The End of Accounting and the Result of this End

With the election of firearm-friendly US president, the stocks of gunmakers plunged to a new low as a victory of his rival might have created last-minute sales of firearms. In the case of Germany, the decision of the Chancellor to not to bail it out, the shares of a German Bank also get slumped.

In both cases, any new information resulted in a sudden and significant change in the value of the company. And in both companies, the financial accounts would have been of no use, whatsoever.

The book, The End of Accounting, starts on the premise that the numbers published by the companies every quarterly, half-yearly and annually, are no longer fulfills the task. The balance sheets haven’t changed since past two centuries.

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Statements of Profit and Loss were duly conceived back, even before World War II. These statements are suited to the businesses that manufacture goods and those investors that don’t measure the trades in the moments. This result in a huge stock of papers or online text pages which no longer determine any company’s valuation.

The important statements made by Professor Baruch Lev and Feng Gu are quite hard to dispute. These authors started comparing accounts of U.S. Steel from 1902 and from 2012. Ignoring the obvious differences such as photos of employees to many sections on risk factors, the basic financial contents were same.

The most striking statistic of the book is that the things published in financial reports makes only five percent of information most of the investors use to make a different decision related to stock-trading.

The odd treatment of intangible assets is one of the accounting fails that has been singled out in the book. In case of buying a brand, it is mentioned in the balance sheet at its purchase price. In case it is built from scratch then it won’t appear to have any value, at all. This distortions increases as intangibles turns out to be quite important. The companies have made investment in hard to value assets by over 60 % in the last four decades whereas cutting the investment in intangible thing by one-third.

Old school accounting has been stretched to breaking point by the internet. Lev and Gu utilizes the Netflix as an instance. In the earnings call which is held by the online broadcaster, the analysts asks different question which has no link with the numbers published by the company. Most of the online businesses have duly taken these matters into their own hands. Data points are no longer included in Generally Accepted Accounting Principles which make up most of the interesting stuff in the report from Facebook, Twitter and other companies like them. The value of goods shifted on Alibaba’s sites remains to be the much-needed numbers for this biggest online retailer from China.

With the advent of emerging markets, the usefulness of financial accounting has met a deadly blow. The most important asset at most of the Chinese companies is the chop, which is a stamp which is used to sign important papers, but it doesn’t appear on the balance sheet. If they lose it, the investors lose their control on the company.

According to authors like Thomas Johnson and Robert Kaplan back in the 1980s, the managers were generally relying on the wrong set of data to make any sort of decision. But the book by Lev and Gu certainly suggests few of the bold new fixes. The most important of them is the “strategic resources and consequences Report” which is a one-page collection of different facts and description which are based on the information required by the investors, from the state of brands along with patents to strategic changes that will certainly help to see into the future along with the past. Another suggestion was to ditch the quarterly reporting of different financial metrics, and it rather puts focus on quality instead of the frequency.

The most important changes would be the simplest one. The Economic profit which is the amount of profit left after the cost of capital covered by a company still doesn’t find its place in company accounts. The result of this is that investors end up to rely on wrong stuff. According to Lev and Gu, the economic profit inclusion in their one-page rundown of things that would matter to shareholders.