Will ac­coun­tants be­come the 21st cen­tury weavers? The pub­lic fo­rum of pub­lic ac­count­ing

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Accounting Today - - Opinion - By Jon Lukomnik See OPIN­ION on 29

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 U.S. 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 def­i­ni­tions? (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 us 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

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

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