Global Journal of Management and Business Research, D: Accounting and Auditing, Volume 22 Issue 2

The larger size of the corporation, with more dispersed share ownership led to questioning whether the proprietary perspective was appropriate for such corporations. For example, Berle and Means (1932) called shareholders of such corporations “nominal owners,” arguing that they would more accurately be described as “creditors.” “By the late 1920's, it had become commonplace to remark on the resemblance between shareholders and bondholders.” (Ireland 2001, 149; also, Lippman, 1914, 60-61 ) 44 44 According to Holstrom & Kaplan (2003, 15), untilthe late 1970s, “management was loyal to the corporation, not to the shareholder,” where management, “…was not to maximize shareholder wealth, but to ensure the growth (or at least the stability) of the enterprise by ‘balancing’ the claims of all important corporate ‘stakeholders’-- employees, suppliers, and local communities, as well as shareholders.” Accounting academics responded with what became known as “entity theory” or the “entity perspective.” For example, Paton (1922, p. 38) argued that “an equity” is a “value representation of a right in property…Properties connote equities and equities connote properties…” in order to prescribe listing the claims of shareholders and creditors as “equities.” This version of the entity perspective prescribing a balance sheet with assets equal to equities was included in Paton and Littleton (1940), a report commissioned by the American Accounting Association to establish a “framework of accounting theory” (Bedford & Zeigler 1975, 438). In 1941, the committee of the American Institute of Accountants rejected Paton and Littleton to avoid “…de-privileging of stockholders, inherent in entity theory” (Cilloni, Marinoni & Merino 2013, 61). Since then, standard setters have required the proprietary perspective for the balance sheets of business corporations. FASB (1985, 18) states that, “In a business enterprise, the equity is the ownership interest. It stems from ownership rights (or the equivalent)and involves a relation between an enterprise and its owners as owners rather than as employees, suppliers, customers, lenders, or in some other nonowner role. FASB (1985, Footnote 30) continues, “Other entities with proprietary or ownership interests in a business enterprise are commonly known by specialized names, such as stockholders, partners, and proprietors…but all are also covered by the descriptive term owners .” Therefore, the balance sheet of the business corporation substitutes the sole proprietor’s “Owner’s Equity” with “Shareholders’ Equity,” implying that shareholders and sole proprietors have identical claims to the firm’s net assets and profits. The only reasonable inference to draw from this balance sheet presentation is that shareholders, like sole proprietor’s and partners, have exclusive legal ownership claims to the corporation’s net assets and profits. In contrast, according to the evidence, non- controlling shareholders have no ownership claims to the net assets or profits. Specifically, shareholders have far fewer legal claims to firm-assets than do sole proprietors and partners and only slightly more claims to firm-assets than beneficiaries of nonprofit corporations. Nonprofit and business corporations both have liquidation protection and, as the evidence reveals, their firm-members (e.g., non-controlling shareholders for the business corporation) have no legal ownership claims to firm-assets. Therefore, perhaps the balance sheet of the business corporation should be more similar to those of the nonprofit corporation than to those of the sole proprietorship. For example, firm-members of nonprofit corporations have no claims to firm-assets; therefore, FASB requires nonprofits to label the net assets as, “Net Assets.” If the shareholders of business corporations have no claims to the firm-assets, how accurately does the balance sheet represent firm- members’ legal claims to corporation’s net assets if it calls them “Shareholders’ Equity”? Does calling the net assets of the business corporation “Net Assets,” like nonprofit corporation better represent the non-existent claims of firm-members, including shareholders, to the firm-assets? This question is perhaps why a recent accounting standard, FASB (2008, OB12) Concepts Statements No. 8, uses the phrase “the claims against the reporting entity,” replacing, “the claims to those resources” and similar phrasing FASB used for decades . 45 The IASB and FASB’s goal to converge accounting standards faltered over conflicts about whether financial reporting should take an entity or proprietary perspective, as noted in the introduction. Van Mourik (2014) examines the conflict, finding confusion on both sides and providing a list of papers on various types of equity theories, which would be helpful in understanding the different reporting perspectives. Ultimately, Van Mourik (2014) uses limited liability as the principle by which to determine reporting perspective for each firm-type. Van Mourik’s focus on limited liability is based on Demsetz (1967) three F ASB (2010, 14) provides the justification for the change, arguing, “…that in many cases, claims against an entity are not claims on specific resources. In addition, many claims will be satisfied using resources that will result from future net cash inflows. Thus, while all claims are claims against the entity, not all are claims against the entity’s existing resources.”The takeaway for this paper is that FASB itself knows that the balance sheet does not accurately show shareholders’ legal claims to net assets. What is the Solution? 45 FASB (1978, 6) Concepts Statement No. 1 states, “Financial reporting should provide information about the economic resources of an enterprise, the claims to those resources...” The Effects of Entity Shielding on Claims to Assets: Implications for Financial Reporting 31 Global Journal of Management and Business Research Volume XXII Issue II Version I Year 2022 ( )D © 2022 Global Journals