The accounting system initially was designed to measure the profits and losses of a manufacturing company. Figuring out the cost of producing a widget or washing machine and the revenue from selling them was relatively easy. But determining the same figures for a service like Web design or a product requiring a lot of intellectual property and intangible assets to produce, like computer software, requires more variables that are open to different accounting treatments.

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Moreover, growing competition, globalization, deregulation, and financial engineering have made the nature ol what many companies do and how they manage risk more complicated. A venture into foreign markets creates a need to use derivatives to hedge foreign exchange risk-at minimum. Many companies have turned to legitimate special-purpose entities to insulate themselves from risks and share costs of expansion. Pressure to develop new technologies, drugs, and other products drives companies into ventures with rivals that limit exposure.

This is where accounting has had a hard time keeping up with advances in business and finance. Accounting rules designed for a company that makes simple products can end up being inadequate to portray a concern like Enron, which in many ways existed as the focal point of a series of contracts -- contracts to trade broadband capacity, electricity, and natural gas and contracts to invest in other technology start-ups.

In addition, because of the leeway in current accounting rules, two companies in the same industry that perform identical transactions can report different numbers. Something as common as depreciating research and development costs can produce different earnings depending on whether the life of the asset is 10 years or five. Under GAAP, both would be allowable and defensible.

Intangible assets is another area that allows companies freedom to determine what results they report. The values placed on these items are largely educated guesses. But they represent an increasing part of total assets. Intangible assets have grown to about 9% of total assets from about 4% five years ago, according to a study of 5,300 companies by Multex.com, a research concern. Although accounting tests can gauge the changes in the value of intangibles, it's often difficult for outside investors to understand how the figures were derived. How the numbers were determined, of course, can affect earnings.

Finally, the increasing importance of a rising stock price gives managers an unprecedented incentive to obfuscate. No longer is a higher stock price simply desirable; it is often essential because stocks have become a vital way for companies to run their businesses. The growing use of stock options as a way of compensating employees means managers need higher stock prices to retain talent.

The use of stock to make acquisitions and to guarantee the debt of special-purpose entities means, as with Enron, that the entire partnership edifice can crash when the underlying stock that props it up falls. And the growing use of the stock market as a place for companies to raise capital means a high stock price can be the difference between failure and success.

Hence, companies have an incentive to use aggressive accounting to boost their reported earnings and prop up their stock price. In the worst-case scenario, that means some companies put out misleading financial accounts. "The argument that honesty is the best policy does not work in such markets, since firms would not be around in the future to reap the benefits of their honesty, wrote Harvard University professors Andre Shleifer and Gene D'Avolio, along with Efi Gildor of Gildor Trading, in a research paper last year.

The bottom line is there's a lot more open to interpretation when it comes to the bottom line, and now investor confidence is weakening because of it.

-- Alan Levinsohn