u "I like the pictures.", my daughter.

p In the distributed hard copies there are small flower images.  They have been deleted from the Web edition since they take up so much space and increase download time.  Headers and footers are missing from the Web edition.  Hence no footnotes appear.


u "It appears to me to be right on the mark conceptually...", a futurist.

p Since AFTF unifies it may be right on target from several perspectives.


u "Your report appears to include many fresh and new ideas.", a government official.

p If this is true, it arises, in part, from ignorance of traditional models.


u "It seems to me that an acceptable unified accounting procedure should scale both to small businesses as well as large complex businesses.  How would this new accounting be applied to a small startup company for example?" , economics student.

p Small may not be a problem since the sophistication of the model may be scaled to the size of the enterprise.  Startup presents a problem since the dual validation procedure will not work.  Perhaps a standardized 15% discount rate could be used in such cases.  Projected cash flows and resulting valuations will unreliable for startups, but they may be better than nothing.  AFTF cannot extract reliability from an inherently unreliable reality.


u " Is there a way for some of us to test these procedures at the grass roots level and validate them in practice?  My concern is that the major institutions will never adopt these procedures until they are proven in practice.", analyst.

p Testing and research is needed.  My limited testing (see Appendix 7: Behavior Patterns) indicates great stability.  I suggest a limited initial phase-in and I volunteer the insurance industry as the guinea pig (see Appendix 5: A Starting Point).  Waiting for proof in practice is catch 22.


u "This proposed accounting standard seems to rely heavily on procedures for validating models and estimates.  How can we be confident that these procedures will not enable unscrupulous corporations to hide or distort the facts?"

p The dual validation and other disciplines (Chapters 6 and 7) are designed to prevent this.  AFTF is based on historic cash flows and market prices which are unequivocal.  Management can deceive, but only temporarily and to a limited degree.

Management is given a responsibility to make judgments about the future and must be allowed the flexibility to be wrong or to fail.  Without this freedom management cannot manage.  Even after the fact, a bad outcome may be the result of good judgment.  Corporations are formed to manage and undertake risk in an uncertain world. Failures are expected.  The company or economy with no failures is unlikely to have many successes.

It is difficult to determine in advance if management is deceiving, is self-deceived or is deceived.  To completely eliminate the capacity of management to deceive would, in fact, eliminate the possibility for management to be wrong and would limit the ability of management to succeed.  Under AFTF deception will not be a significant problem; possible deception is a small price to pay for management freedom (see Chapter 15: Problems with AFTF for further discussion).



u How are assets and liabilities defined under prospective accounting?

p Two ways suggest themselves.  First, assets may be defined as present values of operational cash inflows and liabilities as present values of operational cash outflows.  Shareholder equity would be the excess of assets over liabilities.  This is a fairly traditional definition. Second, we could define assets as the present values of net operational cash flows and equities as the present values of net capital cash flows (to the shareholder).  In this definition both sides of the balance sheet represent the value of the company. They would be equal when the discount rate is the internal rate of return.


u How can prospective accounting be audited?

p The independent auditor's opinion is restricted to those items, which can be exactly verified, and to the general application of accepted principles and practices.  The auditor should be able to perform exact and detailed checks on the cash flow and market price five-year validations.  The auditor makes a general statement of the overall fairness of the financial reports based on modeled cash flows.  Note that modeled cash flows are strongly disciplined.


u How does a plan create an asset?

p Assets are not plans.  Even if we assume that assets are created by plans (asset implies plan), do plans create assets (plan implies asset)?  With prospective accounting they do.  The reason is that assets are defined as the present value of expected cash flows.  Furthermore we only attach a value to those decisions or plans that are informed decisions, which in the AFTF model means a decision for which an unbiased cost/benefit analysis has been made.  This analysis takes full account of the contingencies and probabilities, including the probability of failure.  Under AFTF the plan or decision must be a certified commitment and must be disclosed in the MD&A.  Is the outcome certain?  No, but with good management, careful planning, and prudent diversification, expectations will be essentially realized.  You can bet on it.


u Why is a new accounting model needed?

p There are problems with retrospective accounting (see Chapter 3: Problems with Traditional Accounting of AFTF).  With prospective accounting there are opportunities to make accounting more relevant and decision useful, to unify accounting, to make management more effective, and to make the capital markets more efficient.  The greatest need may be for the accounting profession to modernize.  The accounting profession is being displaced by those who use modern and relevant measurement tools, tools that I believe should be at the core of accounting not just at the fringes.  These tools (present values of expected cash flows) are not unfamiliar to accountants, but they are unfamiliar to financial reporting.  AFTF suggests ways that these tools can be made relevant and reliable and suitable for financial reporting.


u Would the new prospective accounting model replace GAAP outright?

p That is the ultimate goal.  There could be several intermediate steps.  Since the new accounting model is useful for internal management decisions it can be used for internal reporting purposes.  This would be a natural step since the new accounting uses management technologies.  Many companies already use some form of value-added accounting.  The new accounting could be a supplement to GAAP financial statements since there is no proscription against supplemental information in financial reports.  GAAP could evolve piecemeal into a prospective model.  This is already happening, although in a somewhat undisciplined and unstructured manner.  It is possible to phase in the new accounting by industry.  For example, the insurance industry is suggested as an early candidate for prospective accounting.  Since the new accounting satisfies many of the basic goals and principles of GAAP, that term could still be could be used.  The interpretations and implementations would, of course, be different.


u AFTF is based on the concept of shareholder value.  How does this satisfy the concerns and information needs of the creditor?

p The AICPA study Improving Business Reporting - A Customer Focus revealed that the main information goal of creditors was to project cash flows in order to assess the future debt servicing ability of the company.  Since AFTF is prospective and projects expected cash flows, it serves that purpose well.  In contrast, traditional accounting reveals little about the future.  AFTF produces differential values (value added); in particular, it can produce the value added by the loan itself. If the company valuation (including repayments) is positive the loan is justified from the lender's perspective.

More importantly, AFTF reveals shareholder value and value added (or subtracted) to management and to the shareholder.  This will be a powerful force in preserving and creating shareholder value. This, in turn, protects the creditor since shareholder value shields the creditor.  All creditors must be paid in full before any shareholder recovery.


u Under fair value, initial recognition matches cost and the booked cash flow.  What happens under other schemes?

p Under most accounting models, the booking of cash flows is untouched.  There is a difference between recognizing a cash flow and recognizing value, which fair value purports to do.  It is the difference between cash bookkeeping and valuation.  The two are only tangentially related.
Under AFTF we recognize expected future cash flows.  We measure expected cash flows as present values.  They result of these two steps is the recognition of value.  The recognition of value is prospective and is separate from retrospective bookkeeping.  In AFTF, historical cash flows play a central role in the modeling of expected cash flows and in the comparisons of actual to expected, but historic cash flows are not value or value added. 
AFTF is forward-looking, decision-useful, and value-based, GAAP is not.

u Economic Value Added EVATM appears simpler than prospective accounting and has many adherents.  Why not use EVATM?

p Appearances are deceiving. EVATM is very useful, since it takes into account the cost of capital, but it is not simpler.  For one thing EVATM openly claims to be equivalent to the discounted cash flow approach, and it is.  Unless shortcuts which destroy that equivalence are employed, EVATM ultimately involves the same technology and work as the DCF or ECF approaches.  This is not made clear.  It is stated that EVATM requires mainly the traditional income statement and balance sheet, but this is only true if certain adjustments are made, one of which is a difficult adjustment for value added.  It is more direct to start with accurate valuations, the change in which is value added.

EVATM is a management system and is not designed as an accounting model.  AFTF unifies management accounting and financial reporting within a general value-based accounting model.

u AFTF is based, in part, on what seem to be arbitrary and capricious factors, i.e. dual validation, historic cost of capital, value added.  Why should these be accepted?

p Prospective measures, such as PVECF, require a discount rate.  If that discount rate is to be decision-useful to shareholders and their representatives it must be a shareholder cost of capital.  For a given set of expected cash flows capital market prices uniquely determine the cost of capital which applies to those cash flows.  The shareholder's cost of capital must depend on both market prices and expected cash flows.  This is what the dual validation does.  There is no other method which satisfies these requirements.  See The Historic Cost of Capital in the March issue of Future accounting News for further insight.  In the June issue, the article Value Added makes it clear that value added is not an arbitrarily construct but a necessary consequence of the time value of money.  If accounting adopts present values measurements (PVECF), it logically must also adopt value added.

u AFTF reliability depends on past cash flows and past market prices.  For a new company or an IPO without a five-year history how reliable are the AFTF statements?

p Not very.  There is no way to create an accounting reliability in a situation that is inherently unreliable.  The cash flow model will not be adequately validated.  Management expectations may be different from actual.  This may be due to unreliable expectations or an unreliable reality, more likely the latter since diversification and size are limited (like flipping a coin once).  In addition, to unreliable cash flows, no historic cost of capital is available.  This may be solved by convention, for example, use 30% for companies not yet in operation, 25% for companies in operation but not yet profitable, 20% for profitable companies with less than five years operation.  Is this unreliability tolerable?  Shareholder's should have the risk capacity (capital and diversification) to cope with such unreliability.  Many have that capacity and find new companies and IPOs to be, on average, profitable.

   

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