Accounting in Crisis?

Financial Reporting at a
Crossroads
 Laws of Accounting

Trial Balances dont

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

Thequality 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

Whilethe 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

Financialreporting 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

Financialreporting 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
First-Order Feedback
Feedback System
System
Boundary Environment

Inputs Process Outputs

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.
Its not exactly what anybody needs
ITS 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.
Accountingis 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
Universitys Stern School of Business is
increasingly irrelevant.
 New Math for a New Economy

Theproblem, 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, theyre part of the old, old
economy.
 New Math for a New Economy

Ifyou 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

Isit 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
Canwe 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?
Noone 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
Timelyand thorough investigations of
circumstances that may involve
fraudulent financial reporting.
Objectiveand fair assessments of the
role and performance of auditors.
Timelyand meaningful discipline of
auditors and firms that violate
acceptable norms of conduct.
 Regulatory Processes
Regularoversight 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 . . .

Intangible
Assets

Tangible

Industrial Information
era era

Robert K. Elliott
Accounting in the 21st Century
 Intangible Assets

Assetsassociated with product

innovation (R&D)
Assets associated with a companys
brand
Structuralassets 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
Centralto 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 firms market valuation, but
traditional assessment methods
understate its value.
 New Technologies
Information capture technology
Access and monitoring technology
Storage

Telecommunications and inter-

networking
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
Chairmay 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.
Accountingfirms that audit public
companies must register with the Board
and pay registration and annual fees.
 PCAOB Standard Setting

TheBoard 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.
TheBoard 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

Auditcommittees must approve all
services
Auditormust report new information to
audit committee
Offeringspecified 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