By Humphrey Nash
Prospective accounting is designed to measure value, specifically
shareholder value. Value is defined as the present value of expected
cash flows. The present value of all net expected cash flows
for an enterprise is its valuation. The change in the
valuations, adjusted for interest, is the value added. Hence
prospective accounting is value-added accounting. This is
Surprisingly, prospective accounting can be made both relevant and
reliable, so that it becomes suitable for financial reporting as well as
management decisions. This is new.
A new approach to valuation is proposed which combines and coordinates
capital market information with management information. This
approach, called the "dual validation", is one of the
disciplines that makes prospective accounting simultaneously relevant
and reliable. The "dual validation" is described
in the draft proposal Accounting For The Future and in the paper Disciplining
Prospective Accounting, both by the editor. It will also
be fully described in later issues of Future
In addition to the "dual validation", other disciplines are
proposed to enhance reliability. These take the form of
disclosures and checks and balances. The checks and balances
arise from a natural division of labor and responsibilities. This
division is also a key ingredient in making prospective accounting
The traditional accounting income statement and balance sheet would be
replaced by a unified statement of values showing consecutive valuations
and the value added. The value added is defined as the current valuation
less the prior valuation (adjusted for interest). The
interest rate used is the historic cost of capital that emerges from the
The unified statement of values automatically coordinates the progress
of the company with the status of the company, unlike traditional
accounting where the income statement and balance sheet are
uncoordinated. Among other things, this coordination makes
it possible for shareholder equity to be shareholder value.
Using a shareholder cost of capital as a discount rate means that values
correspond directly with decisions; a positive valuation implies a
positive decision. This make prospective accounting
automatically decision-useful. In fact, with prospective
accounting we don't value traditional accounting tangibles at all.
Instead we value decisions.
At the broadest level, the company valuation provides a decision
criterion for stock purchase.
At the line of business level, the valuation provides information as to
whether the LOB is covering the cost of capital. A positive
LOB valuation suggests continuation or expansion; a negative valuation
suggests dropping or changing the LOB. The LOB or division
level of aggregation would be the normal financial reporting level of
At the micro level, a prospective valuation provides decision criteria,
for example, for pricing an individual product or for capital budgeting
This multilevel decision framework of prospective accounting will
improve management and capital market efficiency. It will
also improve the efficiency of accounting functions within an
enterprise. It does this by unifying all accounting and
decisions measures. For example, management must explicitly
quantify its plans in order to evaluate and decide, but this same
process is used for financial reporting, i.e., to determine value and
A prospective accounting model will enhance the role and opportunities
First, accounting will become more relevant so that the accountant will
be adding more value and be more valued.
Second, accounting will be improved and simplified within a clearer
purpose and vision; detailed practice prescriptions or proscriptions
will give way to the general principle.
Third, accounting unification creates an opportunity for the accountant
to assume a broader role within a company.
Fourth, that role involves the accountant in the decision process.
is good for the accountant and good for the decision process.
Prospective accounting has a clear, relevant purpose. It can be made
reliable and feasible with the technologies and structures proposed.