Accounting In The Food And Drink Industry

Editorial Note: We are delighted to publish the following editorial by Professor Lisa Jack of the University of Portsmouth in the United Kingdom. The content is representative of the quality of the material that our colleagues will share at our 2019 Annual Meeting in San Francisco next month.

We hope to see you there! As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.

Is it in the public interest to know about accounting in the food and drink industry? As one of the very few researchers in the discipline who study this field in depth, and I’ve been looking at the industry for nearly 20 years now, what I usually encounter is a vague idea that accounting in the area ‘cannot be that complicated’, something that runs philosophically with a general unawareness of what really goes into producing food and drink in a developed, capitalist country.

It’s not that people are generally disinterested in food and drink, and where it comes from. Yes, some schoolchildren and some adults take supermarket food for granted and are bemused to find that what they eat involves animals and plants (and chemicals). But the TV schedules, in the UK and Canada at least, are filled with people cooking and baking, and investigating ‘how things are made’, food scandals, diets and advising on how to reduce the costs of the weekly shop for families. Gastronomy, artisan foods, organic, vegan – all are taking new footholds and as Julie Guthman of UC Santa Barbara says very quickly become part of a capitalism that embodies (literally) the faults in the system. The domination of capitalist multi-retailers and food processing companies is directly implicated in policy on both obesity and healthy eating.

In fact, most of us have a reasonable general knowledge of food and some perception of what it costs to produce, distribute and sell. But it is a complicated industry, with complicated social interactions at play. The accounting is also complicated – and often under the radar. So, I want to touch first on how others have articulated the underlying problems and then on bringing forward some of the things I’ve found going on under that radar. In particular, here, I’m interested with others on how city dwellers (around 55% of the world’s population according to the UN, and set to rise to 68% by 2050) see food.

Michael Pollen (The Omnivore’s Dilemma) and Michael Carolan (The Real Cost of Cheap Food) are the other must reads in this area, along with Julie Guthman (Weighing In).

One of the most quoted and respected writers in the US is Wendell Berry (b.1934), this is an extract from ‘The Pleasures of Eating’.

I begin with the proposition that eating is an agricultural act. Eating ends the annual drama of the food economy that begins with planting and birth. Most eaters, however, are no longer aware that this is true. They think of food as an agricultural product, perhaps, but they do not think of themselves as participants in agriculture. They think of themselves as “consumers.” If they think beyond that, they recognize that they are passive consumers. They buy what they want — or what they have been persuaded to want — within the limits of what they can get. They pay, mostly without protest, what they are charged. And they mostly ignore certain critical questions about the quality and the cost of what they are sold: How fresh is it? How pure or clean is it, how free of dangerous chemicals? How far was it transported, and what did transportation add to the cost? How much did manufacturing or packaging or advertising add to the cost? When the food product has been manufactured or “processed” or “precooked,” how has that affected its quality or price or nutritional value?

Georg Simmel wrote in 1903 in ‘The metropolis and mental life’: “…the money economy that dominates the metropolis in which the last remnants of domestic production and direct barter of goods have been eradicated and in which the amount of production on direct personal order is reduced daily. Furthermore, [a] psychological intellectualist attitude and the economy are in such close integration that no-one is able to say whether it is the former that has affected the latter or vice-versa”. One result might be that living in a city makes one unaware of the cost of food production, and the effects of a demand for cheap food on suppliers and producers. The English writer Adrian Bell (1931) says that when he was a struggling farmer (having been a city-bred boy who chose an apprenticeship on a farm over other professions): “I began to realise, also, how much of the money which the consumer says he gives so plentifully, and of which the producer says he receives so sparingly, fell through the hole in the middle-man’s pocket into the gulf of wastage and wear-and-tear. What Mrs. Sinks of Surbiton doesn’t realise is that for the privilege of going out at any moment and buying a chicken ready for the oven, she has to pay for all those other times when the chicken was waiting for her and she doesn’t want it”.

This last quote is so relevant to what I hear in conversations that I have today. Consumers (or “individual eaters” for a less pejorative term these days) tell me at length either about how wicked it is that the supermarkets charge so much and make such large profits, or at length about how they are prepared to pay more in order to get quality, or fairness, or whatever, and how wicked it is that supermarkets charge so little for (junk) food. Producers, suppliers and retailers tell me about the difficulties of maintaining incredibly tight NET margins averaging around 1-2% of turnover, but I also find that increasingly, I am looking at the money that vanishes in between. I am also taken with looking, as Bell does, at the problem from the other side, the non-consumer side. Here in the UK, for example, food manufacturing, processing, distribution and selling accounts for some 29.5% of GDP, employs 14% of the workforce and accounts for £22bn of exports (including quite a lot of scotch whiskey). Yet, of the 6,000 companies in the industry (excluding farmers, around 2% of national production), 5,800 are small or mid-sized entities and nearly 1500 are teetering on the edge of insolvency.

What is included then, in a conversation about accounting and the public interest? A surprising number of topics, in fact, which include: subsidies and support from government; the public cost of deleterious consequences of the food industry – public in terms of social and environmental damage; individual costs in terms of health and well-being; pay inequality (there are attested reports of workers in supermarkets having to use foodbanks, whilst executives can be very highly remunerated); the whole cheap food debate linked to the real costs of production; power and capitalism, evinced in the extreme concentration of production and selling in the hands of a few businesses. These debates are already out there but I promised to discuss what things go under the radar, which is what I research. Here are three of them: commercial income; discounting in negotiations and the growth of food service. There is also the nature of narrow margins, marginal costing, performance measurement and risk assessment and their effect on the fairness of the industry*. Enough for a book, let alone one blog post, so I am just going to focus in on commercial income.

In the UK, the largest supermarket (Tesco) was acquitted on charges of fraud related to an overstatement of £250million in its profits. What is not in dispute is that the overstatement related to recognising commercial income in advance.

Following disquiet on its commercial income, the supermarket Morrisons in the UK started to lead the industry on disclosures of this activity in the annual report but only from 2014/15. The Germany-based discounter, Aldi (recently spotted in an outpost in Ames, Iowa and a significant rising player in the UK), states clearly that it does not use commercial income in its purchases.

In the US, as one BBC article reports, “According to Fitch, the credit rating agency, the payments are the equivalent to 8% of the cost of goods sold for the retailers, equal to virtually all their profit.”

So, what is commercial income? Briefly, it is income from suppliers to retailers. This, of course, should elicit the response ‘What, hang on a minute, customers pay suppliers, right, not the other way around?’ This is to fundamentally misunderstand the nature of multiple retailers (supermarkets). In fact, the new terminology handily loses the term ‘market’ but that is what they are offering and managing. Like a marketplace, you pay the market owner for a place and their ability to bring people in to buy. You might reward them for doing the latter well and for selling large quantities of your product. Commercial income, then, includes a raft of payments extracted from the supplier for the privilege of supplying – space, bonuses, discounts offered and so on. However, supermarkets are also now driven by customer demand (created largely by the supermarkets themselves) for full shelves, full choice all year around. Suppliers tied into the system, already taking the slimmest of margins for their products because the margin needed by the retailer to run their system is substantial, are bound to deliver in full, to specification, on time. For some supermarkets, the slightest infringement of this incurs penalties, also accounted for under ‘commercial income’. The supplier might well lose the payment for the consignment as well. An article in the British weekly industry publication in 2015, ‘The Grocer’ lists around 30 different types of commercial income.

Essentially, supermarket profits do not come from consumers, they come from suppliers. Link that with extended payment terms and it becomes clear why small and mid-size food companies, and their employees, are at risk. It is not a case of ‘supermarkets bad, suppliers/consumers good’. There are retailers have records of working to build long-term beneficial relationships with some suppliers and many consumers themselves prefer to shop under the radar than visibly in a local shop, and to have the perceived convenience. The job for accounting researchers is to help devise possible alternatives to enhancing profits that do not involve commercial income, low wages and non-affordable food. That really is a research challenge.

Pay Your Dues and Get Abuse

Editorial Note: We are delighted to publish the following editorial by Paul F. Williams, the 2013 recipient of the Accounting Exemplar Award. The content is representative of the quality of the material that our colleagues will share at our 2019 Midyear Meeting in Orlando next week.

We hope to see you there! As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.


Paul F. Williams is a Professor of Accounting at the Poole College of Management at North Carolina State University. Paul earned a BSF from West Virginia University, and MBA and Ph.D. degrees from the University of North Carolina at Chapel Hill. He joined the N.C. State faculty in 1985 after spending 1977 to 1985 at Florida State University. His research interests include accounting ethics, theory, and critical perspectives in accounting. His publications have appeared in Critical Perspectives on Accounting, Accounting, Organizations and Society, The Accounting Review, Contemporary Accounting Research, Journal of Business Ethics, Accounting and the Public Interest, Accounting Horizons (for which he won the best paper award for 2014), among many other journals. He has served as chairperson of the Public Interest Section of the American Accounting Association and as editor of Accounting and the Public Interest. He received the Public Interest Section’s Accounting Exemplar Award in 2013.

An astonishing event occurred at the 2016 Centennial meeting of the American Accounting Association (AAA). Even more astonishing is that the event went largely unremarked – it passed into history without disrupting the normal life of the North American accounting academy. That it might not be obvious to many of you who happen to read this blog to what I am referring proves my point. It also says something about AAA leadership and even more about AAA members. What it says about us as members of AAA is not encouraging. The event to which I refer is the Plenary devoted to the proposition that accounting will be a learned profession by the year 2036. That obviously means, at least in the opinion of the AAA leadership, accounting is not as yet a learned profession. The astonishing part of the public admission that accounting is as yet not a learned profession is that a characteristic of professions is that they are, by definition, learned. There cannot be an un-learned profession. Would the legal profession or the medical profession ever publicly admit they were not yet learned? A lot more to learn, yes, but not as yet learned? We should be embarrassed by such an admission since we have already had over a century to become learned.

That law or medicine (or any other academic discipline) would admit to such a thing is not likely. This is so for at least two reasons: 1. Something is being learned by someone in order to be admitted to the discipline and that something is substantial and continuously tested with some process for ascertaining the value of that something, and 2. There is not a monolithic organization that controls the process by which something enters the canon of what is permissible learning and what is not. Unlike medicine and law where research and practice are intertwined, the accounting academy in the U.S. is unusual in that the something to be learned to be admitted to the practice of accounting is determined largely by the rules promulgated by regulatory bodies (e.g. FASB, IRS, SEC, PCAOB, etc.). Perhaps only second to the military is any field so dominated by acronyms as accounting – acronyms that stand for organized bodies writing rules. The academy produces very little that actually makes its way into the canon which must be learned to be admitted to the profession (it does however contribute a great deal to what must be believed). Given the academy’s lengthy disinterest in the actual practice of accounting or the actual function of accounting in society, a promise to make accounting a learned profession seems a bit disingenuous.*

Law, medicine, or almost any other scholarly discipline is dispersed. There are vast numbers of people engaged in those disciplines without extensive centralized bureaucratic control. The natural sciences which provide us lay people with the template for the so-called scientific method could not function as sciences under bureaucratic control (the Lysenko affair in the old USSR is a case in point). Freedom to explore is essential to “progress.” There are no single organizations that legislate the structures or contents of scientific disciplines. For example, according to Hossenfelder (2018, p. 153) there were 2,000 physics PhDs awarded in the U.S. in 2012. Membership in the American Physical Society is 51,000 and the membership in the German Physical Society is 60,000. The sheer number and dispersion of people doing physics provides at least a freedom from control by anything other than the constrictions of the discipline itself, i.e., there are certain things you are no longer permitted to believe since they have been ruled out as believable by the discipline, not by an organization that controls the discipline through bureaucratic fiat.

Accounting, at least in North America, is, perhaps uniquely, a discipline where discipline is imposed by a bureaucratic organization. Accounting as an academic discipline is extraordinarily small compared to virtually all other academic disciplines. As the physics example illustrates fields in the natural sciences are populated by thousands of people. Accounting academics are relatively few in number and emerged as such largely in the U.S. Prior to the movement to make business disciplines more scientific, which began in the 1950s, accounting was taught mostly by people from practice and research in the sense of applying the methods of social science was non-existent. What shape a scientific approach to accounting would take was contested territory. The first quantitative applications in accounting appeared in the area of management. The developments in operations research that came about because of WWII appeared in TAR written by people like W.W. Cooper. Edwin Caplin was an early pioneer in introducing psychology to the investigation of accounting – thus was born behavioral accounting research. But the battle for hegemony over the accounting research agenda has clearly been won by the group that claims ownership of the financial reporting revolution. This is a clearly identifiable group of cohorts who matriculated at the University of Chicago between the mid-1960s and the early 1970s. Their significance is evidenced by the fact that the first four Seminal Contributions to the Accounting Literature Awards were given to work produced by that cohort. Apparently nothing of any intellectual value was produced prior to this group of persons steeped in neoclassical economics Friedman style and neoliberal ideology (Friedman was a founding member of the Mt. Pelerin Society).

Because there is a monolithic organization (the AAA) that manages the U.S. professoriate control of the AAA gives control of the agenda. The Seminal Contribution Awards** is a case in point. Perhaps some of you know how the selection process for that award works, but I don’t. Magically it is announced that one has been bestowed, but who does it or how it is done is a mystery. The AAA has a history of self-appointed elites as the laughable case of ARIA (Edwards, et al., 2013) illustrates. The doctoral consortium and the new faculty consortium were created as mechanisms for controlling the agenda. I attended one of the early doctoral consortia in 1974 and the entire program was dedicated to EMH and the methods of financial economics. A most vivid memory of that experience was the panel on which Sandy Burton was invited to speak only to be assaulted for his naïve understanding of the world by rebel soldiers in the financial reporting revolution. Some years later Gary Previts made an effort to introduce doctoral students to broader perspectives and had Tim Fogarty organize a faculty that included a Foucaldian, a leading accounting historian, a past editor of Issues in Accounting Education, an eclectic scholar, and an ethicist. Needless to say the reaction by the AAA’s director of research was one of extreme displeasure and none of those people were ever invited back.

The proclivity of the AAA toward bureaucratic control of the discipline is perhaps understandable. It is, after all, an organization populated mostly by people who lived in the culture of the accounting profession, a culture that places highest value on conformity. To me the latest outrage is the change in procedure for the selection of the best paper awards for Issues and Horizons. In spite of the changes in bylaws made a few years ago, there is no visible effect of those changes on the intellectual agenda of the AAA becoming more diverse. Horizons and Issues were created to devalue certain scholarship. TAR used to contain an Education section, but it was removed because rewarding someone with a TAR citation for writing about education was just not on. Comments were eliminated from TAR as well because a TAR byline could not be provided to someone who just wanted to comment, particularly if the comment cast skepticism on the content of TAR. Horizons was to be where articles that could be comprehended by practitioners were to be published, but it quickly became a paler version of TAR. Since articles in Issues and Horizons were not deemed serious scholarship the best paper awards for those two journals were left to a plebiscite of the members. The winners of the Horizons awards reflected the eclectic interests of the members. Papers dealing with education, systems, audit, history, epistemology, sociology of knowledge, and, yes, financial reporting were winners. This past year, however, the idea of letting the members choose from among all papers published in Horizons, was apparently deemed too risky. The AAA decided that might lead to the “wrong” kind of literature being noted as award winning. So the list of acceptable papers was pared to only five, all of which dealt with financial reporting. What little power the members have to shape what the AAA acknowledges as intellectually worthy has been taken away and without a whimper.

The people who gave us the financial reporting revolution and their successors have for some years now been expressing angst over the stagnant, banal nature of accounting research. As far back as 1991 a group of pre-eminent revolutionaries remarked on the lack of creativity in accounting research (Demski, et al. 1991). Judy Rayburn’s AAA presidency made central the issue of the lack of diversity in accounting research; she invited Anthony Hopwood (noted for Accounting from the Outside) to be her Presidential Speaker. Shyam Sunder made the theme of his presidency Imagining New Accountings and Greg Waymire pushed for Seeds of Innovation while proclaiming, “I believe our discipline is evolving towards irrelevance within the academy and the broader society with the ultimate result being intellectual irrelevance and eventually extinction” (Waymire, 2011, p. 3). But like the monkey with its fist inside the coconut shell, the leadership is incapable of relinquishing their ideological control over the nature of accounting as an intellectual discipline. Accounting research isn’t evolving toward irrelevance; it’s been irrelevant for quite some time. In spite of lip service to Imagining and Innovation, the management style of the AAA is to stifle Imagination and Innovation because that threatens the ideology and the associated reward structure that the financial reporting revolutionaries established nearly 50 years ago and from which they have so richly rewarded themselves. Virtually every North American doctoral program produces the same standardized education designed primarily to enable students to meet the standards of the so-called premier journals, which the revolutionaries also created. The accounting proclivity to standardize everything, even things we don’t understand well enough to standardize, has given us GASS (Generally Accepted Scientific Standards). I admit to being guilty of subsidizing through the dues I have paid this incoherent circumstance of needing more creativity in the academic process but allowing that process to be managed by an organization that has repeatedly demonstrated its inability to cede its autocratic instincts. I have been waiting for decades for our “I’m as mad as hell and I’m not going to take in anymore,” moment. It appears it will never come.

* The history of accounting academia post WWII with its fixation on price level effects and income theories, the creation of JAR and its positivist ideology, and the information metaphor itself stem from intellectual contempt for the premises of accountants in the field. With the exception of Ijiri, the academy abandoned a long time ago the discourses that informed practice because they were intellectually inferior to those of neoclassical economics.

** “Seminal” is apropos since all of the winners so far have been men.

Are Annual Audits still “Fit for Purpose?”

Editorial Note: We are delighted to present the following editorial column by Nick Shepherd, President of EduVision. Nick currently chairs the CPA Canada Committee for developing Statements in Management Accounting.

As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.

Annual reports together with various supplementary requirements and filings are important for boards, investors, rating agencies and others as a foundation to assess and determine the financial health of an organization. Historically this has worked reasonably well; up until the 1970’s most of the corporate value – an average of 80% – was reflected on the balance sheet. If the audit revealed the integrity of assets and liabilities, there was a reasonable expectation that the business was healthy.

Fast forward to today. Most corporate value for owners, investors and others is now intangible with only an average of 15% represented by financial assets. While certain intangibles can be capitalized and included on the balance sheet, the majority are nowhere to be seen, nor are they assessed or reported on through the audit. If an audit is designed to provide reasonable assurance of organizational health and integrity, doesn’t basing this on the verification of only 15% of the value seem high risk?

There is continuing criticism of auditors and the profession for failing to alert investors and others to potential risk when organizations fail – yet how can the profession shoulder the blame when its scope and mandate are determined by compliance with standards that focus principally on tangible assets and liabilities? Apparent failures in oversight and governance approaches are not attributable to the profession alone, but the profession does have a responsibility to reflect on its own role and determine whether the principles that were initially established for audits are still meeting their goals. When significant “sea change” occurs, it requires re-invention rather than improvement. Is society changing the expectations and rules that make an audit relevant? Or are we “re-arranging the deck chairs on the Titanic?”

Customers of the audit profession are increasingly asking for additional information to enhance their risk assessments; this has resulted in regulatory changes as well as voluntary supplemental reporting. In certain jurisdictions, certain supplemental reporting – such as environmental and social issues – are now mandatory. A major thrust is being implemented by those adopting “integrated reporting,” but in most cases, this is not mandatory, audited or based on strongly established standards. A “sea change” it is not! The financial profession does not appear to be front and centre in driving fundamental change, apparently believing that its focus on financial capital remains adequate. Yes, changes are being made, but progress is much too slow; thus, the risk of “surprises” continues to increase.

The profession must start asking some fundamental questions in order to drive governance and accountability changes so that audits are fit for purpose. As a start, let’s consider the drivers of sustainable corporate value creation, and try to “peel back” corporate performance in the areas that might give investors an increased visibility into risk.

From a financial perspective, two sources of cash flow are critical to a sustainable business. First, for most organizations, more than 60% of expenditures are driven by employee costs; yet employee productivity and effectiveness are hard to measure, other than at the macro level. However, we do know that most employee costs are traditionally considered period expenses that convert inputs to outputs.

This is no longer the case, with large portions of employee expense related to building “capacity,” i.e. the contribution of intellectual capital that provides history and process capacity, as well as innovation in process improvement, new products and services, and relationship building with third parties. Only “motivated” employees will do this continually and effectively. To be a sustainable business in the future, the audit should reveal:

    • The overall level of expense committed to employee costs, with a split showing (hopefully) a declining share going into repetitive conversion costs, and a growing share committed to building “intangibles for the future.” Key indicators might also include “strategic reassignments” that give perspectives on whether management is committed to redeploying staff as a result of change versus firing them (which does not create motivation).
    • Levels of employee engagement at a depth of detail that is more than just a general percentage. What is needed is visibility into alignments of individuals, teams and departments with organizational purpose, both in “task” (the work of the business) and also critically in behavior (the stated conduct of the business that is driven by its culture and its understanding of ethical compliance).
    • Leadership effectiveness. Disengagement comes from a gap between what organizations state they do, versus what employees see from leaders. The effective development of internal leadership, accompanied by the results of 360° assessments based on corporate values, would start to identify areas of concern if they exist. It might have been interesting to see what indicators of this type would have shown for some of the banks involved in recent scandals.
    • Focus on “behavioral based” internal controls. Process controls are no longer adequate in an environment where high levels of delegation take place, leading to individual autonomy (this also applies to controls and relationships with third parties. such as outsourcing providers). Stronger reporting is needed on ethical hiring, leadership values and behavior, whistle blowing, levels of employee stress, illness (especially mentally related issues), and other behavioral aspects.

Overall, what users need to know is whether approaches to the workforce are protecting human capital sustainability through effective nurturing and development of people.

The second core cash flow is “cash flow in from customers.” Areas such as retention rates, repurchasing patterns, repeat customers and others are all important, but especially critical are relationships. One factor that could be more fully implemented into annual reporting is the stability of brand value.

The attached table shows 2018 data regarding the year end and most recent brand valuations by either Interbrand or Brand Finance (we used the higher valuation). This table demonstrates that, although the “pure audit” of financials provides insight into book values (i.e. balance sheet / shareholder equity), the shareholders value of their investment (i.e. the market value) is much greater.

Several key questions should be of interest to the investor. Using the traditional audit, is the integrity of the balance sheet acceptable? Is the brand value, as calculated by independent third parties, increasing or decreasing? If so, why? And what is the impact on this for the future? For instance, was a potential “auditable” cause the diversion of human capital resources away from customer support activities to enhance financial capital results? Finally, what makes up the ‘other intangible assets’ that contribute a key part of an investment valuation, but that are not being assessed or audited?”

One key failure of the accounting profession is to grasp and modernize the assessment of goodwill. On a sale or purchase of a business entity, it is the “market value-based intangibles” that end up on the acquirer’s balance sheet that must be assessed for “impairment.” How can an auditor do this effectively if the drivers of this value have not been clearly determined?

As can be seen from the table, book values range from 5.9% of value to 24.4%, and it is these underlying valuations of “financial capital” that a traditional audit discloses. If these are examples of the impact on financial capital of the growing knowledge economy, then one can only conclude that audits that remain focused on financial capital alone are not “fit for purpose.”


Reimagining a More Ethical and Sustainable Management Accounting Curriculum

Editorial Note: We are delighted to present the following editorial column by Richard Kravitz, the Editor In Chief of the CPA Journal. As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.

Furthermore, the opinions expressed below do not reflect the position of the CPA Journal, The New York State Society of CPAs, or the Board of Directors or Executives of the New York State Society of CPAs.

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. This article focuses on the components of value creation within publicly traded multinational corporations. It also addresses how these valued components are all but ignored in the accounting classroom, in AACSB’s model curriculum for accounting education, and by the majority of our accounting professoriate.

Accounting is a practical discipline. It focuses on the application of skills and knowledge that enable practitioners to identify, measure, monitor, control and report on business activities. However, the real drivers of long term value creation within the modern global corporation are no longer measured by these traditional accounting tools. Financial accounting, cost accounting, and managerial accounting methodologies provide little guidance on how to accurately report on the condition and value of global business. Accounting information teaches us very little about great companies whose great products and services drive our postmodern global economy.

Similarly, accounting information ignores the dominant creators of long term sustainable value, i.e. the growth drivers of modern enterprise. Accounting rules even expense many of the value creators, such as reputational capital [brand marketing], intellectual capital [patents, trademarks, business method processes], human capital [talented workforce], social and relationship capital [infrastructure, health, education and safety], and others.

Accounting also does not account for the impact that global corporations have on society. For the past 20 years, organizations such as Ceres, the GRI, the IIRC, the UN Global Compact and others have been looking at this issue. Mervyn King, founder of the IIRC, for example, focuses on the evolution of the corporation from share value to shared values, and from a shareholder centric to a stakeholder centric perspective.

Nevertheless, the average time a shareholder in America owns a US public company, according to Prem Sika in the The Myth of Shareholder Ownership, is 22 seconds.  Even Larry Fink, the consummate Milton Friedman capitalist who heads Black Rock, now suggests a new approach to corporate earnings: “Profits With Purpose.” But accounting does not measure purpose.

Finally, the lack of relevance of accounting information was amplified by luminary NYU professor Baruch Lev in his seminal work, The End of Accounting. According to Lev, “financial information contributes only 4-5% of decision relevant information for investors.” What a loss for accounting relevance.

The Critical Role of Accountants in our Post Modern Global Economy

While our training may be suspect, the role of accountants in society is not. Accountants are even more critically important in today’s global society; they are arguably more important than ever. Indeed, accounting remains a critically important gatekeeping profession.

The obligation of accountants, as its founders passionately argued, lies in their ethical responsibility to protect the public, and to insure public trust. Accountants are the historical stewards and fiduciaries of the public interest. Indeed, accountants protect the public from corporate mischief. They help insure honesty and trust in our institutions. And they report on companies that are too good to fail, too strong to fail, and yes, even too big to fail.

Accounting in a Global Environment – What has changed?

This is not our parent’s world from a global corporate perspective. It is not the world that existed even 40 years ago:

• 52 of the largest economies of the world today are multinational corporations, not sovereign nations.
• The top 2000 companies generate more than 50% of the global GDP.
• The market cap of Apple, at almost one trillion dollars, even after decline, is larger than the GDP of all of the European Union Countries except for two.
• The market cap to book value of the top 5 global corporations is between seventy five to a hundred to one. US Steel, the consummate brick and mortar corporation, on the other hand, still boasts a ratio of market cap to book value of about one to one.
• Walmart employs 2.7 million people, half the population of New Zealand.
• Google uses more electricity than the country of Sweden.
• 85% of the federal government expenditures of the United States are made to corporations, including transportation, defense, and nuclear power firms, as well as various other organizations that now perform tasks that government once performed.
• Today, corporations impact societies and stakeholders to a greater extent than at any time in history.

The Exponential Growth of Intangibles

So why is there such a huge divide between traditional accounting measurements, and between book value and market caps? What has happened during the past 40 years is revolutionary. According to the authors of Capitalism without Capital, the intangible revolution has impacted society far more than the industrial revolution of a few hundred years earlier.

87% of the value of today’s postmodern global corporation [per Ocean Tomo] lies hidden in its intangibles. These hidden assets or strategic resources do not appear on the balance sheet, income statement, cash flow statement or in retained earnings. They do not appear in inventory, goodwill, or tangible long term assets. They do not appear in the pages of accounting texts.

Strategic resources [such as intangible or hidden assets] power society today. Strategic capital drives long term value creation in our postmodern global corporation. Cost accounting texts ignore them, but they are familiar to all of us. These hidden intangibles include knowledge, data, information and ideas. They are the conceptual assets and creators of corporate value today. In fact, the investment in intangibles at 2-3 trillion dollars a year is now the dominant creator of corporate value. Intangibles include intellectual property, patents, trademarks, brands, brand identify, a skilled and talented workforce, business method patents, business processes, and supply chain sourcing.

Financial accountants and auditors hide conceptual assets from the public. They are expensed or hidden from the balance sheet. Conceptual assets are buried in SG&A or Cost of Sales, with the exception of those conceptual assets which are acquired or booked on the balance sheet for financial statement disclosure purposes. This is not deliberate; it occurs because accountants have not been trained to recognize intangibles.

Realigning Accounting Education

Accounting students invest 4 to 5 years of their lives in accounting schools. They hone their skills on traditional financial and managerial accounting techniques while ignoring 87% of the value of the global corporate enterprise. What a loss for accounting’s relevance. What a huge hole, then, that exists in the education curriculum. In future blog posts, I will suggest a realignment of accounting education.

Accounting and the Public Interest

We usually begin our blog posts with a customary disclaimer that our columnists only speak for themselves, and do not express the positions of the AAA or of any other party.

This post, however, is different. Our columnist Amy Hageman does speak for us! She is the incoming Senior Editor of our section’s flagship journal Accounting and the Public Interest (API).

We are delighted to introduce her to our members with this blog post. Welcome, Amy, to your new role. And thank you for your contribution to our Section!

My name is Amy Hageman, and I have the honor and privilege of serving as the Senior Editor of Accounting and the Public Interest (API) for a three-year term, beginning in January 2019 through 2021. API has a rich history of excellent Editors, and currently has an outstanding group of Associate Editors and Editorial Board members. This journal serves an important role in our field – as it is an American Accounting Association (AAA) section journal focusing on socially responsible accounting research. The journal has a history of publishing work from leading accounting academics – and I believe this trend will continue as universities’ emphasis on showing how accounting research positively impacts society continues to grow. I am excited to take on the role of Senior Editor of API, as I want to positively influence the future of this journal by increasing its presence, quality, and efficiency, and in helping to establish API as one of the top specialty accounting journals in the field.

Currently, my primary objective is to build on and expand the tradition of excellent scholarship published by this journal, as well as enhancing the efficient administration of API. One of my aims is to provide guidance to submitting authors to enhance the quality and contribution of their work, as well as working across other AAA sections to identity potential submissions that could further our understanding of how accounting affects the public interest. In short, I am striving to continue the tradition at API of aiming to publish articles across a wide variety of functional areas of accounting using an equally-wide array of methodologies.

These are several opportunities to improve the impact of API. A long-term goal is to see an increase in citations of published articles in API, and for more universities to positively evaluate API in making promotion and tenure decisions. One strategy for potentially increasing the journal’s impact is to consider publishing special issues, which have the potential to increase both readership and citations. One possible idea would be a special issue dedicated to a specific theme. Potential themes could include professional and business ethics, governance of accounting organizations, social and environmental accounting trends, or responsible actions by governmental and non-profit accounting entities. Another possibility would be to devote a special issue to increasing the journal’s impact beyond the United States – such as a special issue on U.S.-Canadian issues, or on accounting issues that are emerging in Europe. Such a special issue may be a way of reaching contributors who may not have submitted to API in the past. Another is to potentially hold a special conference tied to the journal.

Overall, API is an outstanding journal with a rich history and an even brighter future. As I begin my three-year Editor term, my goal is to strive to act as an excellent steward of this journal and to work to further improve both the quality and overall impact of API. Thank you for entrusting me with this role, and I look forward to working together to disseminate public interest-related research in API.

Redefining Audit Quality

During the past two weeks, our contributing columnists Steven Mintz and Sri Ramamoorti shared their perspectives on the topic of Audit Quality. This week, Michael Kraten completes the trilogy of blog posts by asking whether the profusion of unaudited sustainability data should compel our profession to modify our definition of audit quality.

As always, when you read the comments of our columnists, please keep in mind that they only speak for themselves. They are not expressing the positions of the AAA or of any other party.

We are presenting this trio of articles to illustrate the rich editorial value of the conversations that you will join when you attend our Midyear Meeting. Please keep in mind that the manuscript submission deadline of our meeting is Monday, January 14, 2019.

Are you aware of the massive volume of disclosure data that is defined by the Global Reporting Initiative? A firm that fully complies with the GRI’s directives must report on 3 sets of universal standards, 6 sets of economic standards, 8 sets of environmental standards, and 19 sets of social standards.

How about the Sustainability Accounting Standards Board? Its standards encompass a set of 77 industries.

And the United Nations? It has defined 17 Strategic Development Goals.

These data sets have become so massive that organizations now require guidance to determine how to organize it all! And thus another entity has developed a framework to meet that need; the International Integrated Reporting Council defines 5 governance, 4 business model, and 6 capital factors that can be employed to structure the reported data.

Because these data sets are gigantic in size, corporate sustainability reports are expanding into massive tomes as well. Let’s assume, for instance, that we are interested in researching Coca Cola’s sustainable agriculture policies and metrics. We would begin by reviewing all 21 pages of its Sustainability Report for 2017. We would then read its 13th page on Agriculture more intently.

What next? A link on that Agriculture page would take us to Coca Cola’s full 2017 Agriculture Update. On that web page, we would find additional links to information about the organization’s Sustainable Agriculture Guiding Principles (SAGPs), Seven Steps to Supplier Verification, 5bv20 Supply Chain program, fifteen research studies, a set of climate protection goals, Field to Market program, Farm Sustainability Assessments, Sustainable Agriculture Initiative Platform …

… and the list continues.

These disclosures are clearly voluminous in length and dense with content. But how much of it was subjected to independent assurance activities?

Hmm. It’s a bit difficult to find the answer to that question. The very last page of the 2017 Sustainability Report sports a circle entitled “Assuring The Adequacy Of Our Disclosures.” A click on that icon carries us to a web page with a brief section entitled “Assurance 2017.”

That section contains a link to Ernst & Young LLP’s Review Report. How much of Coca Cola’s sustainability data was reviewed by the public accounting firm?

Four metrics.

Not much, eh? The Review Report only addressed Coca Cola’s Greenhouse Gas Emissions value of 5.54 millions of metric tonnes, Water Replenishment percentage of “More Than 100%,” Water Use Ratio of 1.92, and Lost Time Incident Rate of 0.57.

Furthermore, although the scope of E&Y’s independent review work was limited to these four measurements, it still failed to address key concerns about the validity of Coca Cola’s water replenishment and use disclosures.

We usually define audit quality in terms of assessing the validity of the information that is presented in the Annual Report. And we often expand that definition to the supplemental disclosures in the 10-K and 10-Q reports.

But should we also consider the massive amounts of data disclosures that are presented to the public outside of these traditional reports? Would it be helpful to redefine our concept of “Audit Quality” to encompass the extent to which the auditors are, in essence, ignoring other critical public disclosures?

Michael Kraten, PhD, CPA is a Professor of Accounting at Houston Baptist University. He is also the President of AQPQ Management Consulting.

The Future of Auditing

Last week, our contributing columnist Steven Mintz led off our three part series on audit quality by addressing the topic of mandatory audit rotation. This week, our columnist Sri Ramamoorti continues the conversation by discussing the Expectation Gap, the Information Gap, the need for non-GAAP measures, and the future of auditor education.

We acknowledge, and thank, The CPA Journal’s Editor In Chief Richard (Rick) Kravitz for permitting us to repurpose and reposition content that originally appeared in the February 2017 edition of his publication. The material appeared in an article entitled The Future of Auditing: A Roundtable Discussion; it is available online in its entirety.

Rick is a friend of the AAA Public Interest Section. He is a frequent presenter at our meetings and symposia, and is a contributing columnist to this blog as well.

Dr. Sridhar Ramamoorti, ACA, CPA/CITP/CFF/CGMA, CIA, CFE, CFSA, CGAP, CGFM, CRMA, CRP, MAFF, is an associate professor of accounting at the University of Dayton. Previously, he was an associate professor of accounting and director of the Corporate Governance Center at the Michael J. Coles College of Business at Kennesaw State University. Dr. Ramamoorti was also a principal in the Professional Standards Group of Andersen Worldwide, Sarbanes-Oxley Advisor for Ernst & Young’s National Advisory Practices, a Corporate Governance partner with Grant Thornton, and was a principal leading the governance, risk and compliance (GRC) practice of Infogix, Inc. In December 2016, Dr. Ramamoorti completed a three-year term on the prestigious Standing Advisory Group of the Public Company Accounting Oversight Board (PCAOB).

Why are we utilizing our blog in this manner? We are showcasing our perspectives in order to generate interest in our midyear meeting. If you would like to present your own work about accounting and the public interest, please keep in mind that the manuscript submission deadline is Monday, January 14, 2019.


Sri, in our previous blog post, our colleague Steven Mintz suggested that mandatory auditor rotation may help address certain challenges that confront the audit profession. He cites KPMG’s 109 consecutive year audit relationship with GE as one that is ripe for rotation, in light of GE’s recent travails. What do you think?

You know, the medical profession’s lament applies to us, too—that the operation was successful, but the patient died. All we are able to assure as auditors are the standards and the processes that are the inputs to the audit. But we are unable to guarantee the outcome. Yet, the first thing that happens when there is the collapse of a company, perhaps because of poor governance or a terrible business model, is that the business failure is almost immediately equated with an audit failure. And we have to live out the consequences as a profession. I think this is also going to be part of the education of the public, that we can’t be held responsible for a mistake that is being really committed by company management and their governance.

Having said that, any century-old relationship between an audit firm and its client certainly raises questions about the lack of independence in appearance. The optics aren’t good, even if the client is growing and profitable.

But don’t users of financial statements expect auditors to be held responsible for such mistakes? And if there is an expectation gap, is there also an information gap?

On this issue of the expectations gap, as far back as 1988, the MacDonald Commission in Canada very systematically broke it down into three separate gaps. One was the standards gap, another was the performance gap, and the third was the communications gap. That’s one framework.

More recently, in 2012, the International Auditing and Assurance Standards Board [IAASB] talked about the information gap. There is a lot more information than what appears in the financial statements, and hence, the recent pressure on the profession to look in some way or the other at these non-GAAP measures. They’re just proliferating, and it’s clear that there is much more that investors and other stakeholders are demanding to know. In a world that is awash with information, I think these demands have gotten only worse. Herbert Simon, a Nobel Prize winner and a polymath, said, “a wealth of information creates a poverty of attention.” Simon perceptively noted that many designers of information systems incorrectly represented the design problem as information scarcity rather than attention scarcity. We don’t have information scarcity; we have information abundance. Attention scarcity is the real issue.

He went on to say what was really needed were systems that excelled at filtering out unimportant or irrelevant information. This is going to be one of the future jobs of the auditing profession, to serve as that filter in such a way that we define relevance to our stakeholders. That really allows us to become trusted as a profession, because people don’t know what’s relevant and what’s not. We are really becoming the curators of information in terms of its underlying quality, its relevance, and providing that decision context in which stakeholders can maximally use that information. The recent proliferation of non-GAAP measures, potentially more relevant but perhaps less reliable, is highlighting this perspective. In a way, I am merely expanding on what the AICPA’s Elliott Committee concluded in its 1996 Report.

It sounds like you’re calling for the development of Integrated Reports that include both GAAP and non-GAAP measures. Are we adequately educating auditors to perform assurance activities on such reports? Or do we need to modify our education practices in creative ways?

I’ve always wondered why ours is probably the only discipline—I won’t say profession—in which the word “creative” is a bad word. Creative accounting is not a bad thing. After all, as Albert Einstein famously remarked, “Imagination is more important than knowledge.”

H. G. Wells maintained that it is nature’s inexorable imperative that you either adapt or perish. One may choose not to change, however, because survival is not mandatory. Given all the change that we’re seeing, if we remain in the status quo, we’re finished. We have to be grabbing at these opportunities to become more relevant in a fast-changing world.

In my opinion, we are facing a human capital crisis in the accounting profession. However, the problem is not with the young people who are entering the profession. They are actually very smart. There are these very advanced and sophisticated technologies that are really putting the lie to what used to be big problems. They can be solved, but you’ve got to be creative. And you need to master some of these new technologies.

For instance, let’s think about the classic problem of finding a needle in a haystack. Pretty difficult, isn’t it? And yet, some of our young professionals might suggest that we wave an industrial grade magnet over the stack, and the needle will simply jump up.

To me, the need for being creative is fulfilled by having a diversity of experience, curiosity, and the ability to learn continuously. These are the kind of people we’re looking for, and the profession should be able to attract them. The worst type of auditor we could have in today’s world is the gullible auditor. We want the skeptical auditors who will not accept answers at face value. They’re always going to dig deeper. We want to attract these kinds of insatiably curious kids into our profession.

I think it’s going to require a different skill set, a different kind of ability among young people. I’m not sure we want the types of students who did really well only in accounting, as in the olden days.

Are we, as a profession, up to this challenge?

We started by talking about the past, the present, and the future. And that progression, to me, gives us the opportunity to use hindsight to get insight, which hopefully will allow us to get foresight.

Sigmund Koch, a very famous and distinguished professor of psychology at New York University, in 1985 observed that the mark of maturity of a profession is its ability to do soul-searching. And so the fact that we are doing this kind of [discussion] is itself evidence that this is a profession that has that capacity, that is willing to look at itself critically. The profession is a prestigious one with a glorious history. You cannot have true accountability without proper accounting, so I have tremendous hope for the future.