Editorial Note: We are delighted to publish the following editorial by Paul F. Williams, the 2013 recipient of the Accounting Exemplar Award. The content is representative of the quality of the material that our colleagues will share at our 2019 Midyear Meeting in Orlando next week.
We hope to see you there! As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.
***
Paul F. Williams is a Professor of Accounting at the Poole College of Management at North Carolina State University. Paul earned a BSF from West Virginia University, and MBA and Ph.D. degrees from the University of North Carolina at Chapel Hill. He joined the N.C. State faculty in 1985 after spending 1977 to 1985 at Florida State University. His research interests include accounting ethics, theory, and critical perspectives in accounting. His publications have appeared in Critical Perspectives on Accounting, Accounting, Organizations and Society, The Accounting Review, Contemporary Accounting Research, Journal of Business Ethics, Accounting and the Public Interest, Accounting Horizons (for which he won the best paper award for 2014), among many other journals. He has served as chairperson of the Public Interest Section of the American Accounting Association and as editor of Accounting and the Public Interest. He received the Public Interest Section’s Accounting Exemplar Award in 2013.
An astonishing event occurred at the 2016 Centennial meeting of the American Accounting Association (AAA). Even more astonishing is that the event went largely unremarked – it passed into history without disrupting the normal life of the North American accounting academy. That it might not be obvious to many of you who happen to read this blog to what I am referring proves my point. It also says something about AAA leadership and even more about AAA members. What it says about us as members of AAA is not encouraging. The event to which I refer is the Plenary devoted to the proposition that accounting will be a learned profession by the year 2036. That obviously means, at least in the opinion of the AAA leadership, accounting is not as yet a learned profession. The astonishing part of the public admission that accounting is as yet not a learned profession is that a characteristic of professions is that they are, by definition, learned. There cannot be an un-learned profession. Would the legal profession or the medical profession ever publicly admit they were not yet learned? A lot more to learn, yes, but not as yet learned? We should be embarrassed by such an admission since we have already had over a century to become learned.
That law or medicine (or any other academic discipline) would admit to such a thing is not likely. This is so for at least two reasons: 1. Something is being learned by someone in order to be admitted to the discipline and that something is substantial and continuously tested with some process for ascertaining the value of that something, and 2. There is not a monolithic organization that controls the process by which something enters the canon of what is permissible learning and what is not. Unlike medicine and law where research and practice are intertwined, the accounting academy in the U.S. is unusual in that the something to be learned to be admitted to the practice of accounting is determined largely by the rules promulgated by regulatory bodies (e.g. FASB, IRS, SEC, PCAOB, etc.). Perhaps only second to the military is any field so dominated by acronyms as accounting – acronyms that stand for organized bodies writing rules. The academy produces very little that actually makes its way into the canon which must be learned to be admitted to the profession (it does however contribute a great deal to what must be believed). Given the academy’s lengthy disinterest in the actual practice of accounting or the actual function of accounting in society, a promise to make accounting a learned profession seems a bit disingenuous.*
Law, medicine, or almost any other scholarly discipline is dispersed. There are vast numbers of people engaged in those disciplines without extensive centralized bureaucratic control. The natural sciences which provide us lay people with the template for the so-called scientific method could not function as sciences under bureaucratic control (the Lysenko affair in the old USSR is a case in point). Freedom to explore is essential to “progress.” There are no single organizations that legislate the structures or contents of scientific disciplines. For example, according to Hossenfelder (2018, p. 153) there were 2,000 physics PhDs awarded in the U.S. in 2012. Membership in the American Physical Society is 51,000 and the membership in the German Physical Society is 60,000. The sheer number and dispersion of people doing physics provides at least a freedom from control by anything other than the constrictions of the discipline itself, i.e., there are certain things you are no longer permitted to believe since they have been ruled out as believable by the discipline, not by an organization that controls the discipline through bureaucratic fiat.
Accounting, at least in North America, is, perhaps uniquely, a discipline where discipline is imposed by a bureaucratic organization. Accounting as an academic discipline is extraordinarily small compared to virtually all other academic disciplines. As the physics example illustrates fields in the natural sciences are populated by thousands of people. Accounting academics are relatively few in number and emerged as such largely in the U.S. Prior to the movement to make business disciplines more scientific, which began in the 1950s, accounting was taught mostly by people from practice and research in the sense of applying the methods of social science was non-existent. What shape a scientific approach to accounting would take was contested territory. The first quantitative applications in accounting appeared in the area of management. The developments in operations research that came about because of WWII appeared in TAR written by people like W.W. Cooper. Edwin Caplin was an early pioneer in introducing psychology to the investigation of accounting – thus was born behavioral accounting research. But the battle for hegemony over the accounting research agenda has clearly been won by the group that claims ownership of the financial reporting revolution. This is a clearly identifiable group of cohorts who matriculated at the University of Chicago between the mid-1960s and the early 1970s. Their significance is evidenced by the fact that the first four Seminal Contributions to the Accounting Literature Awards were given to work produced by that cohort. Apparently nothing of any intellectual value was produced prior to this group of persons steeped in neoclassical economics Friedman style and neoliberal ideology (Friedman was a founding member of the Mt. Pelerin Society).
Because there is a monolithic organization (the AAA) that manages the U.S. professoriate control of the AAA gives control of the agenda. The Seminal Contribution Awards** is a case in point. Perhaps some of you know how the selection process for that award works, but I don’t. Magically it is announced that one has been bestowed, but who does it or how it is done is a mystery. The AAA has a history of self-appointed elites as the laughable case of ARIA (Edwards, et al., 2013) illustrates. The doctoral consortium and the new faculty consortium were created as mechanisms for controlling the agenda. I attended one of the early doctoral consortia in 1974 and the entire program was dedicated to EMH and the methods of financial economics. A most vivid memory of that experience was the panel on which Sandy Burton was invited to speak only to be assaulted for his naïve understanding of the world by rebel soldiers in the financial reporting revolution. Some years later Gary Previts made an effort to introduce doctoral students to broader perspectives and had Tim Fogarty organize a faculty that included a Foucaldian, a leading accounting historian, a past editor of Issues in Accounting Education, an eclectic scholar, and an ethicist. Needless to say the reaction by the AAA’s director of research was one of extreme displeasure and none of those people were ever invited back.
The proclivity of the AAA toward bureaucratic control of the discipline is perhaps understandable. It is, after all, an organization populated mostly by people who lived in the culture of the accounting profession, a culture that places highest value on conformity. To me the latest outrage is the change in procedure for the selection of the best paper awards for Issues and Horizons. In spite of the changes in bylaws made a few years ago, there is no visible effect of those changes on the intellectual agenda of the AAA becoming more diverse. Horizons and Issues were created to devalue certain scholarship. TAR used to contain an Education section, but it was removed because rewarding someone with a TAR citation for writing about education was just not on. Comments were eliminated from TAR as well because a TAR byline could not be provided to someone who just wanted to comment, particularly if the comment cast skepticism on the content of TAR. Horizons was to be where articles that could be comprehended by practitioners were to be published, but it quickly became a paler version of TAR. Since articles in Issues and Horizons were not deemed serious scholarship the best paper awards for those two journals were left to a plebiscite of the members. The winners of the Horizons awards reflected the eclectic interests of the members. Papers dealing with education, systems, audit, history, epistemology, sociology of knowledge, and, yes, financial reporting were winners. This past year, however, the idea of letting the members choose from among all papers published in Horizons, was apparently deemed too risky. The AAA decided that might lead to the “wrong” kind of literature being noted as award winning. So the list of acceptable papers was pared to only five, all of which dealt with financial reporting. What little power the members have to shape what the AAA acknowledges as intellectually worthy has been taken away and without a whimper.
The people who gave us the financial reporting revolution and their successors have for some years now been expressing angst over the stagnant, banal nature of accounting research. As far back as 1991 a group of pre-eminent revolutionaries remarked on the lack of creativity in accounting research (Demski, et al. 1991). Judy Rayburn’s AAA presidency made central the issue of the lack of diversity in accounting research; she invited Anthony Hopwood (noted for Accounting from the Outside) to be her Presidential Speaker. Shyam Sunder made the theme of his presidency Imagining New Accountings and Greg Waymire pushed for Seeds of Innovation while proclaiming, “I believe our discipline is evolving towards irrelevance within the academy and the broader society with the ultimate result being intellectual irrelevance and eventually extinction” (Waymire, 2011, p. 3). But like the monkey with its fist inside the coconut shell, the leadership is incapable of relinquishing their ideological control over the nature of accounting as an intellectual discipline. Accounting research isn’t evolving toward irrelevance; it’s been irrelevant for quite some time. In spite of lip service to Imagining and Innovation, the management style of the AAA is to stifle Imagination and Innovation because that threatens the ideology and the associated reward structure that the financial reporting revolutionaries established nearly 50 years ago and from which they have so richly rewarded themselves. Virtually every North American doctoral program produces the same standardized education designed primarily to enable students to meet the standards of the so-called premier journals, which the revolutionaries also created. The accounting proclivity to standardize everything, even things we don’t understand well enough to standardize, has given us GASS (Generally Accepted Scientific Standards). I admit to being guilty of subsidizing through the dues I have paid this incoherent circumstance of needing more creativity in the academic process but allowing that process to be managed by an organization that has repeatedly demonstrated its inability to cede its autocratic instincts. I have been waiting for decades for our “I’m as mad as hell and I’m not going to take in anymore,” moment. It appears it will never come.
* The history of accounting academia post WWII with its fixation on price level effects and income theories, the creation of JAR and its positivist ideology, and the information metaphor itself stem from intellectual contempt for the premises of accountants in the field. With the exception of Ijiri, the academy abandoned a long time ago the discourses that informed practice because they were intellectually inferior to those of neoclassical economics.
** “Seminal” is apropos since all of the winners so far have been men.
Saturday, March 23, 2019
Sunday, March 17, 2019
Are Annual Audits still “Fit for Purpose?”
Editorial Note: We are delighted to present the following editorial column by Nick Shepherd, President of EduVision. Nick currently chairs the CPA Canada Committee for developing Statements in Management Accounting.
As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.
Annual reports together with various supplementary requirements and filings are important for boards, investors, rating agencies and others as a foundation to assess and determine the financial health of an organization. Historically this has worked reasonably well; up until the 1970’s most of the corporate value – an average of 80% – was reflected on the balance sheet. If the audit revealed the integrity of assets and liabilities, there was a reasonable expectation that the business was healthy.
Fast forward to today. Most corporate value for owners, investors and others is now intangible with only an average of 15% represented by financial assets. While certain intangibles can be capitalized and included on the balance sheet, the majority are nowhere to be seen, nor are they assessed or reported on through the audit. If an audit is designed to provide reasonable assurance of organizational health and integrity, doesn't basing this on the verification of only 15% of the value seem high risk?
There is continuing criticism of auditors and the profession for failing to alert investors and others to potential risk when organizations fail – yet how can the profession shoulder the blame when its scope and mandate are determined by compliance with standards that focus principally on tangible assets and liabilities? Apparent failures in oversight and governance approaches are not attributable to the profession alone, but the profession does have a responsibility to reflect on its own role and determine whether the principles that were initially established for audits are still meeting their goals. When significant “sea change” occurs, it requires re-invention rather than improvement. Is society changing the expectations and rules that make an audit relevant? Or are we “re-arranging the deck chairs on the Titanic?”
Customers of the audit profession are increasingly asking for additional information to enhance their risk assessments; this has resulted in regulatory changes as well as voluntary supplemental reporting. In certain jurisdictions, certain supplemental reporting – such as environmental and social issues – are now mandatory. A major thrust is being implemented by those adopting “integrated reporting,” but in most cases, this is not mandatory, audited or based on strongly established standards. A “sea change” it is not! The financial profession does not appear to be front and centre in driving fundamental change, apparently believing that its focus on financial capital remains adequate. Yes, changes are being made, but progress is much too slow; thus, the risk of “surprises” continues to increase.
The profession must start asking some fundamental questions in order to drive governance and accountability changes so that audits are fit for purpose. As a start, let’s consider the drivers of sustainable corporate value creation, and try to “peel back” corporate performance in the areas that might give investors an increased visibility into risk.
From a financial perspective, two sources of cash flow are critical to a sustainable business. First, for most organizations, more than 60% of expenditures are driven by employee costs; yet employee productivity and effectiveness are hard to measure, other than at the macro level. However, we do know that most employee costs are traditionally considered period expenses that convert inputs to outputs.
This is no longer the case, with large portions of employee expense related to building “capacity,” i.e. the contribution of intellectual capital that provides history and process capacity, as well as innovation in process improvement, new products and services, and relationship building with third parties. Only “motivated” employees will do this continually and effectively. To be a sustainable business in the future, the audit should reveal:
Overall, what users need to know is whether approaches to the workforce are protecting human capital sustainability through effective nurturing and development of people.
The second core cash flow is “cash flow in from customers.” Areas such as retention rates, repurchasing patterns, repeat customers and others are all important, but especially critical are relationships. One factor that could be more fully implemented into annual reporting is the stability of brand value.
The attached table shows 2018 data regarding the year end and most recent brand valuations by either Interbrand or Brand Finance (we used the higher valuation). This table demonstrates that, although the “pure audit” of financials provides insight into book values (i.e. balance sheet / shareholder equity), the shareholders value of their investment (i.e. the market value) is much greater.
Several key questions should be of interest to the investor. Using the traditional audit, is the integrity of the balance sheet acceptable? Is the brand value, as calculated by independent third parties, increasing or decreasing? If so, why? And what is the impact on this for the future? For instance, was a potential “auditable” cause the diversion of human capital resources away from customer support activities to enhance financial capital results? Finally, what makes up the ‘other intangible assets’ that contribute a key part of an investment valuation, but that are not being assessed or audited?”
One key failure of the accounting profession is to grasp and modernize the assessment of goodwill. On a sale or purchase of a business entity, it is the “market value-based intangibles” that end up on the acquirer’s balance sheet that must be assessed for “impairment.” How can an auditor do this effectively if the drivers of this value have not been clearly determined?
As can be seen from the table, book values range from 5.9% of value to 24.4%, and it is these underlying valuations of “financial capital” that a traditional audit discloses. If these are examples of the impact on financial capital of the growing knowledge economy, then one can only conclude that audits that remain focused on financial capital alone are not “fit for purpose.”
As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.
Annual reports together with various supplementary requirements and filings are important for boards, investors, rating agencies and others as a foundation to assess and determine the financial health of an organization. Historically this has worked reasonably well; up until the 1970’s most of the corporate value – an average of 80% – was reflected on the balance sheet. If the audit revealed the integrity of assets and liabilities, there was a reasonable expectation that the business was healthy.
Fast forward to today. Most corporate value for owners, investors and others is now intangible with only an average of 15% represented by financial assets. While certain intangibles can be capitalized and included on the balance sheet, the majority are nowhere to be seen, nor are they assessed or reported on through the audit. If an audit is designed to provide reasonable assurance of organizational health and integrity, doesn't basing this on the verification of only 15% of the value seem high risk?
There is continuing criticism of auditors and the profession for failing to alert investors and others to potential risk when organizations fail – yet how can the profession shoulder the blame when its scope and mandate are determined by compliance with standards that focus principally on tangible assets and liabilities? Apparent failures in oversight and governance approaches are not attributable to the profession alone, but the profession does have a responsibility to reflect on its own role and determine whether the principles that were initially established for audits are still meeting their goals. When significant “sea change” occurs, it requires re-invention rather than improvement. Is society changing the expectations and rules that make an audit relevant? Or are we “re-arranging the deck chairs on the Titanic?”
Customers of the audit profession are increasingly asking for additional information to enhance their risk assessments; this has resulted in regulatory changes as well as voluntary supplemental reporting. In certain jurisdictions, certain supplemental reporting – such as environmental and social issues – are now mandatory. A major thrust is being implemented by those adopting “integrated reporting,” but in most cases, this is not mandatory, audited or based on strongly established standards. A “sea change” it is not! The financial profession does not appear to be front and centre in driving fundamental change, apparently believing that its focus on financial capital remains adequate. Yes, changes are being made, but progress is much too slow; thus, the risk of “surprises” continues to increase.
The profession must start asking some fundamental questions in order to drive governance and accountability changes so that audits are fit for purpose. As a start, let’s consider the drivers of sustainable corporate value creation, and try to “peel back” corporate performance in the areas that might give investors an increased visibility into risk.
From a financial perspective, two sources of cash flow are critical to a sustainable business. First, for most organizations, more than 60% of expenditures are driven by employee costs; yet employee productivity and effectiveness are hard to measure, other than at the macro level. However, we do know that most employee costs are traditionally considered period expenses that convert inputs to outputs.
This is no longer the case, with large portions of employee expense related to building “capacity,” i.e. the contribution of intellectual capital that provides history and process capacity, as well as innovation in process improvement, new products and services, and relationship building with third parties. Only “motivated” employees will do this continually and effectively. To be a sustainable business in the future, the audit should reveal:
- The overall level of expense committed to employee costs, with a split showing (hopefully) a declining share going into repetitive conversion costs, and a growing share committed to building “intangibles for the future.” Key indicators might also include “strategic reassignments” that give perspectives on whether management is committed to redeploying staff as a result of change versus firing them (which does not create motivation).
- Levels of employee engagement at a depth of detail that is more than just a general percentage. What is needed is visibility into alignments of individuals, teams and departments with organizational purpose, both in “task” (the work of the business) and also critically in behavior (the stated conduct of the business that is driven by its culture and its understanding of ethical compliance).
- Leadership effectiveness. Disengagement comes from a gap between what organizations state they do, versus what employees see from leaders. The effective development of internal leadership, accompanied by the results of 360° assessments based on corporate values, would start to identify areas of concern if they exist. It might have been interesting to see what indicators of this type would have shown for some of the banks involved in recent scandals.
- Focus on “behavioral based” internal controls. Process controls are no longer adequate in an environment where high levels of delegation take place, leading to individual autonomy (this also applies to controls and relationships with third parties. such as outsourcing providers). Stronger reporting is needed on ethical hiring, leadership values and behavior, whistle blowing, levels of employee stress, illness (especially mentally related issues), and other behavioral aspects.
Overall, what users need to know is whether approaches to the workforce are protecting human capital sustainability through effective nurturing and development of people.
The second core cash flow is “cash flow in from customers.” Areas such as retention rates, repurchasing patterns, repeat customers and others are all important, but especially critical are relationships. One factor that could be more fully implemented into annual reporting is the stability of brand value.
The attached table shows 2018 data regarding the year end and most recent brand valuations by either Interbrand or Brand Finance (we used the higher valuation). This table demonstrates that, although the “pure audit” of financials provides insight into book values (i.e. balance sheet / shareholder equity), the shareholders value of their investment (i.e. the market value) is much greater.
Several key questions should be of interest to the investor. Using the traditional audit, is the integrity of the balance sheet acceptable? Is the brand value, as calculated by independent third parties, increasing or decreasing? If so, why? And what is the impact on this for the future? For instance, was a potential “auditable” cause the diversion of human capital resources away from customer support activities to enhance financial capital results? Finally, what makes up the ‘other intangible assets’ that contribute a key part of an investment valuation, but that are not being assessed or audited?”
One key failure of the accounting profession is to grasp and modernize the assessment of goodwill. On a sale or purchase of a business entity, it is the “market value-based intangibles” that end up on the acquirer’s balance sheet that must be assessed for “impairment.” How can an auditor do this effectively if the drivers of this value have not been clearly determined?
As can be seen from the table, book values range from 5.9% of value to 24.4%, and it is these underlying valuations of “financial capital” that a traditional audit discloses. If these are examples of the impact on financial capital of the growing knowledge economy, then one can only conclude that audits that remain focused on financial capital alone are not “fit for purpose.”
Wednesday, March 13, 2019
Reimagining a More Ethical and Sustainable Management AccountingCurriculum
Editorial Note: We are delighted to present the following editorial column by Richard Kravitz, the Editor In Chief of the CPA Journal. As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.
Furthermore, the opinions expressed below do not reflect the position of the CPA Journal, The New York State Society of CPAs, or the Board of Directors or Executives of the New York State Society of CPAs.
The accounting curriculum, while relevant 40 years ago, has lost much of its relevance today in our post-modern global economy. Accounting education fails to account for the real drivers of enterprise growth in the digital economy. This article focuses on the components of value creation within publicly traded multinational corporations. It also addresses how these valued components are all but ignored in the accounting classroom, in AACSB’s model curriculum for accounting education, and by the majority of our accounting professoriate.
Accounting is a practical discipline. It focuses on the application of skills and knowledge that enable practitioners to identify, measure, monitor, control and report on business activities. However, the real drivers of long term value creation within the modern global corporation are no longer measured by these traditional accounting tools. Financial accounting, cost accounting, and managerial accounting methodologies provide little guidance on how to accurately report on the condition and value of global business. Accounting information teaches us very little about great companies whose great products and services drive our postmodern global economy.
Similarly, accounting information ignores the dominant creators of long term sustainable value, i.e. the growth drivers of modern enterprise. Accounting rules even expense many of the value creators, such as reputational capital [brand marketing], intellectual capital [patents, trademarks, business method processes], human capital [talented workforce], social and relationship capital [infrastructure, health, education and safety], and others.
Accounting also does not account for the impact that global corporations have on society. For the past 20 years, organizations such as Ceres, the GRI, the IIRC, the UN Global Compact and others have been looking at this issue. Mervyn King, founder of the IIRC, for example, focuses on the evolution of the corporation from share value to shared values, and from a shareholder centric to a stakeholder centric perspective.
Nevertheless, the average time a shareholder in America owns a US public company, according to Prem Sika in the The Myth of Shareholder Ownership, is 22 seconds. Even Larry Fink, the consummate Milton Friedman capitalist who heads Black Rock, now suggests a new approach to corporate earnings: “Profits With Purpose.” But accounting does not measure purpose.
Finally, the lack of relevance of accounting information was amplified by luminary NYU professor Baruch Lev in his seminal work, The End of Accounting. According to Lev, “financial information contributes only 4-5% of decision relevant information for investors.” What a loss for accounting relevance.
The Critical Role of Accountants in our Post Modern Global Economy
While our training may be suspect, the role of accountants in society is not. Accountants are even more critically important in today’s global society; they are arguably more important than ever. Indeed, accounting remains a critically important gatekeeping profession.
The obligation of accountants, as its founders passionately argued, lies in their ethical responsibility to protect the public, and to insure public trust. Accountants are the historical stewards and fiduciaries of the public interest. Indeed, accountants protect the public from corporate mischief. They help insure honesty and trust in our institutions. And they report on companies that are too good to fail, too strong to fail, and yes, even too big to fail.
Accounting in a Global Environment – What has changed?
This is not our parent’s world from a global corporate perspective. It is not the world that existed even 40 years ago:
• 52 of the largest economies of the world today are multinational corporations, not sovereign nations.
• The top 2000 companies generate more than 50% of the global GDP.
• The market cap of Apple, at almost one trillion dollars, even after decline, is larger than the GDP of all of the European Union Countries except for two.
• The market cap to book value of the top 5 global corporations is between seventy five to a hundred to one. US Steel, the consummate brick and mortar corporation, on the other hand, still boasts a ratio of market cap to book value of about one to one.
• Walmart employs 2.7 million people, half the population of New Zealand.
• Google uses more electricity than the country of Sweden.
• 85% of the federal government expenditures of the United States are made to corporations, including transportation, defense, and nuclear power firms, as well as various other organizations that now perform tasks that government once performed.
• Today, corporations impact societies and stakeholders to a greater extent than at any time in history.
The Exponential Growth of Intangibles
So why is there such a huge divide between traditional accounting measurements, and between book value and market caps? What has happened during the past 40 years is revolutionary. According to the authors of Capitalism without Capital, the intangible revolution has impacted society far more than the industrial revolution of a few hundred years earlier.
87% of the value of today’s postmodern global corporation [per Ocean Tomo] lies hidden in its intangibles. These hidden assets or strategic resources do not appear on the balance sheet, income statement, cash flow statement or in retained earnings. They do not appear in inventory, goodwill, or tangible long term assets. They do not appear in the pages of accounting texts.
Strategic resources [such as intangible or hidden assets] power society today. Strategic capital drives long term value creation in our postmodern global corporation. Cost accounting texts ignore them, but they are familiar to all of us. These hidden intangibles include knowledge, data, information and ideas. They are the conceptual assets and creators of corporate value today. In fact, the investment in intangibles at 2-3 trillion dollars a year is now the dominant creator of corporate value. Intangibles include intellectual property, patents, trademarks, brands, brand identify, a skilled and talented workforce, business method patents, business processes, and supply chain sourcing.
Financial accountants and auditors hide conceptual assets from the public. They are expensed or hidden from the balance sheet. Conceptual assets are buried in SG&A or Cost of Sales, with the exception of those conceptual assets which are acquired or booked on the balance sheet for financial statement disclosure purposes. This is not deliberate; it occurs because accountants have not been trained to recognize intangibles.
Realigning Accounting Education
Accounting students invest 4 to 5 years of their lives in accounting schools. They hone their skills on traditional financial and managerial accounting techniques while ignoring 87% of the value of the global corporate enterprise. What a loss for accounting’s relevance. What a huge hole, then, that exists in the education curriculum. In future blog posts, I will suggest a realignment of accounting education.
Furthermore, the opinions expressed below do not reflect the position of the CPA Journal, The New York State Society of CPAs, or the Board of Directors or Executives of the New York State Society of CPAs.
The accounting curriculum, while relevant 40 years ago, has lost much of its relevance today in our post-modern global economy. Accounting education fails to account for the real drivers of enterprise growth in the digital economy. This article focuses on the components of value creation within publicly traded multinational corporations. It also addresses how these valued components are all but ignored in the accounting classroom, in AACSB’s model curriculum for accounting education, and by the majority of our accounting professoriate.
Accounting is a practical discipline. It focuses on the application of skills and knowledge that enable practitioners to identify, measure, monitor, control and report on business activities. However, the real drivers of long term value creation within the modern global corporation are no longer measured by these traditional accounting tools. Financial accounting, cost accounting, and managerial accounting methodologies provide little guidance on how to accurately report on the condition and value of global business. Accounting information teaches us very little about great companies whose great products and services drive our postmodern global economy.
Similarly, accounting information ignores the dominant creators of long term sustainable value, i.e. the growth drivers of modern enterprise. Accounting rules even expense many of the value creators, such as reputational capital [brand marketing], intellectual capital [patents, trademarks, business method processes], human capital [talented workforce], social and relationship capital [infrastructure, health, education and safety], and others.
Accounting also does not account for the impact that global corporations have on society. For the past 20 years, organizations such as Ceres, the GRI, the IIRC, the UN Global Compact and others have been looking at this issue. Mervyn King, founder of the IIRC, for example, focuses on the evolution of the corporation from share value to shared values, and from a shareholder centric to a stakeholder centric perspective.
Nevertheless, the average time a shareholder in America owns a US public company, according to Prem Sika in the The Myth of Shareholder Ownership, is 22 seconds. Even Larry Fink, the consummate Milton Friedman capitalist who heads Black Rock, now suggests a new approach to corporate earnings: “Profits With Purpose.” But accounting does not measure purpose.
Finally, the lack of relevance of accounting information was amplified by luminary NYU professor Baruch Lev in his seminal work, The End of Accounting. According to Lev, “financial information contributes only 4-5% of decision relevant information for investors.” What a loss for accounting relevance.
The Critical Role of Accountants in our Post Modern Global Economy
While our training may be suspect, the role of accountants in society is not. Accountants are even more critically important in today’s global society; they are arguably more important than ever. Indeed, accounting remains a critically important gatekeeping profession.
The obligation of accountants, as its founders passionately argued, lies in their ethical responsibility to protect the public, and to insure public trust. Accountants are the historical stewards and fiduciaries of the public interest. Indeed, accountants protect the public from corporate mischief. They help insure honesty and trust in our institutions. And they report on companies that are too good to fail, too strong to fail, and yes, even too big to fail.
Accounting in a Global Environment – What has changed?
This is not our parent’s world from a global corporate perspective. It is not the world that existed even 40 years ago:
• 52 of the largest economies of the world today are multinational corporations, not sovereign nations.
• The top 2000 companies generate more than 50% of the global GDP.
• The market cap of Apple, at almost one trillion dollars, even after decline, is larger than the GDP of all of the European Union Countries except for two.
• The market cap to book value of the top 5 global corporations is between seventy five to a hundred to one. US Steel, the consummate brick and mortar corporation, on the other hand, still boasts a ratio of market cap to book value of about one to one.
• Walmart employs 2.7 million people, half the population of New Zealand.
• Google uses more electricity than the country of Sweden.
• 85% of the federal government expenditures of the United States are made to corporations, including transportation, defense, and nuclear power firms, as well as various other organizations that now perform tasks that government once performed.
• Today, corporations impact societies and stakeholders to a greater extent than at any time in history.
The Exponential Growth of Intangibles
So why is there such a huge divide between traditional accounting measurements, and between book value and market caps? What has happened during the past 40 years is revolutionary. According to the authors of Capitalism without Capital, the intangible revolution has impacted society far more than the industrial revolution of a few hundred years earlier.
87% of the value of today’s postmodern global corporation [per Ocean Tomo] lies hidden in its intangibles. These hidden assets or strategic resources do not appear on the balance sheet, income statement, cash flow statement or in retained earnings. They do not appear in inventory, goodwill, or tangible long term assets. They do not appear in the pages of accounting texts.
Strategic resources [such as intangible or hidden assets] power society today. Strategic capital drives long term value creation in our postmodern global corporation. Cost accounting texts ignore them, but they are familiar to all of us. These hidden intangibles include knowledge, data, information and ideas. They are the conceptual assets and creators of corporate value today. In fact, the investment in intangibles at 2-3 trillion dollars a year is now the dominant creator of corporate value. Intangibles include intellectual property, patents, trademarks, brands, brand identify, a skilled and talented workforce, business method patents, business processes, and supply chain sourcing.
Financial accountants and auditors hide conceptual assets from the public. They are expensed or hidden from the balance sheet. Conceptual assets are buried in SG&A or Cost of Sales, with the exception of those conceptual assets which are acquired or booked on the balance sheet for financial statement disclosure purposes. This is not deliberate; it occurs because accountants have not been trained to recognize intangibles.
Realigning Accounting Education
Accounting students invest 4 to 5 years of their lives in accounting schools. They hone their skills on traditional financial and managerial accounting techniques while ignoring 87% of the value of the global corporate enterprise. What a loss for accounting’s relevance. What a huge hole, then, that exists in the education curriculum. In future blog posts, I will suggest a realignment of accounting education.