Category Archives: Law

My pet gripe in the whole accounting simplification debate is how business and the accounting industry citie Enron as evidence that we need less detailed rules. They argue that detailed rules provide a roadmap for technical compliance that violates the spirit of the rules. In contrast, simple rules could not be gamed. In fact, Enron demonstrates the need for detailed rules.

Enron is best known for its use of Special Purpose Entities (SPEs) to manipulate accounting results. Enron would own most of a subsidiary corporation or partnership, but outsiders would have voting control, so that the entity would not be treated as part of Enron on its (consolidated) financial statements. Practice at the time was that outside investors put up at least 3% of the equity capital. In fact, in many of the Fastow/Enron deals, outsiders did not, and would not, put up 3% because the deals were so screwy. Clear rules worked. (Substantive accounting rules cannnot stop fraud.) End of story.

But, argues business, the 3% was so tempting that it encouraged the deals. Rather, if the rules left the separateness decision to the accountant’s judgment, she would have stopped these deals. Wrong! Details below.

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So, it is time to make my central point about accounting: The more work that the accountants do, the less work that the user has to do.

Accountants could just give investors the raw books and records. (As discussed in an earlier post, modern computers probably could handle this info if in a standard format, but something still would be missing: analysis by those familiar with the day-to-day of the business) Accountants analyze, compress, and format all this information so as to make it usable by investors and other consumers of financial information. It is work hard making a lot of data tell the kind of story that the users need. Business managers do not want to pay for this hard work. Unfortunately for them, their bosses, the shareholders, need for this work to be done in order for them to be able to police management’s stewardship effectively.

Unaccountable accountants below!

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After much backing and filling, it is time to get serious about talking about financial statements that the average investor can understand — simplified accounting. This is not what an accountant means when she talks about simplification, however. To her, simplification is anything that makes her life easier: particularly, fewer and less detailed rules. In almost every case, the two views of simplification are at war. That will be the topic tomorrow.

There is one, easy first step toward real simplification: standardization of the form of financial statements. Today, no 2 companies’ financial statements look alike. The statements themselves have different names. Microsoft’s “balance sheet” is GE’s “statement of financial position.” Also, the items are presented differently using different language. Microsoft’s balance sheet shows 12 types of asset. GE, which is a much more complicated empire, has only 11. (GE’s “other assets” are almost twice the size of their property, plant, and equipment.)

More in the footnote.

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Yesterday, I wrote about how companies are measuring customer satisfaction. This is an example of the variety of useful information that investors might find helpful that are not required to be collected and disclosed today. Another example is new metrics that quantify the success of a company’s development of technology (research and development and all that goes with them). And so on.

Which gets me back to my discussion about a week ago of the goal of financial disclosure, which is to help investors value stocks and bonds. These newer metrics are not measured in dollars. There is no precise way to use this information in valuing a company. (As compared to, say, accounting earnings; which can be converted into a value of a company just by multiplying by them by an average of the price-earnings ratios of similar companies.)

Nothing below. Don’t look….

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Sorry my post is so late. I used Atlantic Broadband’s server problems this evening as an excuse for a nap. My one-year-old, black lab mix, rescue dog just exhausts me.

Yesterday, I started ruminating about how one helps investors understand a business’ principal investments in the new economy: a business’ intangible assets. Monday, The Wall Street Journal (on page B3 of the print edition) had an interesting article about this. (Can’t provide a free link, sorry. The article is only available online with a pay service, and I do not want to cause Michael problems by violating a WSJ copyright.)

The article discusses how to measure customer satisfaction. A satisfied customer is likely to become a repeat customer or recommend the company. Satisfied customers make a business more valuable, as they mean future business.

Big companies, like GE and Enterprise Rent-A-Car are learning a lot about how their businesses are doing by polling customers and asking them to score the companies on a 1 to 10 scale on a few simple questions, such as how likely that the customer would recommend the business to a friend. These customer polls generate numbers, although not in dollars. Numbers beyond the domain of accountants.

More apres click.

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So, we start trying to decide whether accountings that the average investor can understand are feasible. The first question is whether the average investor can understand business in the “new economy.” To oversimplify, it seems to me useful to divide the new economy into 2 pieces: First, there is the world of post-modern finance: derivatives and their progeny. Second, is the world of high-tech.

When I think of derivatives, I always think of the old Eddie Murphy movie, Trading Places. Ralph Bellamy and Don Ameche are trying to explain the futures markets (the first public derivatives market) to the street person played by Eddie Murphy. Insightfully, Eddie noted something like “you guys are bookies.” Black and Scholes (after whom the first model for valuing derivatives is named) could not have put it better. Derivatives are just fancy bets on the value of something, with little or no investment in the item gambled on. Pricing the gamble is hard. Understanding the gamble is easy.

High tech below.

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