Transcript Accounting in Crisis? - University of Alaska

Accounting in Crisis?
Financial Reporting at a
Crossroads
Laws of Accounting

Trial Balances don’t

Bank reconciliations never do

Working capital does not

Return on investments never will
The “New” Pledge of Allegiance

One nation, under greed, with stock
options and tax shelters for all.
Consider Five
Quotations
Quotation #1

Transparent accounting plays an
important role in maintaining the vibrancy
of our financial markets.

Alan Greenspan
Chairman, Board of Governors of
The Federal Reserve Board
Quotation #2

The single most important innovation
shaping the (American capital) market
was the idea of generally accepted
accounting principles. We need
something similar internationally.

Lawrence H. Summers
Former Deputy Secretary of the Treasury
March 9, 1998 Remarks before the IMF
Quotation #3

The quality of information we now
receive from companies in the U.S. is
about the best we have ever seen and
exceeds that of almost any other nation.

Abby Joseph Cohen
Chair, Investment Policy Committee Goldman,
Sachs & Co.
Quotation #4

We are in a situation now in our society
where the temptations to provide “bad”
financial reporting are probably greater
than they used to be. The need to get
the stock price up, or to keep it up, is
intense.

Floyd Norris, Reporter
2001 Annual Report of the Financial
Accounting Foundation
Quotation #5

While the U.S. accounting is generally
recognized as the best in the world, the
Enron collapse that unfolded in 2001 has
reminded us all that there is still room for
improvement.

Manuel H. Johnson, FAF Chairman
2001 Annual Report
of the Financial Accounting Foundation
What is the “purpose”
of Accounting?
Objective #1

Financial reporting should provide
information that is useful to present and
potential investors and creditors and
other users in making rational
investment, credit, and similar decisions.
Objective 1 continued

The information should be
comprehensible to those who have a
reasonable understanding of business
and economic activities and are willing to
study the information with reasonable
diligence.
Objective #2

Financial reporting should provide
information to help present and potential
investors and creditors and other users
in assessing the amounts, timing, and
uncertainty of prospective cash flows.
Objective #3

Financial reporting should provide
information about the economic
resources of an enterprise, the claims to
those resources (obligations of the
enterprise to transfer resources to other
entities and owners’ equity), and
Objective #3 continued

The effects of transactions, events, and
circumstances that change its resources
and claims to those resources.
First-Order Feedback System
Boundary
Environment
Inputs
Outputs
Process
Feedback Loop
Control
Sensor
General Purpose Financial
Statements

GPFS means that Information is . . .

Not exactly what the investors need,

Not exactly what the creditors need,

Not exactly what the managers need,

Not exactly what the regulators need,

Not exactly what the tax man needs.

It’s not exactly what anybody needs

IT’S A COMPROMISE!!!
New Math for a New
Economy
Allan Webber
FastCompany,
Issue 31, p. 214 January/February 2000
New Math for a New Economy

Accounting is all about accuracy.

Accounting is all about hard numbers.

Accounting is all about accountability.

Accounting is a time-honored tool for
making hard decisions about dollars and
cents, about profits and losses.
New Math for a New Economy

Accounting is the land of bean counters,
of number crunchers – men and women
with green eyeshades and calculators.

Accounting says Baruch Lev, Professor
of Accounting and Business at New York
University’s Stern School of Business is
increasingly irrelevant.
New Math for a New Economy

The problem, says Lev, is that the
systems of accounting and financial
reporting that are being used today date
back more than 500 years.

These systems are not only part of the
old economy, they’re part of the old, old
economy.
New Math for a New Economy

“If you cannot be a good accountant,”
Pacioli wrote, “you will grope your way
forward like a blind man and may meet
great losses.”
The Evolution of the
Knowledge Professional
Robert K. Elliott and
Peter D. Jacobson
Accounting Horizons, March 2002
Introduction

Wealth creation depends on knowledge
work as never before, a change full of
implications for those who provide
information services.

We argue that a new economic model
has created a need for a new type of
information professional.
Four Economic Paradigms

Hunting and Gathering

Agriculture

Industry

The Information Economy
Questions

Is it possible that the role of the new
information professional will never be
fully defined? Since technology is now
advancing at such a rapid rate, could the
role of the new information technology
professional be a moving target?
Questions

Is it possible for a profession to
consciously “reinvent” itself?

Is the accounting profession attempting
to “reinvent” itself, or what?
Questions

The author argues that the accounting
profession should take the initiative to
expand its role in the information
economy and serve as the foundation of
the new information professional. Are
there other professional disciplines that
might serve as well or better as a
foundation for the new information
professional?
Financial Reporting at a
Crossroads
Michael H. Sutton
Accounting Horizons
December 2002
Challenging Questions

Can we believe in and rely on the
independent audit?

Can we believe that our accounting and
disclosure standards provide the
transparency that is essential to
investors and the public?
Challenging Questions

Can we rely on self-regulatory systems
to ensure audit quality and to root out
and discipline substandard
performance?

No one wants Congressional Required
Accounting Principles (CRAP makes a
pretty lousy acronym!)
Challenging Questions

Can we rely on corporate governance
processes – oversight by boards of
directors and audit committees – to ride
herd on management and to see to it
that auditors do their job?
Some Recommended
Changes
Regulatory Processes

Timely and thorough investigations of
circumstances that may involve
fraudulent financial reporting.

Objective and fair assessments of the
role and performance of auditors.

Timely and meaningful discipline of
auditors and firms that violate acceptable
norms of conduct.
Regulatory Processes

Regular oversight and periodic
examinations of the policies and
performance of independent auditors.

Timely and responsive changes in
professional standards and guidance
when a need for improvements is
identified.
So . . . What is “wrong”
with Accounting?
Fundamental Problems

“Transaction” oriented

Narrow focus on financial data

Reporting is periodic and not real-time

Limited accessibility of information

Too high a level of aggregation
Fundamental Problems

Limited flexibility which prevents
answering queries that cross functional
boundaries.
THE Fundamental
Accounting Problem?
THE Fundamental Problem

We are using a 500-year-old system to
make decisions in a complex business
environment in which the essential
assets that create value have
fundamentally changed.

Baruch Lev Professor of Accounting
NYU Stern School of Business
New Math for a New Economy
www.fastcompany.com
Shifts in Assets . . .
Assets
Intangible
Tangible
Industrial
era
Information
era

Robert K. Elliott
Accounting in the 21st Century
Intangible Assets

Assets associated with product
innovation (R&D)

Assets associated with a company’s
brand

Structural assets – better, smarter,
different ways of doing business.

Monopolies (barriers to entry).

Baruch Lev
New Math for a New Economy
Intangible Assets

Expensive to acquire and to develop.

Extremely difficult to manage

Property rights are fuzzy

Baruch Lev
New Math for a New Economy
Matching Principle Violation?

Accounting is based on the matching
principle.

Good matching = good income number.

Knowledge assets = mismatch.
What does all of this
have to do with AIS?
Subtitle: Are you trying to impress
me? Or, are you trying to scare
me?
Accounting in 2015
Michael Alles, Alexander Kogan
and Miklos A. Vassarhelyi
The CPA Journal, November 2000
Relevance of Accounting

Central to the future of accounting is the
continuing relevance of accounting
measurement for corporate management
and firm valuation.
Relevance of Accounting

The balance sheet and income
statement are ceasing to function as
relevant measures of a business as
underlying processes undergo profound
change . . .
Profound Changes . . .

Many companies only own research and
development (R&D) and outsource
distribution and manufacturing.

Physical possession of inventory
becomes meaningless where supply
chain management is key.
Profound Changes . . .

Businesses have adopted unorthodox
ownership structures emphasizing
alliance, tracking stocks, profit sharing
agreements, and opportunistic joint
ventures.
Profound Changes . . .

Intellectual property is a primary source
of a firm’s market valuation, but
traditional assessment methods
understate its value.
New Technologies

Information capture technology

Access and monitoring technology

Storage

Telecommunications and internetworking

Pervasive computing
New Technologies

XML standards

Automatic workpapers

System monitoring architecture

Automatic inventory tracking
The Sarbanes-Oxley
Act of 2002
Public Companies Accounting
Reform and Investor Protection Act
of 2002
Sarbanes-Oxley Act of 2002

Directly impact these groups:

CPAs and CPA firms auditing public
companies.

Publicly traded companies, their employees,
officers, and owners. (Includes CPAs
employed by publicly traded companies as
CFOs or in their finance department)
Sarbanes-Oxley Act of 2002

Directly impact these groups:

Attorneys who work for or have as clients
publicly traded companies; and

Brokers, dealers, investment bankers and
financial analysts who work for these
companies.
PCAOB

Establishes a new Public Company
Accounting Oversight Board (PCAOB).

Board composition

Two must be or must have been CPAs

Three must not be and cannot have been
CPAs
PCAOB

Board composition – continued

Chair may be CPA, but must not have
practiced accounting during the five years
preceding appointment.

Appointed by the SEC.

Subject to SEC oversight
PCAOB - Funding

The Board will be funded by public
companies through mandatory fees.

Accounting firms that audit public
companies must register with the Board
and pay registration and annual fees.
PCAOB – Standard Setting

The Board will issue standards or adopt
standards set by other groups or
organizations, for audit firm quality
controls for the audits of public
companies.
PCAOB – Standard Setting

These standards include: auditing and
related attestation, quality control, ethics,
independence and “other standards
necessary to protect the public interest.”

The Board has the authority to set and
enforce audit and quality control
standards for public company audits.
PCAOB – Other Powers

Investigative and Disciplinary authority

International authority
The Sarbanes-Oxley
Act of 2002
New Roles for Audit Committees
and Auditors
Audit Committees & Auditors

Auditors report to audit committee

Audit committees must approve all
services

Auditor must report new information to
audit committee

Offering specified non-audit services
prohibited
Audit Committees & Auditors

Audit partner rotation

Employment implications.
The Sarbanes-Oxley
Act of 2002
Criminal penalties and protection
for whistleblowers.
Criminal penalties

Failure to maintain workpapers

Document destruction

Securities fraud

Fraud discovery

Protection for whistleblowers