Leading The Next Information Revolution
by Humphrey Nash

Abstract

Peter F. Drucker is critical of traditional accounting as a management decision tool.   Viewing traditional accounting as a barrier to the effective use of information technology for management purposes, he suggests the use of new concepts which look outward to encompasses more than traditional accounting concepts.   He is critical of traditional accounting's focus on costs and accounting tangibles.   The author suggests that prospective accounting may address Drucker's concerns.

Drucker's View

Peter Drucker has identified the next business information revolution as one which asks and answers the questions, 

What is the meaning of information?

What is its purpose?

According to Drucker these questions lead to a new definition of the business function as the "CREATION OF VALUE AND WEALTH".   Although this function may not be entirely new, the application of information technologies to this function is certainly still in its infancy.

"Yet, despite its importance and impact, the next information revolution has so far been largely ignored by the information establishment.   For it has started in the information system of which - though it is the oldest and still the most widely used one - IT people, as a rule, tend to be both ignorant and contemptuous: Accounting."
Peter F. Drucker, The Next Information Revolution, Forbes ASAP, August 24, 1998 Page 47

This assessment holds true for accounting in its broader sense, i.e., that science that encompasses value measurement and decision criteria.   Unfortunately, this broader definition is not accepted or adopted by the accounting profession: CPAs, AICPA, FASB, SEC, IASC, et al.   The sad fact is that the accounting profession ignores and disdains the accounting revolution taking place outside the narrow confines of traditional retrospective financial reporting and of the role of information technologies in that revolution.

This attitude is dangerous.   It is dangerous to the users of accounting information (management and shareholders) and to the producers of accounting information (the accounting profession).   Without a value-based accounting system, management and shareholders cannot make informed decisions.   By not providing decision-useful information traditional accounting becomes an irrelevant formality.   This has not escaped observation.

It was thought by Peter Drucker and others that,

"The computer would, in short order, revolutionize the work of top management.   It would, we all agreed, have its greatest and earliest impacts on business policy, business strategy, and business decisions.   We could not have been more wrong."
Peter F. Drucker, The Next Information Revolution, Forbes ASAP, August 24, 1998 Page 47

The stumbling block or barrier was accounting, specifically traditional retrospective financial reporting.   Retrospective accounting cannot be innovative.   Traditional accounting measures are not value measures and are ineffective in supporting decisions which create value.


"But for none of these top management tasks (innovation, value creation) does the traditional accounting system provide any information.   Indeed, none of these tasks is even compatible with the assumptions of the traditional accounting model.   The new information technology, based on the computer, had no choice but to depend on the accounting system's data."
Peter F. Drucker, The Next Information Revolution, Forbes ASAP, August 24, 1998 Page 47

This data was suitable only for cost accounting for operations, which "explains information technology's near-zero impact on the management of business itself".

"Information technologists, especially chief information officers in business, soon realized that the accounting data are not what their associates need - which largely explains why MIS and IT people tend to be contemptuous of accounting and accountants."
Peter F. Drucker, The Next Information Revolution, Forbes ASAP, August 24, 1998 Page 47

It is doubtful that many IT people are "contemptuous" of accountants, but the limitations of traditional retrospective accounting are probably well understood by top management including top IT personnel.


"... what was needed was new concepts."
Peter F. Drucker, The Next Information Revolution, Forbes ASAP, August 24, 1998 Page 47

These concepts included economic-chain accounting, activity-based accounting, Economic Value Added accounting (EVA), and the executive scoreboard (balanced scorecard?).   However, these are still criticized by Drucker as being focused "inward on costs and efforts rather than outward on opportunities, changes, and threats."

The Next Information Revolution

Drucker points out that the next information revolution will be to provide complete and decision-useful measures for management.   Prospective accounting, especially the type illustrated by Accounting For The Future (AFTF), is a mechanism which provides such management measures in the form of information useful for operational, tactical, and strategic management decisions.

AFTF goes further by unifying all accounting and providing decision-useful information to a broader audience.   In particular, it provides a relevant and reliable mechanism for financial reporting.   AFTF also provides relevant information for other purposes, such as, mergers and acquisitions, regulation, incentive compensation, dividend policy, and financing decisions.

How is it possible for one accounting model to satisfy a multitude of business purposes?   The answer is that business has a single purpose or function.   That function is the "CREATION OF VALUE OR WEALTH" - to be more precise the creation of shareholder value (for publicly traded companies).

There is one and only measure of value, namely, shareholder value.

There is one and only one criterion for decisions, namely, does it add shareholder value?

How is it possible for a single measure to capture the multitude of factors and complex considerations that management must take into account?   The answer again is simple.   The measure to be used is the present value of all future cash flows.   Future cash flows take into account all relevant factors or contingencies.   If it affects future cash flows then it is relevant.   If it does not affect future cash flows then it is not relevant.

Still, it might seem that there are relevant dimensions other than cash flows.   This would certainly be true if we only consider current cash flows, but future cash flows capture all.   How about the company's capabilities, its market share, its reputation, its environment, its customers, its employees, its structures, its franchises, its visions, and a myriad of other intangibles? 

Now we hit the nail on the head.   It is precisely these intangibles that are captured by the future.   It is precisely these intangibles that are missing from traditional retrospective accounting.   It is precisely these traditional accounting intangibles that create or permit the creation of shareholder value.   It is precisely these accounting intangibles that provide the forward and outward view of opportunities, changes, and threats.


AFTF recognizes the factors that affect future cash flows, thereby allowing users to meaningfully recognize the future cash flows and, in turn, to measure value as the present value of those cash flows.   The discount rate is the shareholders' cost of capital.   This permits users to make decisions based directly on the value measure.   A positive value implies a positive decision.   A negative value implies a negative decision.

This correspondence between valuations and decisions works at all levels.   It works when a decision is made to introduce a new product or re-price an old product.   It works when a decision is made to invest or divest in a line of business.   It works for financing or dividend decisions.   It works for mergers and acquisitions (taking into account the new combined cash flows).   Most importantly, it works at the capital market level.

The value of all of the company's products and services, or all of its lines of business, or all of its divisions is the company value.   Under AFTF, this value is measured in shareholder terms.   If the value of the company exceeds the price of the company then the present value of the cash flows to the investing shareholder is positive.   If shareholder value is reported to the current or potential shareholder then the shareholder can make the appropriate investment decision.   This is the clear purpose of financial reporting.   Anything else is smoke.

Leading the Revolution

The next information revolution will be the development, production, and use of forward-looking, decision-useful information.   This revolution is already underway.   There is no stopping it.

So far the revolution has been haphazard with many independent and disconnected implementations.   Financial analysts use a prospective approach by making adjustments or corrections to traditional accounting reports and by projecting future cash flows.   The manager may anticipate costs and benefits to justify a project.   Management may explore capital expenditures (capitalization of assets being a partial recognition of future benefits).   The company may assess lines of business for expansion or contraction.   Setting prices may involve estimating sales costs and sales revenues.   Mergers and acquisitions require valuations.   Human resources departments may need to assess employee costs and benefits for hiring, training, or outplacement.   The acquisition of, or right to use, information or technology may need to be evaluated.   Any deficiency of future cash flows may need to be funded, such as insurance reserves, pensions, retiree health benefits, or other contingent net liabilities.

All the above implementations use the same technology, namely, future cash flows discounted at a cost of capital.   In fact, this technology is almost universal.   The major exception is financial reporting.

Who will formally recognize this revolution?   Who will structure and unify it?   Who will guide and discipline it?   Who will profit from it?   Who will lead it?

The accounting profession should assume that leadership, since it has the most suitable knowledge base for the job.   The accounting organizations (AICPA, FASB, IASC, SEC) are natural choices to formally develop the basic concepts, operating principles, and specific standards needed for a prospective accounting model.   The CPA is well suited, by reason of training and experience, to understand the nature and purpose of prospective accounting.   The CPA audit function is an appropriate and capable mechanism to guide, control, and discipline prospective accounting.   The CPA can apply and enforce the concepts, principles, and standards of prospective accounting both as internal and external auditors.

An important facet of the control of prospective accounting would be the control over information.   This would involve control over the nature, quantity, and quality of information gathered or produced.   As far as prospective accounting is concerned, the Information Technologists would be under the control of the accountant.   In particular, AFTF defines prospective accounting very broadly to encompass all prospective methods (including financial reporting).   Since prospective methods are currently very widely used (except for current financial reporting), the accountant would have responsibility for, and firm control over, a broad range of information technology.  This control would be in the decision-useful setting that prospective accounting methods provide.   The relevance of the information provided for or produced by prospective accounting should reduce any contempt that IT management may feel toward traditional accounting.


The CPA would audit all information used for decision purposes, not just that used in financial reporting.   The unification of accounting requires that all such information must be coordinated.   A common centralized data or information base would be used for all departments and for all functions from pricing to financial reporting.   The CPA would ensure the appropriateness, completeness, currentness, consistency, and accuracy of decision information.   This is not as formidable as it may seem.   All decision technologies use the same prospective methods.   They all use expected cash flows and a discount rate.   In fact, the cash flows and discount rate would be the same.   Hence, reported total company value-added would be the sum of the values added by decisions, actions, or events during the period.   Since the technology and assumptions are the same, the audit function is directly scalable and additive.

"Many of the traditional essential skills of CPAs are being replaced by new technologies".

The CPA Vision Project

"One answer is for the accountant to himself employ new technologies to the fullest.   Another answer is for the accountant to exercise firm control over accounting and information technologies.   Accounting unification would extend and improve that control.   The best answer is for the accounting profession to create new technology.   Technology is not the problem.   It's the solution."

Future Accounting News, March 1999

Conclusions

The draft proposal Accounting For The Future (AFTF) attempts to overcome some of the natural hesitation that the accounting profession has in measuring the future.   AFTF provides specific structures and methodology that make prospective accounting relevant, reliable, and feasible.   It does so with minimum disruption to traditional accounting principles.   It leaves most basic principles intact; in fact, it depends on them.   It leaves most bookkeeping functions intact (simplifying some).

AFTF proposes a broader, more relevant, and decision-useful role for accounting.   This role would bring accounting into the mainstream of financial decision theory and practice.   It would bring discipline and cohesiveness to that theory and practice.   This new role can create great opportunities for the science of accounting, for accounting organizations, and for the accountant.