Peeling away financial reporting issues one layer at a time

Financial Accounting’s Relevance Lost

My best insights (but who am I to judge?) come from reading something for which accounting is the furthest thing from the author’s mind:

“My own view is that people tend to underestimate the pace of technological change but they tend to overestimate the pace of human change. That is, if you go back to past visions of the future as they were displayed in world fairs, for example, they generally fail to anticipate how quickly we will invent things like wireless communication, but they always imagine that social structures will change faster than they actually do. They imagine people living without nuclear families, without dysfunctional political squabbles. They imagine that technology will streamline and rationalize social institutions. That never happens.” [emphasis added]

David Brooks, a moderate conservative, and  his liberal colleague, Gail Collins, are widely read NYT columnists in their own rights.  A couple of years ago, they decided to collaborate on “The Conversation,” a series of columns that is adequately described by the series title.  That these two can have a humorous and constructive give-and-take in this polarized political climate is worth noting all by itself.

But, more to the point, the above statement from Brooks struck the nerve that got my accounting juices flowing.  Double-entry accounting was a great technological advancement when it was conceived however many centuries ago that was.  Further advances in technology have reduced costs associated with financial reporting, but other costs have increased because needed ‘rationalization of social institutions’ has been hindered by “dysfunctional political squabbles.”

For example, in her popular book on the history of accounting, Jane Gleesen-White cited research claiming that when externalities are taken fully into account, McDonald’s consumes $200 worth of resources in order to produce one Big Mac.

Yikes! I know what your thinking — two hundred bucks? Let’s just say that the full, full cost of a Big Mac is merely $10. That’s still an astounding number.

Accounting by the Corporation is not the Same as Accounting for the Corporation
Although the problem of accounting for externalities has always existed, it had been less significant than a flea on a horse’s hindquarter until about one hundred years ago.  That corporations—a social institution designed to promote large-scale investments—would consume so much without accounting for that consumption is surely an unintended consequence of its establishment in the law.
When resource consumption is portrayed by financial reporting standards as if it were free—or  merely under-costed—corporate decision makers will inevitably find value-creating projects from the corporation’s standpoint, even when aggregate costs exceed aggregate benefits.
I’m sure that everything I have written to this point has been a huge understatement; yet no accounting standard setting body has ever seriously considered any of this.  The implicit reasoning goes something like this: it’s not our job.  Accounting standards are largely the creature of the federal securities laws; which are intended to prevent public companies from misleading its investors, and to provide information that puts investors on a level-playing field with respect to available information.  As long as investors get adequate information to value a company, and not be mislead by unscrupulous management, then let the chips fall where they may.
It is simply not in the job description of the standard setter to prevent the use of accounting standards to make kings while destroying families, much less soil the air we breathe, or  determine where the Atlantic Ocean stops and New Jersey begins (a tip of the hat to Gail Collins for that bit of imagery).
I’ll be the first to admit that the problem of adequately accounting for externalities is hard. My grad school advisor, the late Tom Burns, once remarked that defining the entity of account—roughly speaking, drawing the line between events that affect the corporation and everything else—is the thorniest problem in accounting.  I suppose I should summon up some empathy for accounting standards setters who haven’t even paid lip service to this problem—but I can’t.
I can’t, because accounting standards setters are richly paid, and they serve at the pleasure of oligarchs, who require that more attention is paid to their predilections and ideologies than to the plausibly deniable costs of mis-pricing resources.  We can all recite the litany of problems that have occurred in our generation alone, and precisely identify who has benefitted while most everyone else has lost: treating stock options granted to employees as if there is no cost to other shareholders; not recognizing the implications on pension plans (private and governmental) when assets fail to grow as hoped; or misrepresenting the economics of banks and the loans they make.  Trust me, I can think of many more.
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I wonder how much David Brooks actually knows about accounting.  I’ll bet it’s far more than he realizes.


  1. Reply Edith Orenstein April 1, 2013

    It’s always a daunting task to comment on your scholarly posts. But, that’s rarely stopped me in the past, and hey, it’s April Fool’s today, so why not try? (1) Not that I’m a bona fide trekkie or anything, I would hold up Star Trek’s world of advanced technology with continuing civilizations at war as a counterexample to Brooks’ views of lack of foresight as to the future of technology and an overestimation of a perfect society cited in your article. (2) Is there still a separate science or profession of ‘cost’ accounting per se, (outside of the field of government contracting and procurement) and are your claims about the responsibilities of “accounting standard setters” blending the two fields and attendant objectives (cost accounting for internal measurement purposes, and financial accounting for external measurement purposes) together? Or are you postulating that the traditional “cost accounting” and “financial accounting” should be one and the same, since many say that the investor should see the results of the business “through the eyes of management”? Regardless of your answers or those of your readers, once again, a thought-provoking post!

    • Reply Tom Selling April 2, 2013

      Hi, Edith:
      Thanks for posting a comment. I was not speaking of “cost” or “managerial” accounting,” although my reference to “relevance lost” had Bob Kaplan’s book in mind regarding managerial accounting. Regardless of how one labels the problem, there it is a fact that financial reporting affects resource allocations that in turn affect society. The corporation is a social institution, and it seems that it has not been adapted sufficiently over time to reflect this reality. The imagination of the writers of Star Trek may be interesting, but it hardly constitutes evidence one way or another of David Brooks’s assertion.

  2. Reply IV April 18, 2013


    I like what you are attempting to address — to prevent the incentivization of the consumption of resources which are owned, essentially, in common — but I fear that an actual attempt to implement a measurement system would, at first and likely for a long time, produce accounting figures whose philosophic inadequacy would make intangible accounting seem quite sound. And further it would likely become a problem of the allocation of rights and the legal upholding of the rights of people on a massive scale. I think this is possible but it reminds me of Weber’s iron cage and I find myself more inclined to let important externalities be incorporated into the system over time and with strict future political purpose. For instance, the credits that crude refiners have to purchase if they are not blending biofuels into their output is a way of creating artificial costs to (1) mimic the cost of externalities and (2) create an incentive for “better” action. While I am not so sure this particular example is truly moral or better for society (it is, after all, the use of land for stuff that isn’t food) it could be incorporated and modified for different externalities and thereby imposed as a “regulatory burden”. But, still, I think it is up to the SEC because it seems to involve rights more than accounting interpretation, in my opinion. A broad swipe to enforce rights, and thereby curb externalities, would effect corporate accounting for the better but the increase in the granularity of rights which would possibly result might be a practical encumbrance which is bad for humanity as a whole.

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