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