The accounting profession’s current squabbles between the provincial and federal bodies reminds us of an old saying: “Nero fiddles while Rome burns.” Rather than arguing over which body accountants are members of, we must come together to solve the existential threat of the profession’s irrelevance.
In his 2019 letter to Berkshire Hathaway shareholders, Warren Buffett neglected to open with the percentage change in the company’s per-share book value: “It’s now time to abandon that practice,” he wrote. “The fact is that the annual change in Berkshire’s book value…is a metric that has lost the relevance it once had.”
Accountants everywhere should have rushed into action. When Buffett, the world’s most famous investor and a lifetime user of financial statements, says they are largely irrelevant, the profession should be alarmed.
Over the past three decades, our economy has shifted, from industrial to digital. These are night and day. The first is based on scarcity of inputs: raw materials such as wood, coal and iron ore, and of human labour. The second relies on an abundance of inputs: human creativity and social and relationship connections, to name two.
The critical difference is quite simple: In the industrial economy, if I have a car and I sell it to you, you have a car, and I do not. In the digital economy, if I have an idea and I sell it to you, we both have an idea that we can use to make money.
As Paul Romer outlined in his 2018 Nobel Prize acceptance speech, we will, for the foreseeable future, be navigating a mixed economy that uses finite tangible resources and infinite intangible resources to create value.
The ways in which we account for value creation in these two different economies must also be different. The marketplace has recognized this shift, but accounting has not. In 1975, Generally Accepted Accounting Principles (GAAP) book value represented 84 percent of the market value of the stocks included in the Fortune 500 index. By 2020, GAAP book value represented just 10 percent of the index’s market value.
The vanished 90 percent was made up of intangible assets: investments in human creativity, social and relationship connections, data and other intellectual property. Absent formal recognition of these assets, Canadian policy makers will continue to make decisions about our economy based on outdated information and assumptions.
The problem is not that accountants do not know how to account for intangible assets. IFRS (International Financial Reporting Standards) 38 spells out the methodology, known as value in use. The problem, rather, is an outdated mindset.
Because accountants are focused on ensuring that assets are not overstated, they tend to dramatically understate them. Under current GAAP, only purchased intangible assets such as goodwill can be recorded, and the value-in-use methodology is periodically applied to ensure these assets are not overvalued. But what about the missing 90 percent that represents our future?
Although it is a member of the International Accounting Standards Board, Canada still has its own standard-setting bodies. Members of the profession must collaborate to develop accounting standards that allow companies to recognize their intangible assets.
Not only would this help to align financial reporting with the reality of the digital age, but it would also help Canadian entrepreneurs to get the financing they need to ensure the country’s future prosperity.
This piece first appeared in The Globe and Mail.
