On Understanding Mattessich and Ijiri: A Study of Accounting Thought by Nohora García

1 Introduction

The marginal productivity of mainstream empirical accounting studies seems to become smaller and smaller. We believe it is high time to revisit neglected but important contributions of axiomatic approach in the 1960s and 1970s in order to enrich our understanding of accounting phenomena. In this regard the meticulously researched work on Richard Mattessich and Yuji Ijiri by Nohora García (2018) cannot be timelier.

This commentary focuses on their understanding of income concept and its influence on their axiomatic construction of accounting measurement. García (2018, 217–218) points out that

(Ijiri’s) work employs the conventional economic notion of income. This reveals a curious contrast in that, although Ijiri set out a theory of (conventional) accounting that was an alternative to the dominant approach, this notion of income followed neoclassical economic tradition,

and poses a question: “Does this reveal a lack of critical examination of neoclassical economic theory?”. We shall agree on this critique, though from a different viewpoint than García’s one. Not only Ijiri but also Mattessich misunderstood the neoclassical, more specifically, Hicksian income concept as explained in Value and Capital (Hicks, 1946, Ch. XIV), although this misunderstanding is regrettably not limited to them. ^[1]

In the following section, we examine not only how Ijiri and Mattessich understand economic income but also what kind of income concept Hicks and other neoclassical economists really bear in mind in their theoretical work.

2 Hicks, Hayek, Fisher, Cochrane and the neoclassical concept of income

Both of them took the Hicks’s Income No. 1 as the central (neoclassical) economic concept of income. ^[2] Ijiri asserts that

[his own] definition of income as a change in the resource set is consistent with the Hicksian concept of income as ‘the maximum value which [one] can consume during a week, and still expect to be as well off at the end of the week as he was at the beginning’ (Ijiri, 1975, 54–55).

It is true that Hicks claimed that “this is what the central meaning [of income] must be”, but Ijiri’s definition is more specific. Actually Hicks proposed a more operational concept of income approximating “the central meaning as Income No. 1,” which is “the maximum amount which can be spent during a period if there is to be an expectation of maintaining intact the capital value of prospective receipts (in money terms)” (Hicks, 1946 [1939], 173). This concept indeed corresponds to Ijiri’s definition of income. ^[3] Mattessich also took Income No. 1 as the income concept of Hicks, contrasting the Irving Fisher’s definition with Hicks’s one. He claimed that “the first one (Fisher’s) is based on flow variables, the second (Hicks’s) is based on stock variables” (Mattessich, 1964, 23).

However, their reading of Value and Capital is found wanting to say the least. In addition to Income No. 1, Hicks proposed another operational income concept called Income No. 2, which is “the maximum amount the individual can spend this week, and still expect to be able to spend the same amount in each ensuing week” (Hicks, 1946 [1939], 174). Hicks proposed Income No. 2 in addition to Income No. 1. ^[4] But what is crucial here is that he made it clear that “Income No. 2 is then a closer approximation to the central concept than Income No.1” (Hicks, 1946 [1939], 174). Income No. 1 was proposed pedagogically as a first approximation ^[5] because it is more intuitive and easily understandable than Income No. 2. ^[6]

Mattessich’s claim notwithstanding, not only the Fisher’s income concept but also the Hick’s one are based on flow basis. According to Hicks, (1946 [1939], 179),

the income which is relevant to conduct must always exclude [even realized] windfall gains; if they occur, they have to be thought of as rising income for future weeks (by the interest on them) rather than as entering into any effective sort of income for the current week.

This constrasts with Mattessich’s assertion that “Hicks definition … definitely includes capital formation” (Mattessich, 1964, 23).

Nicholas Kaldor (1955, 66) pointed out that Hicks’s income concept is the same as that of Friedrich Hayek, both “defining the maintenance of Capital simply in terms of the maintenance of Income”, and coined “The Hayek-Hicks approach”. Hicks himself admitted that his conceptual framework explained in Value and Capital is similar to Hayek’s: “When I wrote Value and Capital, Chapter XIV, I was myself an adherent of the Hayekian school on this matter, so I can appreciate the qualities of Professor Hayek’s definition” (Hick 1942, 175).

Although Hicks somewhat distanced himself from his original complete adherence to Hayekian income concept in Hicks (1942), ^[7] his (and Hayek’s) basic premise that capital is a derived concept of income, not vice-versa, remained intact. Capital loss due to the change of expectations is explicitly separated from depreciation and is not considered (negative) income (Hicks, 1942, 177–178).

In turn, Hayek (1935, 245) explicitly acknowledged the similarity between his own and Fisher’s approaches: “the solution of the problem which seems to be implied in his [Fisher’s] discussion, or at least the only solution which seems to be consistent with it, appears to be very much the same as that attempted in this paper.”

The primacy of income series over asset values is not a historical curiosity. Recently John Cochrane, a leading neoclassical financial economist, has tried to construct a multi-period equilibrium asset pricing model focusing on “the optimal stream of final payoffs, rather than on the composition and dynamics of portfolio returns” (Cochrane, 2014, 1). According to his American Finance Association presidential address, not only ”dynamic portfolio theory overall might get a lot simpler if we look at payoff streams rather than look at dynamic trading strategies that achieve those streams”, but also current-value oriented accounting procedures need be changed: “Perhaps banks’ complaint that low asset prices represent ‘illiquidity’ or ‘temporarily depressed valuations’ rather than insolvency … makes some sense … Perhaps ‘hold to maturity’ accounting is not as silly as it sounds” (Cochrane, 2011, 1083; 1088).

Although Ijiri (1975, p. 88) seemed to acquiesce a little on the relative advantage of current value over historical cost concerning decision-usefulness, accounting numbers largely based on historical cost are likely to be more decision-useful than those based on current value after all. ^[8] In fact, recent advances in empirical research on financial markets – questioning their efficiency - have shown that Ijiri might have been too defensive. Theoretically speaking, whether we adhere to neoclassical economics or not, the primacy of income over capital is undeniable as shown by the consistency of Fisher, Hayek, Hicks and Cochrane.

3 Accounting models and the neoclassical notion of income

Therefore, contrary to conventional wisdom, the neoclassical notion of income – or at least some versions of it developed by these leading economists – is closer to traditional earnings based on the income statement approach, rather than comprehensive income based on the balance sheet approach. Although Ijiri’s understanding of Hicksian income concept may be somewhat imprecise, it seems nevertheless curious that Ijiri, a stringent critic of the balance sheet approach, employed the income concept based on this approach, as pointed out by García.

We presume that Ijiri’s adherence to income as a change in the resource set ^[9] is a direct result of his axiomatic construction of accounting measurement where so-called nominal or income statement accounts do not exist. Nominal accounts are the ones directly involved in the accounting representation of business income to the accounting entity, ^[10] as explained by Littleton in the excerpt below. In other words, within Ijiri’s axiomatic accounting framework, the income statement cannot be distinguished from the mere periodical difference of the balance sheet. Every transaction is constructed as an exchange of real assets and no distinct function is given to nominal income statement accounts. On the other hand A. C. Littleton, whom Ijiri greatly admired, pointed out the crucial importance of nominal accounts in accounting measurement: “In order to see, by means of records, how enterprise property came to fruition, economic (nominal) accounts had to be invented to provide an opposite for economic transactions, that is, for those transactions which were more than an obvious exchanging of equivalent kinds at the moment … Without the use of goods accounts, expense accounts, and a summary profit and loss account, the comparative fruitfulness of particular activities … could not be read from the record … Without nominal accounts, a coherent scheme of fully interrelated accounts converging into capital account would not be possible. Without this scheme the operations that we now call double-entry bookkeeping could not be carried on, and statements designed to analyse the economic activities that constitute the reason for the existence of an enterprise could not be constructed“(Littleton, 1953, 28).

Mattessich’s axiomatic approach is similar to Ijiri’s in this non-existence of the nominal account as a fundamental element of the accounting system. ^[11] Their choice appears to come from their quest for an axiomatic definition of this system, based on the “objectively” measurable exchange of assets. In this regard, a stock-based income concept is indispensable to their system and Hicks’s Income No. 1 seems to justify their approach.

More than forty years ago, one of us made the following remark:

The point at issue is whether or not the factor corresponding to a nominal account could be incorporated in his definition of the economic transaction. Professor Mattessich asserts it could be, while I think it could not, as long as his definition is left as it stands (Saito, 1973, 107). ^[12]

The same point can be made of Ijiri’s axiomatic construction.

No one has yet managed to give us an adequate answer to our question.