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Date: 2024-06-25 Page is: DBtxt001.php txt00015899

Voices: Will accountants become the weavers of the 21st century?

Original article:
Peter Burgess COMMENTARY
Accountancy is very powerful. I 'completed' my formal education with the training to become a Chartered Accountant in London. This was in the 1960s and I was in my 20s, and it was pretty obvious to me that accountancy was the profession that had the best foundation for the analysis and management of all the things that really mattered.

I was not disappointed. Early in my career, I was given assignment after assignment that stretched me to the limit. When I was a young trainee accountant (articled clerk) wirh Cooper Brothers & Co in London my assignments stretched my understanding of how a business actually worked and how public investments could change the course of history.

Several decades later I had a modest role in the negotiations that took place to try to achieve 'reciprocity' between 'Chartered Accountants' from the various governing bodies around the world and 'Certified Public Accountants' in the United States. Reciprocity was not achieved in large part because of fundamental differences in the understanding of the relationship between a 'reality' and a 'legal construct'. America has a preferenace for a 'legal construct' over a 'reality' which explains ... in my view ... a lot of what does not work well in the USA but facilitates the 'gaming' of the system for the benefit of the powerful.

In the early 1980s the United States came out of the economic difficulties of the 1970s by embracing what I think of as a 'Reagan' doctine. Reagan put the growth of corporate profits ahead of most everything and enabled government policy and corporate behavior to achieve this goal. Corporate organizations relocated 'en masse' from the Unionized Mid-West to the South of the country where 'right to work rules' were in place and wages a fraction of the Union wages of the Mid-West. After this, there was migration of major businessess out of the United States, with the center of gravity of corporate production moving out of the United States to low wage countries mainly in Asia, and especially China.

A version of this continues to the present time. I have referred to this as the 'financialization' of the modern Western World with the United States and the United Kingdon in the lead. This has worked well for 'investors' and 'owners' but for everyone else it has been problematic. The last 40 years has seen record growth in almost every dimension of inequality at the same time that 'oligarchs' in their various manifestations have achieved amazing wealth.

Since Reagan, there has been a massive downward shift in quality of life for 'working class' people in America. While the economic 'totals' and the economic 'averages' have improved over the past four decades, the 'shape' of the data has changed. The 'top' has done very well over this time period, but everyone else has lost ground. In the early 1980s half the population had above average income and wealth and half had less than the average ... a normal distribution. By the end of the 2010s, some 40 years later only 20% of the population had above average wealth and income while some 80% had below average wealth and income. In other words, inequality has become the dominant feature of the modern economy.

There are many reasons for this, not least of which is something that I refer to as 'financialization' of the modern economy. That is ... if it makes a 'profit' it must be good.

In the years since Reagan there has been a massive decline in US manufacturing employment. Almost everything is now manufactured in 'low wage' countries. Corporate profits have grown but at the expense of American society. There has been a huge investment by the corporate sector in 'globalization' but rather little investment by the American public sector in either infrastructure or public services and the results have not been good.

A majority of Americans are dissatisfied with the way their lives have been going and this is reflected in fractious politics. In my view, President Biden has made good progress in passing legislation that will improve the lives of ordinary people over the objection of right wing operatives who have enabled failed Reaganomics for about four decades.

At the present time, it is possible for massive amounts of information to flow 'at the speed of light'. This is a problem. Unless this information flow is 'factual' then it can do more harm than good and can be 'weaponized' for all sorts of bad reasons. The 'media' is meant to be a safeguard in the American system, but this role as safeguard cannot be functional unless those that work in the media are experienced enough to know what is going on ... and that is by no means universal at this point in history. In the modern media it is not so much a dialog between 'left' and 'right' but more promotopn from the 'top' against the 'rest of us'!
Peter Burgess
Voices: Will accountants become the weavers of the 21st century?

Written by Jon Lukomnik

Published ... November 19 2018, 9:00am EST

I am an investor, not an accountant. But sometimes the view from the outside is useful. And from where I stand, accountants are facing a slow-moving existential crisis.

A profession, any profession, needs two things to thrive. First, it needs to be relevant, that is, to fulfill a needed purpose for society. Second, it needs professionalism and competence.

So, in the case of accounting and auditing, the profession needs to be reporting and assuring relevant information. I’ll define that as information that the users find valuable in making investment decisions. It needs to be professional in doing that, meaning accountants need to be educated, independent, ethical.

Though there are exceptions, the profession generally gets professionalism right. So why do I say the profession is facing a slow-moving existential crisis that, left unchecked, will reduce accounting and auditing to a fragment of its current import?

Today's drivers of value are largely intangible assets, such as data, intellectual property, branding, code, and business model. These are notoriously difficult to discern from traditional accounts. That is understandable; our accounting system was created when capital -- in the form of tangible assets -- was king. But understandable doesn’t mean acceptable. Make no mistake, it is not acceptable anymore. Consider these statistics:

Intangible assets now make up 84 percent of the market value of the S&P 500. That’s up from just 17 percent in 1975. We investors clearly value things like investment in brands, new business processes, skills development for employees, R&D, etc., as drivers of future value. In other words, we believe these investments will create revenues in the future. But accounting can’t figure out how to value those non-tangible assets, so it treats those investments as expenses. That just doesn’t make sense.

Here is a specific example: As of when I wrote this, Amazon was trading at a price/earnings ratio of 149 and a price to book of more than 26. This is a company with an enterprise value of $940 billion and is followed by 44 sell-side analysts and thousands of buy-side ones. Clearly, either we investors have collectively lost our minds, or book and earnings are understated in economic terms.

What makes that understatement so important is that services now are more than 80 percent of the US economy and growing.

A Google search for “same store sales” yields 359 million hits. Search for “EBITDA” and you’ll return 16 million citations. Neither of those measures, one a key performance indicator and one a non-GAAP metric, are defined by the Financial Accounting Standards Board. Yet they drive investment decisions. Unfortunately, the profession seems to prefer going deeper into the rabbit hole of fine-tuning financial-statement accounting standards – seven years for revenue recognition and now who knows how many years for lease accounting – rather than poking their heads out from the burrow and saying: Investors are using these types of non-GAAP metrics and KPIs, wouldn’t it be nice if they were actually defined? And then we could account for and assure against those definition? (Now that is a relevant business opportunity.)

We have a culture clash. Capital markets are, by nature, innovation machines. And the real economy is dominated by disruptive technologies and new entrants. The average lifespan of an S&P 500 company was 33 years in 1965. It was down to 24 years in 2016. The pace of innovation continues, so that the lifespan is projected to be down to just 12 years a decade from now. By contrast, accountants and auditors are, and should be, conservative by nature -- not in the political sense, but in the “holding to traditional values” dictionary definition. For each individual engagement, that’s not only appropriate, but good. There is value to professional skepticism and to using precedent as a guide. But for the profession as a whole, it creates a problem: What is being accounted for and attested is an ever-decreasing share of the information available and used.

Investors are information junkies, and the amount of data available is stunning. The “digital universe” (i.e., all the data in the world) grew from 0.13 zettabytes in 2005 to 16 zettabytes in 2016, a 12,300 percent increase. (A zettabyte is 1 trillion gigabytes.) And it’s predicted to grow to 163 zettabytes by 2025, or another 1,000 percent increase. Equally amazing is that artificial intelligence and computer power will enable we investors to take an ever-increasing portion of that unstructured data and turn it into decision useful information.

Ideally, we’d like more of that data to be standardized, structured and assured, because that’s better-quality data. But if that’s not available, we’re still going to use it.

Here’s the analogy. When I was in London recently, I was honored to be asked to speak at the Guild Hall of the Worshipful Company of Weavers, Spinners and Dyers. The hall was huge, located in prime real estate in the square mile of the City of London. Even the bathrooms were wood-paneled and decorated with 15th century silk weavings, any one of which I would be proud to own and display on the largest wall of my living room, though I probably could not afford any of them. Judging by the display of wealth, weaving was obviously central to the medieval and early industrial economy of England. But it’s not today. Weaving is still a viable craft and business, but on a much smaller, less central scale. Other parts of the economy grew faster and weaving did not keep up.

Already, there are investors using artificial intelligence, crossed with risk algorithms, to create live portfolios. Even in that world, traditional accounting is still valuable -- but of less value than it was a decade ago, a year ago, a month ago, a day ago, a minute ago. The trend is not going to reverse. Limiting the focus of the profession to traditional financial statements will, by definition, limit accounting to reporting and assuring a shrinking share of the information investors use.

If that happens, accounting will be the Worshipful Company of Weavers of the 21st century. Once important, still an honorable calling, but nowhere near as central to the capital markets as it used to be, or could be.

What does the profession have to do to avoid that fate?

First, broaden what is accounted for and assured, so as to increase relevance to investors. This is not an easy process. I have sympathy for the standard-setters. On the one hand, no one wants to be reactive to the newest fads, lest the standard-setters spend time on things like “eyeballs” in the lead-up to the dot-com crash. But there are time-tested non-GAAP metrics investors use, like EBITDA, and KPIs, like same store sales. Perhaps the profession should adopt the rules the Rock and Roll Hall of Fame uses: If a metric is still important after 25 years, it should be considered for induction into a FASB Hall of Standards.

Second, create an industry-wide effort to rethink the entire area of intangible assets. There are scores of great thinkers and researchers looking at this already, but there is no consensus toward fundamentally reforming accounting to accurately reflect them on financial statements.

Third, look at what we can be done to standardize sustainability metrics. Yes, this is controversial, but I am not suggesting it for political reasons. The signatories to the Principles for Responsible Investment comprise the vast majority of the world’s largest asset owners and asset managers, with aggregate assets under management of some $80 trillion. That is four times U.S. GDP. The very first requirement of being a signatory is, “We will incorporate [environmental, social and governance] issues into investment analysis and decision-making processes.” While there may be some signatories who only pledge but don’t act, even if you assign a gargantuan 50 percent discount on how many of those firms actually use ESG metrics, there is a need for better information and a major opportunity for the profession. Last year, 395 of the S&P 500 put out some type of sustainability report. But only 38 percent are assured, and 90 percent of those are only partially assured. And even those are often not assured by accountants.

Accounting faces a choice: Increase relevance, or become the 21st century equivalent of the Worshipful Company of Weavers. Still viable, but not central to the economy of today. Yes, the profession faces a slow-moving, but existential crisis for the profession. But it’s also an opportunity.

Jon Lukomnik ... Jon Lukomnik is a long-time institutional investor. This article is adapted from a talk he gave recently to CPA Canada.

Posted by CFECPA .... Tuesday, November 20 2018 at 9:39 PM
Bean-counters or weavers? Audited financial statements are a dinosaur. Accounting is fairly simple. Where did the money come from and where did it go? GAAP, GAAS, FASB and the rest of the alphabetic soup do nothing more than enable bean-counters to extort excessive fees based upon mythical chargeable hours. Further, bean-counters have an inherent conflict of interest as the longer something takes, the more they make.

Posted by DavidP ... Tuesday, November 20 2018 at 12:55 PM
one more thing. Sorry to be difficult, but Jon has it exacly backwards. Accounting is not going anywhere, it has been around for hundreds of years and there is a reason something like 40% of CFOs are CPAs. You can't pick up GAAP and double entry accounting in a couple of weeks, there is a barrier. What IS going away is the paper pushing non-value added racket called Wall Street and London etc which survives from subsidized bailout …

Posted by DavidP ... Tuesday, November 20 2018 at 12:05 PM
The capital goods sector of the global economy has been stretched out in an unnatural way by the huge increase in M1, first under Greenspan, then Bernanke, whose entire term was marked by one giant crusade against deflation - a successful one in the sense there was no credit crunch on his watch. An unsuccessful one in the additional dislocations created. With the coming tightening campaign, will come a drop in the money …

Posted by scottbieber ... Tuesday, November 20 2018 at 9:26 AM
Public companies and their stakeholders in financial reporting are only one constituancy served by the accounting profession. Accounting and accountants are also key players in tax reporting and private business financial reporting, planning and management. Often, what is important for the public company sector is irrelevant or insignificant for the other parties. Consequently, Mr. Lukomnik's vision for public company accounting may not hold true from the rest of the profession.

Posted by lrwcma ... Tuesday, November 20 2018 at 9:05 AM
Jon raises some excellent points in regard to one customer group of the accounting profession - investors and creditors; but for professional accountants who work in business, there is an even more important customer group - managers and executives inside the company/organization. The question really is: are they being served any better? Is the accounting profession loosing ground in both areas because it won't change fast enough?

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