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

Baruch Lev, Feng Gu

• Publisher: Wiley
• Year: 2016
• ISBN:
  9781119191087
• Edition: 1
• Topic: Business
• Subtopic: Finance
• Index: Business

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.

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

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In which we show, using US Steel’s financial reports from 1902 (yes, 1902) and 2012, that the structure and content of corporate financial reports—balance sheets, income and cash flow statements—haven’t changed over the past 110 years, despite dramatic increases in investors’ sophistication, information processing ability, and complexity of business operation. Surprised? We don’t blame you.

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Spot the Differences

The year is 1903. Theodore Roosevelt is in his third year of presidency, the Ford Motor Co. produces its first car—the Model A (available, as Henry Ford said, in any color as long as it's black)—and the first World Series is played: Boston Americans (soon the Boston Red Sox) versus the Pittsburgh Pirates. No surprise, Boston wins with Cy Young pitching. Alas, there is no television to watch the game, nor is there air transportation, or shopping malls. Not even the Internet—no Facebook or Twitter. But steel is produced, and the largest steel producer in the world—United States Steel Corporation (US Steel)—publishes its first annual report to shareholders. The main components of this report, the balance sheet and the income (profit or loss) statement for the previous year, 1902, are recast below, alongside with—fast-forward 110 years—their 2012 counterparts. (The original 1902 US Steel statements are reproduced in the Appendix.)

Recall your early childhood when you likely played the popular game Spot the Differences. Examining two seemingly identical pictures, you were challenged to identify minute, hidden differences. We challenge you to do the same with the two US Steel balance sheets and income statements, spanning 110 years, displayed below and in the next page. The purpose of the exercise: a first glimpse at the progress, or rather, lack thereof, of accounting and financial reporting over the past century plus decade.

Amazingly, you'll find that there are absolutely no differences in the structure and information items provided to investors by the two financial reports. Same layout of the income statement (Table 1.1) and balance sheet (Table 1.2), and identical information items disclosed in the two reports: assets, liabilities and equity in the balance sheet; and revenues minus an array of expenses in the income statement—as if investors' information needs and tools of financial analysis and securities valuation were frozen over the past 110 years, and no advances had been made in information processing and data display. Imagine if the report that people get today following a comprehensive physical checkup were identical to what patients received from their doctors 110 years ago. Yet, the corporate annual checkup report is frozen in time. Don't be misled by the “low” sales in 1902—$560 million. Converting this 1902 figure to 2012 values with the help of the Consumer Price Index (CPI) yields $16,324 million, pretty close to the actual 2012 sales of $19,328 million. So, US Steel was already a sizable enterprise 110 years ago, worthy of comparison with today's company.

Table 1.1 United States Steel Corporation Consolidated Income Statement

	(in $ Millions)
	Year 1902	Year 2012
Sales	$ 560	$19,328
Cost of sales	(411)	(18,291)
Gross profit	149	1,037
Minus Expenses:
Selling & general expenses	(13)	(654)
Other gains/(losses)	5	(136)
Interest income	3	7
Interest expense	(9)	(247)
Income tax	(2)	(131)
Net income (loss)	133	(124)

Table 1.2 United States Steel Corporation Consolidated Balance Sheet

	(in $ Millions)
	Year 1902	Year 2012
Assets
Current Assets
Cash & equivalents	$56	$570
Net receivables	49	2,090
Inventories	104	2,503
Other current assets	5	211
Total current assets	214	5,374
Investments	4	609
Property, Plant & Equipment	1,325	6,408
Intangibles	—	253
Goodwill	—	1,822
Other noncurrent assets	4	751
Total assets	$1,547	$15,217
Liabilities
Current Liabilities
Accounts payable	$19	$1,800
Payroll payable	4	977
Accrued taxes	1	146
Other current liabilities	26	67
Total current liabilities	50	2,990
Long-term debt	371	3,936
Employee benefits	—	4,416
Other noncurrent liabilities	30	397
Total liabilities	451	11,739
Stockholders' Equity
Common stock	1,018	3,282
Retained earnings	78	196
Total shareholders' equity	1,096	3,478
Total Liabilities and Equity	$1,547	$15,217

There is an important difference, however, between the 1902 and 2012 US Steels: While the company g...

Table of contents

• Cover
• Title Page
• Copyright
• Table of Contents
• Dedication
• Acknowledgments
• The Book in a Nutshell
• Prologue
• Chapter 1: Corporate Reporting Then and Now: A Century of “Progress”
• Chapter 2: And You Thought Earnings Are the Bottom Line
• Part One: Matter of Fact
• Part Two: Why Is the Relevance Lost?
• Part Three: So, What's to Be Done?
• Part Four: Practical Matters
• Epilogue: Advocacy Needed
• Author Index
• Subject Index
• End User License Agreement