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The End of Accounting and the Path Forward for Investors and Managers

ISBN: 978-1-119-19109-4
288 pages
June 2016
The End of Accounting and the Path Forward for Investors and Managers (1119191092) cover image

Description

An innovative new valuation framework with truly useful economic indicators

The End of Accounting and the Path Forward for Investors and Managers shows how the ubiquitous financial reports have become useless in capital market decisions and lays out an actionable alternative. Based on a comprehensive, large-sample empirical analysis, this book reports financial documents' continuous deterioration in relevance to investors' decisions. An enlightening discussion details the reasons why accounting is losing relevance in today's market, backed by numerous examples with real-world impact. Beyond simply identifying the problem, this report offers a solution—the Value Creation Report—and demonstrates its utility in key industries. New indicators focus on strategy and execution to identify and evaluate a company's true value-creating resources for a more up-to-date approach to critical investment decision-making.

While entire industries have come to rely on financial reports for vital information, these documents are flawed and insufficient when it comes to the way investors and lenders work in the current economic climate. This book demonstrates an alternative, giving you a new framework for more informed decision making.

  • Discover a new, comprehensive system of economic indicators
  • Focus on strategic, value-creating resources in company valuation
  • Learn how traditional financial documents are quickly losing their utility
  • Find a path forward with actionable, up-to-date information

Major corporate decisions, such as restructuring and M&A, are predicated on financial indicators of profitability and asset/liabilities values. These documents move mountains, so what happens if they're based on faulty indicators that fail to show the true value of the company? The End of Accounting and the Path Forward for Investors and Managers shows you the reality and offers a new blueprint for more accurate valuation.

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Table of Contents

Acknowledgments xi

The Book in a Nutshell xiii

Prologue xxv

CHAPTER 1 Corporate Reporting Then and Now: A Century of “Progress” 1

CHAPTER 2 And You Thought Earnings Are the Bottom Line 15

PART ONE Matter of Fact 27

CHAPTER 3 The Widening Chasm between Financial Information and Stock Prices 29

CHAPTER 4 Worse Than at First Sight 41

CHAPTER 5 Investors’ Fault or Accounting’s? 50

CHAPTER 6 Finally, For the Still Unconvinced 61

CHAPTER 7 The Meaning of It All 67

PART TWO Why Is the Relevance Lost? 77

CHAPTER 8 The Rise of Intangibles and Fall of Accounting 81

CHAPTER 9 Accounting: Facts or Fiction? 94

CHAPTER 10 Sins of Omission and Commission 104

PART THREE So, What’s to Be Done? 113

CHAPTER 11 What Really Matters to Investors (and Managers) 119

CHAPTER 12 Strategic Resources & Consequences Report: Case No. I—Media and Entertainment 133

CHAPTER 13 Strategic Resources & Consequences Report: Case No. 2—Property and Casualty Insurance 146

CHAPTER 14 Strategic Resources & Consequences Report:

Case No. 3—Pharmaceutics and Biotech 163

CHAPTER 15 Strategic Resources & Consequences Report:

Case No. 4—Oil and Gas Companies 179

PART FOUR Practical Matters 197

CHAPTER 16 Implementation 199

CHAPTER 17 So, What to Do with Accounting? A Reform Agenda 213

CHAPTER 18 Investors’ Operating Instructions 230

Epilogue: Advocacy Needed 241

Author Index 243

Subject Index 247

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Author Information

BARUCH LEV is the Philip Bardes Professor of Accounting and Finance at the NYU Stern School of Business. He has authored more than 100 research studies and five books, including Winning Investors Over.

FENG GU is an Associate Professor and Chair of the Department of Accounting and Law at the University at Buffalo. He has written numerous articles for top research journals.

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Reviews

"..goes far beyond a mere provocation and could be considered one of the most effective reviews on the current status of accounting."  (European Accounting Association, June 2017)

Praise for The End of Accounting and the Path Forward for Investors and Managers

"Utilizing and valuing intangible assets is essential for companies' investment and capital allocation decisions. This book proposes a thoughtful approach for managers and investors to appraise intangibles and thereby more accurately assess a company's value and performance. It's an important book for business leaders to read."
—Samuel J. Palmisano, Former Chairman, CEO, and President, IBM

"Reading this amazing book, I was reminded of Bill James' revolution in the analysis of baseball (Sabermetrics), celebrated in the book and movie Moneyball. Baruch Lev and Feng Gu argue for similar revolution in securities' analysis, where the financial stakes are orders-of-magnitude higher and the economic implications infinitely greater. The authors take us gently by the hand and escort us through every key aspect of their stunning case with a rare combination of clarity, humor, and scholarly authority—to be acted upon by investors and managers."
—Gene Epstein, Economics and Book Editor, Barron's

"The authors have identified an important area for investors—the accounting and reporting distortions of the actualities of businesses. They do an excellent job proposing ways to overcome these distortions. All investors should be cognizant of the issues presented in this book."
—Win Murray, Director of Research, Harris Associates L.P.

"This is one of those rare accounting and finance books that is both thought-provoking and visionary. The authors propose and demonstrate an exciting and highly practical new direction for corporate reporting and investment analysis, focusing on the value- creating resources of the enterprise. An essential reading for investors, accountants, and standard-setters."
—Allister Wilson, Global Audit Partner, Ernst & Young LLP

"A thought-provoking book on how to make accounting and financial reporting more relevant to investors, where intangible assets play a key role."
—Josef Lakonishok, CEO, LSV Asset Management

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Press Release

June 27, 2016
The End of Accounting and the Path Forward for Investors and Managers

Our financial system faces serious risk due to its dependence on corporate financial reports, which haven’t evolved since their roots in our industrial economy and are now out of touch with what really determines the value of a company today.  These outdated reports can jeopardize capital markets and misinform our most critical business decisions on everything from corporate restructuring to mergers and acquisitions.

In THE END OF ACCOUNTING and the Path Forward for Investors and Managers (Wiley, June 27, 2016), Baruch Lev (NYU Stern) and Feng Gu (SUNY at Buffalo) expose the flaws of generally accepted accounting principles (GAAP), and propose a new system that Barron’s says “improves transparency of corporate accounting rather than seeking to delude investors.”

Corporate earnings have long been thought to “move markets” as harbingers of future performance, yet these reported earnings no longer reliably predict such performance, nor can reported losses reliably point to operational problems, mainly due to accounting regulations that have embraced intangibles expensing and nonrecurring items. Accounting earnings are also based on multiple subjective managerial estimates and projections (depreciation, stock option expense, asset write-offs, prospective bad debts, future pension liabilities, etc.) that are prone to errors and manipulations. This results in backward-looking accounting statements that cannot predict an enterprise’s future growth and ability to compete, the authors argue.

In recent years, intangible (intellectual) assets have increasingly bolstered corporate value and competitive edge, while the physical assets are commodities available to all competitors. Yet ironically, physical assets are fully recognized on corporate balance sheets, whereas investments in value creators like patents, brands and know-how are treated as regular expenses without future benefits. The authors point to the patents of Apple and Pfizer, the brands of Coca-Cola and Amazon, and business processes of Walmart and Southwest Airlines as important drivers of these companies’ success, not their physical plants, equipment, or inventory. And corporate investment in “intangible capital” (patents, brands, information and business systems) now surpasses investment in physical assets by a wide margin, increasing by almost 60 percent over the past four decades.  

Demonstrating accounting’s bias, the authors note “GAAP” accounting practices would not recognize a brand, like Coke, as an asset if you developed it, but if your company were to buy it, its value would be displayed on your balance sheet.  The practice of accounting has created (and continues to protect) this misguided managerial incentive of buying an asset over developing it. This is one of many examples that perpetuate misleading data on widely trusted accounting reports.  But change is within our grasp.

A Path Forward:  the Strategic Resources and Consequences Report

In order to combat such deficiencies, the authors developed the Strategic Resources and Consequences Report as a performance assessment and valuation framework that takes into account truly useful economic indicators that reflect corporate strategy and its execution.  Designed to gauge a company's true value-creating resources and their deployment, this model better guides critical investment decisions to help managers and investors to:

  • Implement a new, comprehensive system of performance indicators;
  • Focus on strategic, value-creating resources in company management and valuation, and
  • Find a path forward for improved investment decisions with actionable, up-to-date information.

This new report is a model focused on the strategic, value-enhancing resources (assets) of modern enterprises, like patents, brands, technology, natural resources, operating licenses, customers, business platforms and unique enterprise relationships, rather than on the commoditized plant, machines, or inventory displayed on corporate balance sheets. The need for this system is demonstrated across four key economic sectors:  

Media and entertainment – how companies like SiriusXM and Netflix must monitor strategic assets such as brands, customers, content, and agreements with vendors - factors GAAP accounting still fails to capture.

Pharmaceutical and biotech – how non-GAAP disclosures, like Pfizer’sand Gilead’s product pipeline information, can be used to project growth and market share trends.   

Oil-and-Gas – how information on companies’ dynamic property management, like that of Devon Energy, can be used to assess strategic success and future growth.  

Insurance – how companies like Progressive and Allstate rely on brand and product innovation to drive value, and apply risk management tools to manage and contain underwriting risk exposure, i.e. potential losses from catastrophic events.

Exposing the hidden risks to our financial system of current standards of accounting and reporting, THE END OF ACCOUNTING and the Path Forward for Investors and Managers provides professionals, investors and capital market regulators with an urgently needed new path toward relevance, transparency and accuracy.

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