each enti-

ty’s incentives, information requirements, and controls necessary for successful execution of the contract. The
approach not only serves as a starting
point for introducing each topic or situation, but the questions serve as a useful
teaching tool for proceeding from a discussion of why accounting is desired or
necessary to how accounting assists
contracting parties in assessing risks
and rewards, monitoring, and controlling activities.
Advantages of a Contracting
Framework
A contracting approach helps to integrate the many subareas of accounting
and attacks the traditional tribal structure of accounting education, a limitation recently resurrected by Demski
(2002a). Initiating classroom discussion
with contracting questions that establish
the entities, incentives, resource flows,
and the need for information breaks
down this stovepipe approach in teaching accounting. Once one adopts the
contracting framework for a firm, one
can analyze external contracts in the
same way as internal contracts. In other
words, managerial accounting issues are

Environmental Protection
Agency

Telephone company

Retirees

Utilities (gas, electric,
and water)

Auditors

Waste
collection
services

Securities and
Exchange Commission

Pension
funds

Business

Financial
analysts
Taxing
authorities

Employees

Creditors

Suppliers
Local
community

FIGURE 1. Entity diagram.

Customers

Shareholders

addressed alongside financial accounting issues, which makes the segregation
unnatural.
Unlike the decision-usefulness
approach, the contracting perspective
does not stop at blurring the distinction
between managerial and financial
accounting. It ties the many other subareas of accounting together, helps define
the domain of accounting, and allows
for more complex business problem
analysis. For example, tax effects become an important consideration in
most contracts, because tax authorities
are “uninvited third parties” in otherwise bilateral contracts.
An example from Scholes and Wolfson (1992) best illustrates the richness
of a contracting perspective extending
to considerations outside the narrow
boundaries of financial and managerial
accounting. Consider the decision to
either lease or buy business equipment.
In most countries, the government
encourages capital investment by providing tax incentives to the owner
through rapid depreciation write-off.
Alternatively, if a business rents the
equipment, the rental payments may be
tax deductible over the period of the
lease. The decision-usefulness perspective would emphasize collection and use
of the information about the user’s marginal tax rate, discount factors, and cash
flows from each alternative to determine
whether renting or buying has the highest present value for the user.
Thus, one expands the analysis
through the contracting perspective not
only to examine the transaction from the
acquirer’s view but also to facilitate consideration of the provider’s decision variables. Each party can have unique marginal tax rates, cost of capital (discount)
factors, and profitability status. If the
user of the equipment is a firm with a low
marginal tax rate, the user may find it
more desirable to rent the equipment. If
the owner of the equipment is a firm with
a high tax bracket, the owner would find
it more attractive to lease it and retain the
depreciation tax benefit. Both businesses
have incentives to enter into a contract
(because each needs the other), but the
property rights are arranged so that the
low-tax-bracket business effectively sells
its excess depreciation tax benefit to the
high-tax-bracket business. This transacNovember/December 2004

71

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tion is accomplished through reduction
of the rental rate to the low-tax-bracket
lessee in exchange for the right of the
lessor to take rapid depreciation, for tax
purposes, on the equipment. The negotiated settlement is dependent on the
unique characteristics of each party in
the transaction and can result in a solution quite different from the one that
might be reached by considering only the
user. In this case, the acquirer may be
motivated to forgo the depreciation tax
benefit because it is more than offset by
lower rental rates. Thus, this kind of
analysis allows for a much richer discussion of financial accounting standards
related to leasing and the ethics of offbalance-sheet financing.
It should be evident from this example that we are proposing an approach
that is much broader than one based on
a purely legalistic view of the firm. In
the broader approach, implicit contracts
become increasingly important because,
in many relationships, it is not the legal
system that is enforcing performance
but, rather, social norms, trust, and/or
mutual gain. For example, a firm might
establish wellness programs (for the
encouragement of physical exercise and
provision of facilities) or family counseling centers for its employees.
Although these centers are part of the
benefits for workers, they are driven not
by a threat of legal action but by a belief
in the productivity effects of having
happy employees and a desired negotiated reduction in medical and insurance
costs owing to healthier workers.
Having a framework based on contracting also allows the instructor to
deemphasize the rule-based method of
instruction and, instead, to focus on
information concepts. Contracting parties outside the firm, such as shareholders and creditors, require accurate performance measures to reduce information
asymmetry and make better resource
allocation decisions. The need for high
quality income measures for discrete
time periods necessitates the use of
accrual accounting procedures. Curricular coverage of financial accounting topics such as stock-option compensation
and accrual accounting pension expense
recognition can be justified and their
content explained based on demand for
relevant and reliable performance mea72

Journal of Education for Business

sures by outside parties in the contracting
nexus. Such disclosures reduce the informational advantage of inside parties and
provide monitoring mechanisms for contract enforcement, contract negotiation,
and efficient allocation of resources.
Finally, a contracting framework also
facilitates an emphasis on accounting
research throughout the curriculum, a
goal recently reinvigorated by Demski
(2002b). Principal/agent investigations
are natural fallouts from the owner/
management contracts or management/
employee contracts. With the contractual emphasis on performance, studies
examining the relative value of cash
versus accrual performance measures
provide interesting additions to the
accounting courses. The contract that
the entity has with equity holders and
the impact that accounting performance
measures have on the resource allocation decisions of owners allow instructors to introduce capital market research
into the classroom. Empirical research
results on earnings quality, income
smoothing, and the impact of transitory/
permanent or expected/unexpected earnings components on stock prices provide
evidence that leads to interesting discussions and higher level learning based on
a consideration of contractual relationships between owners and management.
The Not-for-Profit Example
As an example that demonstrates the
versatility of the contracting approach,
we present a case that examines the
operations of a center for the homeless.
The providers of the resources for the
center include donors, volunteers, and,
to a limited extent, federal and local governments. The executive director and the
board of directors have responsibility for
the stewardship of the resources, which
flow to the beneficiaries of the center.
Although there are continual resource
flows from the providers to the center,
the contracts have no tangible resource
flows from the center back to the
providers (other than the governmentprovided tax deduction for financial contributions). Unlike situations involving
stockholders in a for-profit entity, there
are no tradable residual claims and no
owners. The accounting system is still
very important to the parties contracting

for a homeless shelter, but it is clearly of
a different form.
Multiple accounting topics are illustrated according to the contractual organization of a not-for-profit entity. In the
class, we also discuss the importance of
a mission statement and use of resources consistent with the mission
statement for maintaining the taxexempt status. The discussion invariably
turns to the need for an independent
audit to provide an assertion about the
appropriate use of the resources of the
center. Not-for-profit entities place
heavy reliance on budgets and adherence to line-item budgets for various
activities of the center. Students spend a
significant amount of time examining
the budget of the entity, including performing a sensitivity analysis of different scenarios of resource availability. In
this context, we also compare the topic
of revenues and expenditures for notfor-profit entities with an income statement for a for-profit firm.
Performance evaluation, a managerial
accounting topic, has important relevance for the center. The class examines
a balanced scorecard of financial and
nonfinancial measures, along with the
inherent difficulties in measuring true
rehabilitation of a guest of the center.
This case provides a real-life example to
illustrate all of the above interconnected
accounting topics. Because several students typically volunteer in not-forprofit entities, they tend to engage more
actively in these discussions and
enhance the learning of the whole class.
Limited-Information-Environment
Example
A second example focuses on a scubadiving business that is considering an
expansion contract to provide services
and instruction at a new location on the
beach in the Cayman Islands. The case
contains traditional managerial accounting considerations involved in the decision whether to expand or not, such as
incremental variable and fixed costs, relevant costs, and return on investment.
The case also necessitates consideration
of traditional financial accounting implications of the expansion, such as additional debt load, income considerations,
and liquidity effects.

Note

Pa
rtn
er

In this article, we proposed the use of
a broad economic, inquiry-based framework for learning about accounting and
its role in society. The approach advocated is consistent with the recommendations of the Bedford Committee
(1986), recommendations of Albrecht
and Sack (2000), and suggestions by
Demski (2002a) and a host of other
accounting scholars and practitioners.
The approach exposes students to a

SONR #1
LLC

Sole
member

Michael Kopper

$1K

ted
mi
Li

er
rtn
Pa

JEDI
Limited
Partnership

M
M
83
$3

SONR #1
L.P.

K
$115

G.P.

Chewco
Investment L.P.

Guarantee fee

Ge
ner
al

Conclusion

G.P.
$240MM
loan

L. P.
$11.4
MM

Note

Enron

A familiarity with contracting concepts is a prerequisite for understanding
the business motivation and the accounting requirements for complex business
transactions involving multiple entities,
firm restructurings, and financial instruments. In Figure 2, we present the entity
diagram for Chewco, one of Enron’s special purpose entities. Instructors can use
this complex diagram to illustrate (a)
how contracts are written to specify
rights, obligations, and payoffs of contracting parties; (b) control issues; and
(c) why ownership equity is important
for an entity. For example, there were

Barclays

e
nte
ara
gu
t
b
De

concerns about the fairness of the terms
of the contract with respect to Enron and
the payoff function based on the nonindependent status of Kopper, the manager
of Chewco and an Enron employee. The
diagram also make clear the importance
of organizational form and the maneuvering through companies with limited
liability and various partnership arrangements to give the appearance that Enron
did not control Chewco. Finally, the diagram illustrates how the then 3% rule for
nonconsolidation worked and why the
rule was violated for Chewco. Issues
concerning ethics and related-party
transactions are also easily addressed in
this case.

Contracting Notions in Advanced
Accounting Courses

$132MM advance

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postcontractual asymmetric-information
environment. In the absence of more
ownership involvement, students may
be asked to consider the form of compensation contracts that would achieve
management behavior consistent with
the long-term goals of the business.
Under conditions of increased risk to
outside creditors and investors, the
scuba business may also experience a
higher cost of capital for all decisions,
including the proposed expansion.

However, the real value of this case
arises when students consider the establishment of contracts with a business in
the Cayman Islands, where the business
is not required to file tax returns, has no
threat of tax audits, has no requirements
to provide audited financial statements,
and is able to choose from an array of
international financial accounting standards. Students quickly realize that the
information environment provides
increased risk for outside parties to contracts with the scuba business. Without a
tax system, which generally provides
incentives to report lower income, and
without financial audits to provide a reasonable level of assurance, management
would possess an unusual information
advantage and would have a tendency to
be less risk averse, more freewheeling,
and more prone to overstatement of
actual results. In this situation, banks
would negotiate for lower borrowing
limits or higher interest rates or would
require more detailed information on
people than they would in less asymmetric precontracting environments.
Ownership structure would shift to more
monitoring, more oversight, and more
control, with potentially more local or
hands-on stewardship in the exaggerated

Big River
Funding LLC
Sole
member

$114K

Michael Kopper (96.5%)
William Dodson (2.5%)

$11.1MM
Note

Barclays

$341K

Little River
Funding LLC
$10K

L. P.

$331K
Note

Barclays

Big River
and Little
River
Reserve
Accounts

Sole
member

SONR #2
LLC

Sole
member

William Dodson
(replaced
Michael Kopper)

$6.6MM

FIGURE 2. Chewco entity diagram. From the Report of Investigation by the Special Investigative Committee of the
Board of Directors of Enron Corporation, William C. Powers, Jr., Chairman, February 1, 2002, p. 51.

November/December 2004

73

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broad range of accounting topics and
provides a stronger conceptual linkage
of general education, business education, and accounting education than does
the traditional decision-usefulness
approach that focuses on only one entity,
the user of accounting information. An
economics-based conceptual framework
for studying accounting, in conjunction
with an inquiry-based approach to learning, is consistent with the blueprint provided by the Boyer Commission (1998)
for enriching undergraduate education at
research universities.
Little evidence exists that a broad
economic-based approach to accounting education is optimal for all schools
and all students, yet it is consistent with
the recommendations of practically all
of the critics of accounting education.
Given these criticisms and the general
belief that the approach to accounting
education is too narrow, our purpose in
this article has been to explain how a
contracting approach can be implemented, suggest advantages of such an
approach, share example materials, and
call for additional exploration with the
approach.
NOTES
1. See Stone and Shelley (1997) for assessment
results.
2. See Scott (1997), especially chapters 1 and
2, for an in-depth discussion of this idea.
3. Today, even the concept of “competition” is

blurring as entities enter into more joint-venture
agreements. Contracting notions help explain the
motivation behind such ventures and their information requirements.
4. Magill and Quinzii (1998) noted that the field
of economics did not develop until it was separated
from the field of law, about 200 years ago. They
expressed surprise “that it takes so long for economists to recognize the fundamental importance of
law and, above all, contracts for a proper understanding of the functioning of an economy” (p. 15).
5. The Homeless Center and Scuba Diving
Cases have been published and distributed by the
American Institute of Certified Public Accountants (AICPA) for instructor use in accounting
courses. The full text of the cases and solutions
can be found in AICPA (1998) and AICPA (1997).
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for accountants: Position statement number
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education: Charting a course through a perilous
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American Institute of Certified Public Accountants (AICPA). (1997). Center for the Homeless,
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ERRATUM
In the September/October 2004 issue of the Journal of Education for Business, Vol. 80, No. 1, the
authorship of the article “The 2003 AACSB Accreditation Standards and Implications for Business
Faculty: A Short Note” (pp. 29 to 34) incorrectly omitted the name of author Morgan P. Miles. The
authors are Morgan P. Miles, Mary F. Hazeldine, and Linda S. Munilla, all of Georgia Southern University, Statesboro, Georgia.

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Journal of Education for Business