By Matthew Biddle
In his new book, The End of Accounting and the Path Forward for Investors and Managers, Feng Gu, associate professor and chair of the Accounting and Law Department, asks accounting professionals: Are we doing this the right way? Does the information we report on lengthy financial statements accurately reflect company performance?
Through extensive analysis of quarterly earnings calls and financial statements, Gu and his co-author, Baruch Lev, the Philip Bardes Professor of Accounting and Finance at the New York University Stern School of Business, argue that Generally Accepted Accounting Principles (GAAP) have lost their relevance, and a company’s true worth lies in its strategic, value-enhancing resources — not the variables found on traditional earnings reports.
Since its publication in June, the book has been featured in such major media as the Wall Street Journal, Barron’s, Fortune, Forbes and Inc. magazine, as well as other niche business and accounting publications (see NewsBites). Here, Gu shares more insights from the book.
A: We observed serious flaws in today’s corporate financial reports (consider the growing chasm between market values and the information in financial reports). Our careful examination of analysts’ questions in hundreds of quarterly conference calls revealed that investors focus on business strategy and the success of its execution, rather than the voluminous information in financial reports. GAAP’s shortcomings are so fundamental and endemic to the accounting system that incremental improvements are essentially useless. We don’t advocate for the elimination of corporate periodic reports, but instead propose two reforms: Overhaul the current system and adopt our proposal, which focuses on information that matters.
A: CFO surveys show that current financial reporting has deteriorated into a “compliance exercise,” where executives and auditors try desperately to abide by the minutiae of constantly expanding regulations. Our proposal replaces this mindset with constructive illumination and transparency: informing investors, rather than abiding by regulations, and innovating new modes of disclosure, rather than blindly following regulators’ edicts. This change will be no small task and will require different accounting education, professional exams and certifications, and hiring choices.
A: Focus on information that matters: an enterprise’s strategic, value-creating assets (for example, the customer franchise of media, internet and insurance companies; new product development of pharma, biotech and software companies; and the patents and brands of durable goods manufacturers), and the real value those assets create based on “residual cash flow measure.” In essence, invest in companies that possess unique strategic resources, whose managers can deploy these assets to create value.