Complexity
By Humphrey Nash

A Weak Foundation

Traditional retrospective accounting is built on an inadequate foundation.   Part of this weakness arises from the tyranny of history.   The accounting environment evolved from bookkeeping in an industrial and mercantile economy into financial reporting in a primarily service economy.   This evolution of circumstance was not accompanied by a corresponding evolution of the accounting model.   Changing conditions and purposes required a new vision, new principles, new standards, and new methods.   The change that has occurred is piecemeal and haphazard without the fundamental change that would rationalize and strengthen accounting.   To build a strong foundation for contemporary accounting, it is necessary to ask and answer fundamental questions.   Incredibly these questions have not been asked, or if they have been asked they have not been answered, or if they have been answered they have not been answered by accounting.

Accounting today is not decision-useful.   It is not decision-useful because it is not relevant.   It is not relevant because it does not provide the information needed by its intended audience.   Accounting has not even properly identified its audience.   The AICPA studied users and user needs in some detail for the study Improving Business Reporting - A Customer Focus.   This report correctly identified many problems with accounting and made many excellent general recommendations, but the report did not translate into fundamental change.   It could not, since its charge was to improve existing business reporting, not change the basic accounting model.   The report confined itself and accounting to a narrow purpose and audience.   The purpose was traditional retrospective financial reporting and the audience was defined to be those who accept and use GAAP.   This includes many within the accounting profession, but few outside the profession.

Almost all users of financial information employ a different accounting model, one based on shareholder value.   Shareholder value is relevant to the capital markets and to management and is decision-useful.   Accounting can be decision-useful if it joins the financial community in measuring and reporting value.   Shareholder value can be the basis for a new vision, new principles, new standards, and new methods for accounting.   Value provides provides a strong, simple, and rational foundation for accounting.   The draft proposal Accounting For The Future (AFTF) suggest specific technology and structures to make value accounting relevant, reliable, and feasible.

The Weight of Complexity

The poor health of accounting is well understood within and outside of accounting.   The accounting profession has addressed its symptoms with tourniquets and Band-Aids™ that may stop the bleeding or cover up the lesion, but do not cure the basic problem of lack of relevance (decision-utility).   These Band-Aids™ are applied with increasing frequency, force, and controversy and with decreasing rationale, consistency, and acceptance.   The problem is not the quality or quantity of the efforts.   The profession is making heroic efforts to keep the patient alive, but the profession hasn't identified the disease let alone the cure.   Even if these efforts do no direct harm, they add complexity.

I mention two recent examples of efforts to improve accounting which, if enacted, will increase the complexity of accounting with little purpose and no gain.

The first example is the AICPA Model of Business Reporting (MOBR) which accompanied the AICPA study Improving Business Reporting - A Customer Focus.   I quote myself from Appendix 10 of Accounting For The Future,

"It is my opinion, that much of the added detail and complexity of the MOBR will not of positive value and should be deferred.   It is well motivated, but misguided, at least from the AFTF perspective. "

The reasons for this opinion are detailed in pages 210 through 230 of Appendix 10.   It is also my opinion that AFTF will better accomplish the goals and better satisfy the recommendations of the AICPA study.   Please read that appendix to get an idea of the complexity and futility of the proposed MOBR model.

The second example is the recent FASB Exposure Draft, Using Cash Flow Information and Present Value in Accounting Measurements.   This publication is a revision of a similar publication published in June of 1997.   Both these publications are excellent expositions of the concepts of present values and expected cash flows and FASB is to be commended for its continued efforts to bring at least certain aspects of accounting into the mainstream of financial measurement.   The problem is that the effort is piecemeal with no overall purpose or consistency.   Present values are superimposed on a system that fundamentally doesn't use present values.   The lack of a unified theory complicates rather than simplifies.   Where present value theory is espoused, no practical methods or procedures are described.   The following quotes from the Exposure Draft suggest the complexities and conflicts that inevitably result from an undefined purpose and lack of a unified vision.

The Board expects to decide whether a particular situation requires a fresh-start measurement or some other accounting response on a project-by-project basis.

The Board decided to limit this Statement to measurement issues and not address recognition questions. ...Recognition and measurement are obviously related to one another.

The techniques used to estimate future cash flows and interest rates will vary from one situation to another depending on the circumstances surrounding the asset in question.

The Board expects that accountants will continue to use the traditional approach for some measurements.

The Board has long acknowledged that neither relevance nor reliability is the paramount characteristic of accounting information.

Two Board members disagree with the conclusions stated in paragraph 19 that "the Board expects to adopt fair value as the measurement attribute when applying present value techniques in the initial and fresh-start measurement of assets and liabilities."   (A good portion of the Exposure Draft was devoted to these dissenting members arguments.)

The Board decided to remove from this Statement the notion of entity-specific measurement as an objective of present value measurements.

While there may be good reasons for recognizing some of those intangible assets, that issue is outside the scope of this Statement.

If the measurement includes changes in credit standing, and an entity's credit standing declines, the fresh-start measurement of its liabilities declines.   That decline in liabilities is accompanied by an increase in owners' equity, a result that they find counterintuitive.

A Stronger Foundation

Constructing a complex accounting edifice on a weak foundation with little cohesive purpose creates a danger that the entire structure will collapse from its own weight or from lack of glue.   Without a firmer foundation, accounting may sink into the past.   Accountants and accounting organizations can be the financial architects of the future, but they must work not in a vacuum.  They must determine end-user needs and produce a responsive and relevant blueprint.   Prospective accounting is a blueprint of the future.