When we started drafting this column, the national media was filled with tributes to Steve Jobs, the acclaimed visionary founder and personification of Apple. Although it's always hard to separate hype from truth about a larger-than- life persona, Jobs is/was known for his ability to see things no one else could.
The "Big Brother" Super Bowl commercial announcing the Macintosh in January 1984 helped launch his reputation as perhaps the greatest technological and marketing innovator of our lifetime. His approach to life was also reflected in other advertisements with photos of iconic past figures who dared to "Think Different" about the status quo.
We want to explore what would be accomplished by applying his philosophy to financial reporting.
OTHER PEOPLE'S THINKING?
The memorial offered by Macworld included an excerpt from Jobs' 2005 commencement speech at Stanford that recounted how his life changed when he discovered he had cancer, and then changed again upon learning it was operable. He challenged the graduates to live as he had learned to live: one precious day at a time, aimed at creating a better world than the one they came into. Four sentences jumped off the page for us: "Your time is limited, so don't waste it living someone else's life. Don't be trapped by dogma - which is living with the results of other people's thinking. Don't let the noise of others' opinions drown out your own inner voice. And most important, have the courage to follow your heart and intuition."
Being who we are, we cannot resist applying these words to financial reporting because so many accountants' "hearts and intuition" are squelched by the multitude of timeworn dogmas on what is right and proper and what must never be done.
We challenge everyone reading our words, especially young accountants, to stop "living with the results of other people's thinking."
We also invite you to apply your above-average intelligence to "think different" about what you do and don't do, and to ponder what you ought to do, instead of what you have always done.
To help cast a vision for a new future, we discredit some long-standing dogmas that prevent today's accountants from delivering what our society, economy and capital markets need: useful information that reliably tells the truth, the whole truth, and nothing but the truth. We focus on these three about market values:
1. Nobody knows how to produce reliable market values.
2. Asset impairments, but not increases, must be reported as soon as they happen.
3. Unrealized gains and losses are different from realized gains and losses.
MEASURING MARKET VALUES
The most frequent objection to value-based accounting is that nobody knows how to produce reliable market values. We assert those naysayers are either disingenuous hypocrites or oblivious to the clear contradiction in their claim. As proof, consider the following situations in which accountants already audit and report market values under GAAP.
Cash held in other currencies is marked to market. Receivables are disclosed at market under SFAS 107. Inventory is reported at market when it's lower than cost. Marketable investments, except for some bonds, must be marked to market. Tangible assets and goodwill are carried at market when they're impaired below cost. Accounts, notes, and bonds payable are also disclosed at market under SFAS 107. Stock options are reported at market, albeit only at issuance. Pension assets and liabilities are measured at market before being offset in balance sheets.
Business combinations are the most conspicuous application of value-based accounting because the acquired company's assets and liabilities, including its very intangible in-process R&D, are all brought onto the acquirer's books and statements at market.
In contrast to the dogma, today's accountants are actually quite adept at reliably measuring market values in a wide range of situations.
Before moving on, we assert these irrefutable observations: If values are reliable when they're less than cost, then they're reliable when they're greater than cost, and if values are sufficiently reliable for the footnotes, then they are sufficiently reliable for the statements.
From the first weeks in introductory accounting, instructors proclaim (and students soak up) the dogma that all losses must be recognized when they occur but all gains must be deferred until transactions somehow legitimize them. This flawed "thinking by others" is an unquestioned mantra that must never be violated.
Its persistence is demonstrated by FASB's seemingly never-ending efforts to specify when and how to record asset impairments without acknowledging, and perhaps without seeing, how obviously one-sided this practice is. Surely the same estimation techniques can be applied whether market value is above or below an arbitrary book value.
The consequence of the impairment dogma is deliberately biased misinformation. If financial reports are biased, they lack neutrality. If they lack neutrality, they lack reliability. And, if they lack reliability, they lack usefulness.
Because reports produced under this dogma lack usefulness, they should not be foisted on market participants who either (a) unwittingly swallow the misinformation and make poor decisions, (b) shrug at the unknown and discount stock prices because of their uncertainty, or (c) spend fortunes developing more complete information. In all three cases, economic resources are wasted and companies' capital costs are increased.
UNREALIZED GAINS AND LOSSES
Our November column explained that today's internal control systems are inadequate for producing useful information because they look to a company's own transactions as the primary source of financial statement amounts. Our most significant observation is that those events are woefully inadequate for describing what all users need to know, specifically the current ability of assets and liabilities to affect the amount, timing and uncertainty of future cash flows.
We reprise that point here to illuminate the second timeworn dogma that gains (and some losses) must not be included in income until a transaction occurs. For example, the difference between cost and value for a portfolio of so-called available-for-sale marketable investments is parked in equity as an unrealized gain or loss. Mind you, all that's missing is a phone call to a broker or a mouse click. Who, except victims of dogmatic conditioning, would believe the presence or absence of those trivial acts should determine the timing and amount of reported income?
Of course, disposal transactions are important because they affect cash and risk exposure. We note that the cash effect is already reflected on cash flow statements and the risk is already described on balance sheets. We don't comprehend why income statements are forced to describe not only wealth changes but also the entity's cash flows and risk profile.
When you look at this dogma objectively and otherwise free from the lingering effects of your indoctrination, you can see that these practices are certain to produce misleading information because they have no sound rationale.
IF SO, THEN WHY?
We are figuratively throwing sledge hammers into the giant image of Big Brother in order to confront our readers with the harsh fact that they are unwitting victims and/or perpetrators of a huge hoax. Specifically, today's financial statements do not provide useful and timely information for making rational decisions because ancient dogmas insist they cannot report market values at all times for all assets and liabilities. (Some readers may recall our stunning discovery that systematic depreciation of tangible assets' costs dates way back to Andrew Jackson's presidency!)
Why hasn't practice changed over the centuries? The clear answer is that accountants and managers don't want practice to change. Why not?
Because they're afraid. Afraid of what? They're afraid of the capital markets' ability to punish them. They're afraid of being held accountable for value under their management. They're afraid of real volatility that cost-based reports conceal but market values reveal. They're also afraid to violate unquestioned dogmas because adherence to them is the source of their power and wealth.
Ironically, their fears don't stop them from holding themselves out as truth keepers. Like the pitiable Colonel Jessep in A Few Good Men, they say to the rest of us, "You can't handle the truth," when they themselves are blind to the bigger truth that surrounds them.
Believe it or not, capital markets can indeed handle the truth, far better than those who cling to long-dead dogmas and just can't see they aren't legitimate, especially in today's information-driven world.
Because this column questions the heretofore unquestionable, we've found it to be extraordinarily challenging to write, and realize it's probably even more challenging to read.
But, before retreating to your familiar and comfortable habits of "living with the results of other people's thinking," we ask you to contemplate how much better off the world is with such things as the Internet and all the iPods, iPhones, iPads and the other now-engrained computing and communication innovations produced in response to Jobs's iconoclastic paradigm about the world.
In all seriousness, we invite you to re-evaluate whether you want to devote your own precious and all-too-brief life to preserving obsolete dogmas and imposing them on future generations. When the issue is framed that way, we find an overwhelming preference for "thinking different" by questioning the status quo.
As you might suspect, we made that decision a long time ago, and once again invite you to join us. Surely, seeing the world through this lens will help you make it a better place. Further, accountants who make the leap will be abundantly rewarded, because at long last they will actually provide managers, investors, creditors, regulators and everyone else with useful information, instead of conventional misinformation.
We find that future to be far more desirable than more of the same forever.
Paul B. W. Miller is a professor at the University of Colorado at Colorado Springs and Paul R. Bahnson is a professor at Boise State University. The authors' views are not necessarily those of their institutions. Reach them at firstname.lastname@example.org.
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