This debate needs many contributors, from many jurisdictions and from the different roles that constitute our profession. So, I thought we should start by discussing the matter with the person who has been, for the best part of the last decade, at the heart of how accounting is to be understood, taught and learnt globally – Michael Wells, who was kindly willing to share with us his point of view. (A conversation with Michael Wells on the future of the accounting profession, by Marco Mongiello, Editor of RSM Reporting)
MM: What is brewing in the debate on the future of our profession?
MW: For nearly a decade I served on the Consultative Advisory Group (CAG) that advises the International Federation of Accountants (IFAC) and the International Accounting Education Standard Board (IAESB) that set the International Education Standards (IESs) for the accounting profession. We had very good debates at the CAG about the qualities that are needed today, i.e. what qualities a professional accountant should have and how they have evolved over time. I believe that IAESB has effectively updated the IESs, moving from an input-based approach to a more competence-based approach, driven by some real champions of the new approach. Among them, the Canadians are a great example of a profession that leads by mapping the competencies that an accountant needs today and then aligns the professional qualification accordingly to produce accountants who have those qualities. Their work is built on by others too. The South Africans, for example, embraced the Canadian competence-based approach when they re-aligned their professional qualification. In the US too, there is a Pathways Commission (1) that is doing ground-breaking work; this is changing the view of what accountants do and the qualities that aspirant professional accountants need to develop to excel.
If we ask the average person in the street ‘what is an accountant?’ the picture they have in their mind is usually the grey boring old ‘bean counter’. Today, the qualities of an accountant are necessarily very different. Part of the work of the Pathways Commission (2) is to change the image of the accountant, but of course, this requires changing the way we produce accountants so that they have the skills that businesses need today. The main drivers of change are technology and, perhaps to a lesser extent, globalisation.
Just before this interview you paid for our coffees using your iPhone; all the bookkeeping of that purchase has been automatically captured by the technology that enables the contactless transaction, and that was a very small coffee shop. At Tesco [a major international supermarket chain], when I do my grocery shopping I use a hand-held scanner to scan the products I put in my basket. All the bookkeeping is done by the system. The days of bookkeeping are gone. Too many people in the education of accounting are still training bookkeepers though. This is not to say that people should not know how to do journal entries, but the real skills that accountants need for the future (and even today) are the ability to make judgements and estimates, and the ability to apply principle-based standards. The skill set has changed a lot; there were a great number of people in the accounting profession whose jobs involved mainly bookkeeping, and I think those jobs are gone. The good thing for us accountants is that we will no longer be seen as ‘bean counters’, because there is no more bean counting left to be done!
The real job of the profession is now based on higher level skills, making judgements and estimates, understanding the economics of a transaction and then making sure that the accounts reflect the economics. I think that it is a much more exciting time to be an accountant now! The image of the accountant is lagging behind the role of the accountant. Some of the institutes in the world are battling to re-align their education to the needs of the market, and it is not an easy thing to do. If, for example, you come from a system that mass-produces accountants, and you rely on machine marking multiple-choice questions then those are environments that make it difficult to change. But some of the institutions at the higher end of the profession have not focused on mass production of accountants. I think that they have the competitive advantage of becoming much better in the future because they are already effectively providing skills that the market demands. Some parts of the world through globalisation have received a disproportionate share of bookkeeping through outsourcing; in those jurisdictions people feel that there is an increased demand for bookkeeping, but this is just temporary. In the same way bookkeeping is disappearing today in the UK, it will disappear tomorrow from those jurisdictions that currently do the outsourcing because the technology is changing very effectively and the outsourcing is creating a temporary distortion that could lead some jurisdictions to develop large numbers of bookkeepers. And the last thing a professional institute should do is to produce bookkeepers who will not get jobs!
Some of the research that has been done by the biggest professions in the world is about how to respond to changes. The American Institute, for example, looked at how they should revise their qualifying examinations to provide the skills that are more appropriate to today’s market. However, I think they found it difficult to fully implement the recommendations that flow from their research, because it is difficult to change one’s model. Introducing innovations like capstone multidisciplinary case studies and testing high-order skills (like judgements and estimates) when using machine grading systems is difficult. The education technology is lagging behind, in terms of producing tests that can assess judgements and estimates. Maybe the technology, in time, will be able to assess judgements and estimates, but the technology does not seem to be there yet. There is such a human element in judgement, because economic transactions can be very dynamic. How I see it is that you will not be training drivers when driverless cars will be common technology; similarly we should not be training bookkeepers if soon there will not be any bookkeeping left to do!
Rather, for the foreseeable future, accountants need more and more high-order skills in data-mining and analyses and in making judgements and estimates.
MM: Are there two levels of judgement? One level applied by the preparers of the accounts and the other applied by the users for the interpretation of the accounts?
MW: The preparer makes judgements in preparing the accounts. The auditor audits those judgements. The regulator regulates those judgements. The user has to understand those judgements, so that when they apply their own modelling, they understand what those judgements mean and put them in context with other analyses. It’s a judgements continuum and the users have to use that extra layer of judgement on, for example, what the future economy is going to look like, what the development of technology will be and all of those other aspects that can affect the firm’s performance.
MM: So, preparers, auditors and regulators have to apply their judgement while keeping in mind the final users of the accounts. However, nowadays many companies that are heralded among the most successful globally, show remarkably low profits (if not losses) and may struggle even to return significantly positive cash flows. Are these companies’ accounts apt to support analysis and evaluation of corporate performance?
MW: Well, there is more to it. Take a company like Apple, they outsource everything. In the traditional model of manufacturing your main asset would be your factory. This is no longer the case; now your main assets are intangible, and accounting fails on intangible assets, because most of them are off the books. (3) For accounting to be moving with the times, and for accounting to provide information that is most relevant to the end users, it needs to capture more of the economics, because, as you say, with the evolution of time it is not the physical easy-to-measure assets that are the main assets. The main assets are intangible and off their books. I think it is a failing of accounting that these are not captured in the reporting, because the end user has to, almost in a vacuum, try to make their own estimation of the value of those things. So, if the company was required to provide their view, their quantification, of the market perspective of what those assets are worth, showing what the process was that they used for that calculation, the user would have much more information to try and make their own estimates on the basis of the inputs that are provided by the company. Currently there is just no information! (4)
MM: Following up on your example of Apple, I would add that not only is the production almost completely outsourced, but also the product itself is not a product in the traditional meaning of the word; it is a platform that enables services to be exchanged by third parties, which often have nothing to do with Apple. This makes the estimate of the value of the product even more difficult.
MW: If we want financial information to be useful, which is the purpose of what we are doing, I think that we are due to make changes in what is on the balance sheet. Some of these things are fairly difficult to measure and the measurements are not precise, but that makes it all the more important that information is provided in financial statements on these most important things! Many people will argue that what we cannot do so precisely, and what’s not ‘reliable’, should not be reported, but I think we should focus on relevance, and put it on the balance sheet and disclose the inputs used so that users can make their own assessments of the judgements and estimates. My feeling is that if you get preparers to provide all the relevant inputs, they may as well also provide their own estimate of the value, as this would help the users to understand more about the management, given that the managers’ decisions will be based on those evaluations. Also, in this way the users may adjust the inputs according to their own understanding and, therefore, compare the results they find with those of the managers. Furthermore, changing the inputs and reflecting on the reasons for these changes help understanding how the economics have changed from one period to another period; the users have a view of how the inputs should have changed from one period to the other and they will question why preparers have used different inputs in different periods. All of this is good and valuable information. It is not the final number that is so important, it is the richness of the data that sits behind that number that is most valuable.
Paragraph 125 of IAS 1 requires disclosure of the most sensitive measurement assumptions (key sources of estimation uncertainty),so that you, me and the other readers can use them and make a judgement and understand them. How this input information changes over time is very important but you can also use it to compare across companies in the same industry. You can compare Volkswagen, Toyota and General Motors and ask why this one is using these inputs instead of those. Why is one using this model and another using another model when they are essentially in the same global market? Of course, comparison would be even more meaningful if all companies in the motor vehicle sector prepared their financial information using the same set of international standards. This point, I understand, Ford has expended a great deal of energy in making. No matter how the image of a car brand can be ‘dressed up’ to appear to be different from another, essentially the products, the cars, I think are all essentially the same (this is perhaps why the adverts of cars are all about feelings and image, rather than the technical differences).
MM: I remember reflecting with my students, quite a few years ago, on the income statement of British Airways, which was showing a long and detailed list of costs below its turnover lines of revenues from cargo and passengers. They would show all these costs as an implicit invite to the users to make their own calculation of gross profit and different levels of operating profit. My students and I reckoned, at the time, that this was determined by the elusive concept of service provided by airliners; was it just taking people or goods from A to B, everything else being administrative ancillary services, or were all these other services embedded in the main service? The choice of BA’s accountants seemed to be, at the time, to let the users decide.
MW: It makes a lot of sense to me and that is the reason why we [accountants] do not [have to] specify gross profit. For example, if you are in the agriculture business, you will realise that you must show the fair value of your biological assets. You show the fair value change at the time when it changes, not at the point of sale and this makes a lot of sense to me. Car manufacturers, by way of contrast, report gross profit when they sell a car. However, I think that there is real economics that happen when they take the raw material and the labour and transform them into a car. I think that this is where most of the value comes from. They are recognising no income from the compilation of these inputs and they recognise all of the profit at the time of sale; essentially saying that it is the sale activity that generates all the profit is simply not true! In agriculture they reflect the increase in value of the biological assets as it transforms; how different is a biological transformation from the transformation of raw materials into finished products, like building a car? I think there is little difference, but we have for so long been used to recognising profit only when sales occur that people might find it strange to recognise profit as the fair value of inventories change. Why do we not recognise the value when it is created? That is indeed a change in an asset!
MM: Are these reflections driven by the changes in business models and technology or would they have been applicable years ago, in the context of more traditional economies?
MW: I think we should have always done things differently. I think that what we did historically did not reflect the economics. I grew up in a farming family. We were required to do tax reporting. However, my father and uncle were in partnership and many times I heard them discussing: “how much could we sell this or that asset, or everything that we have accumulated in the business?” They were always looking at the fair value. Using the historical cost would have been completely meaningless. The fact that we have been doing accounting mainly using historical costs does not mean that we should continue doing it that way. In addition, markets have become more developed, and the more developed markets are, the easier it is to estimate fair value. Anyway, I do not think that if something is difficult, that is a good reason for not doing it. Lots of people have in their minds that accounting should just reflect what is certain, but there is little that is certain – everything is an estimate. If you use historical cost accounting for a machine, you must:
- determine the depreciation method that most closely reflects how the entity consumes that machine’s service potential;
- identify significant components that have a consumption pattern different from other components of the machine;
- estimate the machine’s useful life; and
- estimate its residual value.
Remember, residual value is essentially the fair value of an older asset. Moreover, when using the cost model impairment testing involves at least the same, if not more, judgement than fair value because you must estimate value in use and fair value less costs to sell. And on top of that, you must keep track of what the depreciated historical cost would be for the purposes of accounting for the reversal of prior period impairments. So, the argument that there is more subjectivity in fair value accounting than historical cost accounting to me is nonsense.
MM: From the users’ point of view, having to analyse so much more information may become difficult, unless technology can help.
MW: The most important thing is that the relevant information (numbers and words) is reported. Users particularly need information about the most sensitive judgements and the most sensitive measurement inputs. The value added is in forming a view on how that data will change as the economics changes going forward. One of the dangers is that some people may be tempted to crunch all sorts of information and try to give them a meaning they do not have. You can crunch as much irrelevant information as you like but if it is rubbish in, it is rubbish out.
What you need is good quality information coming in and then good modelling for good quality information to come out. This is why taking ratios from databases, which pretend that the operating profit of different companies have the same meaning, is dangerous and can lead to wrong conclusions being drawn. Even if you adjust the numbers for exceptional items, discontinued operations and other data that you may think is ‘noise’ (5),what is the quality of that number anyway if, for example, one company is revaluing its assets using revaluation and depreciation and another is using the historical cost depreciation? You cannot use those two operating numbers in a very comparable way. They are very different. When you have done revaluation, the depreciation has economic relevance, whereas the historical cost depreciation can be totally irrelevant and you are not necessarily provided with the information needed to adjust the irrelevant one to the meaningful one.
Depreciation reflects the consumption of service potential. When the asset is measured at fair value, you are showing a relevant economic consumption. Whereas the historical cost depreciation will show assumptions of the service potential but it is, if significant price changes have occurred, just an allocation of a now irrelevant number and that can be misleading. For example, when using the cost model, if you have two companies that manufacture cars, where one went to an emerging economy first to establish a factory at a relatively low cost and the other followed soon after when the cost of establishing a factory had become much higher, you may find that the first company reports selling cars profitably at prices significantly below the cost at which the second manufacturer can build its cars. This is rubbish! If the first company was to revalue their factory and therefore reflect in their depreciation real economic consumption, it would come out that they are losing money! Of course, it can be economically rational to sell cars below cost to penetrate a market, but to pretend in the accounting that you are making a profit when you are making an economic loss is just pretend! You are giving away revenue to get market share.
A numerical example:
I spend one million dollars building a car-making factory in a country that has significant car import tariffs. Subsequently, due to great improvement in the economy of the country, competitors also want a car factory there. Competitors come along and offer to buy my factory for four million. I reject their offers and a competitor builds a factory just like mine but costing four million. Now we are competing; in an attempt to stave off the competition I drop the price at which I sell cars to below the cost at which my competitor can manufacture its cars. The competitor sells its cars at that price too. If I use the cost model I show a healthy gross profit; if I use the revaluation model I, like my competitor, show a loss for every car that I sell. The cost model ignores the economics that both the competitor and I are consuming a four million factory! This is the craziness; IFRS allows me to show the profit or to show the loss. I can choose to pretend. IFRS also allows me to provide information that reflects the economics of a business and therefore I can choose to provide more relevant information, yet some companies still choose to pretend. I like to think that good companies will choose to show the economics. Why would they want to pretend?
MM: So to ensure that we develop our profession in the right direction, to be relevant in the future, what should we do?
MW: We should be developing the ability to make judgements and estimates, because that is what the accountants of tomorrow must be able to master. There will be no jobs for the bookkeepers; the machines have replaced the bookkeepers! Where the accountants will make a difference will be to make the judgements and estimates that are necessary to prepare, to audit, to regulate and to use the information. There will need to be more emphasis on valuation in the qualification of accountants, less emphasis on bookkeeping, more emphasis on understanding the economics, more emphasis on decision-making, more emphasis on sensitivity analysis, more judgements and estimates focus, and less focus on routine bookkeeping. The key is the integration of different subjects like finance, because being able to value something requires finance techniques. (6)
MM: …but also other subjects, which enable an understanding of the economic environment, the market potential of assets.
MW: Certainly: fair value is pervasive of many aspects of accounting. Take financial assets - even for those financial assets measured using a cost model, their fair value must be disclosed in the notes.
MM: The same goes with marketing, human resources, strategy, innovation and any subject that helps the accountants to gain a firmer grasp of the economics of a business and a better insight into the rationale underpinning its managers’ choices. The accountants will then be better equipped to rely on fully informed professional judgement and they will make estimates that truly reflect the intention of the company’s managers. Moreover, the accountants will provide the users with explanations of both judgements and estimates that really shed light on the economics of firms, helping the users to confidently navigate the challenging waters of fast-changing business models and markets.
In one sentence: lots of excitement ahead for our profession!