First, Do No Harm

By Humphrey Nash

It is the opinion of many scholars that Hippocrates did, in fact, originate the phrase, but in another of his writings, Epidemics, Bk. I, Sect. XI. One translation reads: "Declare the past, diagnose the present, foretell the future; practice these acts. As to diseases, make a habit of two things—to help, or at least to do no harm."[1]

The current GAAP accounting model is transaction and cost based.  It well declares the past (income statement), partially diagnoses the present (fair value), and completely fails to foretell the future.  The problem for accounting end-users (investors, analysts, management) is that all values must be realized in the future.  The current accounting model lacks relevance (decision-utility) to the extent that it fails to recognize the future.  In contrast, the AFTF (Accounting For The Future) accounting model is forward-looking and decision-useful.  It helps.

First, AFTF does no harm to capital markets.  One of the disciplines of AFTF is the dual validation.  The dual validation is a necessary and natural method of insuring that AFTF accounting values are scaled to capital market and economic values.  This means that reported company valuations will be of the same general magnitude as market valuations, i.e., a capital market fair value.  Thus initial AFTF company valuations will not radically differ from or disturb established company market values.

However, there will be an ongoing dialogue between the company and the capital markets, which will progressively refine those values. The capital market communicates its cost of capital (real yield plus inflation expectation plus risk premium plus volatility premium plus whatever) via market prices.  Management communicates its financial expectations via cash flows from validated cash flow projection models.  The dual validation coordinates and disciplines the cash flow models and the resulting values.  The cost of capital (discount rate) and the expected cash flows are clearly revealed, as are unfolding actual-to-expected cash flows.   If any of these or other AFTF financial reporting items are not what the market expected, the market will act accordingly to adjust prices and company valuations.

AFTF values do not simply reflect market values.  AFTF has the unique ability to separate new from old information so that current period economic progress is identified and valued.  Such progress may be internally created or externally imposed value.  Internally developed values may be discoveries, human capital acquisition or development, management actions or informed decisions, capital acquisitions, or revised expectations.  They may be tangible or intangible (future tangibles).  External forces may be economic conditions, competition, lawsuits, product approvals, world events, general capital market conditions, or revised company stock prices.  See the essay Disciplining Prospective Accounting for more detail on the dual validation and how it works.  See the essay The Historic Cost of Capital for some characteristics of the AFTF discount rate.

AFTF provides relevant high-level (processed) information, disciplines and structures to insure reliability, and a long-term view.  These should increase the accuracy and reduce the volatility of market valuations.  Capital market efficiency will improve.

Second, AFTF does no harm to the accounting profession.  AFTF vastly simplifies the theory and practice of accounting.  It preserves the traditional strengths of accounting and employs methods familiar to most practicing accounting.  It preserves bookkeeping, financial measurement and reporting, and a rigorous audit function. It generalizes cost/benefit analysis techniques and extends familiar cash flow analyses and budgeting practices into the future.  AFTF satisfies most basic accounting concepts and principles.  It satisfies the intent of GAAP accounting.  It makes accounting and accountants relevant.  A more relevant accounting science and practice will be rewarded.  The accounting profession will have to adjust somewhat, but it will not be harmed.

Third, AFTF does no harm to accounting overseers.  To the extent that AFTF creates stability and improves the information flow to and from capital markets, the SEC’s mandate will be supported.  To the extent that accounting is made more principles-based and simpler, the mission of FASB and the IASB will be facilitated.  To the extent that accounting relevance is improved, the AICPA’s membership will be more valued.

Fourth, AFTF does no harm to the management process.  AFTF adopts management decision technologies.  It unifies accounting so that management reporting and financial reporting are on the same basis.  Management will be freed from the tyranny of short-term reporting.  Managements will have greater authority and greater responsibility. The management process will be made transparent; management decisions, judgments and expectations will be explicitly stated and reported.  Real time actual-to-expected cash flows will soon reveal the quality of management decisions, judgments, vision and execution.  Such a public record is an essential management control.

Fifth, AFTF does no harm to other interested parties.  AFTF is designed to inform and protect shareholders; by doing so it also protects creditors who have first call on assets.  AFTF changes, but does not diminish, the role of the investment analyst, who will have a new more informed and critical role to play. (See the paper The AIMR and AFTF for a detailed analysis).  By improving management and capital market efficiency, AFTF will benefit society generally.  Employees, suppliers, regulators, and consumers will be direct and indirect beneficiaries.

Conclusion

AFTF does no harm and should not be disruptive.  More important, it helps.