Companies’ financial reporting is failing to capture intangible assets that define success in a digital economy.
This was the view of leading academic and industry experts at an event organised by Imperial College Business School.
Mike Wells, Professor of Practice in the Finance Department of the Business School, chaired a spirited discussion: is accounting losing its relevance?
Professor Wells argued that financial reporting can provide useful information for making good investment decisions, with a positive impact for society. He said: “The better we can get this to work, the more economic development we can have and the more prosperous the society we can live in.”
However, Professor Wells also said that corporate reports sometimes fail to capture the economic resources that are fundamental to the success of modern organisations. This gap between accounting and economics, due to the shift to a digital economy, can be seen in the chasm between companies’ reported numbers and their market capitalisation.
“Intangibles are much more relevant for explaining share price and returns [today than previously]." Mary Barth Professor of Accounting at Stanford University Graduate School of Business
This opens an opportunity to manage earnings, Professor Wells said: “All unethical management needs to do to realise profit is to sell some asset where the fair value of the asset is higher than the accounting value. They can realise that economic gain in accounting when there’s no change in economics.”
Mary Barth, Professor of Accounting at Stanford University Graduate School of Business, said that accounting information had not kept pace with the economy shifting from being manufacturing based to being based on services and information technology. In the 1960s net income, for example, explained two thirds of share prices but the sum is significantly lower in the 2010s. “Intangibles are much more relevant for explaining share price and returns [today than previously],” Professor Barth said.
Speaking in a personal capacity, Hilary Eastman, PwC’s Director of Investor Engagement, said that investors often say “no one is reading annual reports”. PwC surveyed 550 investors and analysts globally and two thirds of respondents said they do read reports, especially in the US.
However, when PwC asked respondents what factors influenced their investment decisions today, accounting was eighth on a list of 15 factors. Worse, in five years’ time, respondents expect accounting to be the tenth most important factor influencing their investment decisions. What’s more, PwC’s polling found that some investors say the quality of reporting impacts investors’ perceptions of the quality of management, a top factor influencing investment decisions.
Ms Eastman said reporting “is not cutting the mustard” and added: “If investors don’t trust management then their willingness to rely on that information would decline. That might be a factor in studies showing that accounting’s relevance is going down. Investors don’t trust it enough as they think, maybe, there’s too much spin.”
Sue Lloyd, vice chair of the International Accounting Standards Board, said that investors were using lots of alternative sources of financial information, from satellite images to web-scraping and credit card purchases. However, Ms Lloyd said that even when they use new approaches, investors are using financial reporting to validate their investment strategies.
Yet she said the IASB is striving to change its reporting standards to make information more relevant for investors and analysts. It has taken the unusual step of meeting investors and analysts to confirm what is (and is not) useful for them.
One of the main frustrations the IASB is trying to address is the comparability of performance measures on the income statement, Ms Lloyd said. It has proposed a raft of changes, including a more granular communication of performance on a more consistent basis and the income statement being split into three different sections — operating, investing and finance. “It’s a response to the fact that companies often come up with bespoke subtitles that are inconsistent across companies,” Ms Lloyd said.
However, she was adamant that accounting is not losing relevance, rather the changes are about making financial reporting even more relevant.
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