A Public Interest Debate!

On March 14, 2019, our Contributing Columnist Rick Kravitz, the Editor In Chief of the CPA Journal, authored a blog post entitled “Reimagining a More Ethical and Sustainable Management Accounting Curriculum.” In that post, he asserted that:

The accounting curriculum, while relevant 40 years ago, has lost much of its relevance today in our post-modern global economy. Accounting education fails to account for the real drivers of enterprise growth in the digital economy.

That drew a rebuttal from Dr. Lawrence Murphy Smith, CPA, a Professor of Accounting at Texas A&M University-Corpus Christi. According to Murphy:

Since I was an accounting student more than 40 years ago, people within and outside the profession have lamented that accounting and financial reporting isn’t doing a good job of providing useful information.

In the editorial column, “Reimagining a More Ethical and Sustainable Management Accounting Curriculum” by Richard Kravitz, this complaint appears once again. On the upside, accountants should be constantly working to ensure the usefulness of accounting and financial reporting. On the downside, this article way overstates the lack of value of accounting information.

The most important piece of accounting information, I would argue, is net income/profit. That number is still calculated, just as it has been through the centuries. To a very large extent the current value and future projected value of net income/profit drives the market value of virtually every modern-day company, whether that market value is 100 times the book value or one times the book value. So, accounting/financial reporting is still relevant; it always has been.

Of course, there will always be exceptions to the predictive power of financial reports. Exceptions result from new technologies, innovative new products, economic cycles, fraudulent financial reporting, brilliant and dismal company leadership, politics, and unexpected events. For example, before the Internet, few people could predict its massive impact on business, which enabled Amazon to become the second largest retail store in the U.S., second only to Walmart. After reading about a very profitable airline company in the summer of 2001, I invested. There was no public awareness that Islamic terrorists were plotting the attack on the World Trade Center. Not long after September 11, 2001, my airline stock was worthless.

The past cannot always predict the future, and by their nature, financial reports are about the past. So, while financial reports are extremely helpful, they cannot guarantee future outcomes. I would argue that financial reports provide a critical part, if not the majority, of information supporting investment decisions. When people are willing to buy stock in a company with giant losses, those people are taking the risk that the company will turn around and make profits in the future. In effect, the future projected value of net income is driving the company’s market value. Sometimes a company turns things around and sometimes it doesn’t. While financial reports are still very relevant in predicting future prospects of most companies, in the final analysis, only God knows the future with absolute certainty.

In conclusion, I have the highest regard for Rick Kravitz and Baruch Lev but I respectfully disagree with their negative assessment of the value of financial statements.

That, in turn, drew a rebuttal to the rebuttal from Rick! He noted:

I would ask the good professor how he can conclude this when Uber, Tesla, Lyft, and dozens of other cash burning companies now have losses in the trillions of dollars and yet possess positive share value. Bad reporting by accountants caused 55 billion dollars of shareholder losses last year, the highest since the Great Recession. And according to Baruch Lev, the information content of the financial statements only constitutes 3% to 4% of information that supports investment decision. What a lack of relevance!

The debate clearly rages on. It clearly will not be resolved in the near future. Nevertheless, our Public Interest Section is delighted to host a professional forum for this lively conversation.