The end of accounting and the path forward for investors and managers

Table of Contents Title Page Copyright Dedication Acknowledgments The Book in a Nutshell The Fading Usefulness of Investors' Information Who Cares? Not Only for Investors Financial Information, a Major Driver of Economic Growth Unique among Regulations About Us and Our Approach Notes Prologue Chapter 1: Corporate Reporting Then and Now: A Century of “Progress” Spot the Differences Differences Spotted Real Improvements Spotted? A Devil's Advocate Takeaway Notes Chapter 2: And You Thought Earnings Are the Bottom Line The Lucrative Earnings Prediction Curb Your Enthusiasm Earnings Had Its Days of Glory But Wait, What about the Earnings Consensus? Takeaway Notes Part One: Matter of Fact Chapter 3: The Widening Chasm between Financial Information and Stock Prices How to Measure the Usefulness of Financial Information Honey, I Shrunk Accounting Some Useful Details And Now for Some Intuition Who's the Culprit—Earnings or Book Values? Are We Fair to Accounting? How Can This Be? Takeaway Notes Chapter 4: Worse Than at First Sight When Is a Message Informative? A Preempted Announcement Measuring Financial Report Timeliness Roll the Tape Aren't We Trivializing Accounting's Contribution? Takeaway Notes Chapter 5: Investors' Fault or Accounting's? Irrational Investors? Eyes to the Future Predicting Corporate Earnings And the Results Are… Reasons, Please Investors Alert: An Accounting Loss Isn't What It Used to Be Takeaway Notes Chapter 6: Finally, For the Still Unconvinced “But Accounting Is Complicated” Experts at Work Vague Information and Disagreement Quantifying Disagreement Takeaway Notes Chapter 7: The Meaning of It All To Recap Should Investors Really Care? A Last-Ditch Defense of Accounting The Decreasing Volatility of Businesses Takeaway Notes Part Two: Why Is the Relevance Lost? Note Chapter 8: The Rise of Intangibles and Fall of Accounting The Intangibles Surge Accounting for Intangibles, Inconsistent and Opaque Worst Yet—Misleading Information More Bad News More, Not Less Information Is Needed Intangibles and the Accounting Relevance Lost Not in Their Best Interest Takeaway Notes Chapter 9: Accounting: Facts or Fiction? “GE Brings Good Things to Life,” But Not to Accounting How Did Estimates Come to Dominate Accounting? Away with Historical Values Roll the Tape Clinching the Deal Takeaway Notes Chapter 10: Sins of Omission and Commission The Missing Accounting Link Accounting and Nonaccounting Events Did We Forget Causation? On Conservative Accountants Takeaway Notes Part Three: So, What's to Be Done? Notes Chapter 11: What Really Matters to Investors (and Managers) The Corporate Mission Digging a Bit Deeper Strategic Resources Mapping Investments to Resources Preserving and Renewing the Strategic Resources Strategic Asset Deployment and Operation Measuring the Value Created The Proposed Strategic Resources & Consequences Report Takeaway Notes Chapter 12: Strategic Resources & Consequences Report: Case No I—Media and Entertainment Sector Synopsis Sirius XM: Resources & Consequences Report Subscribers Growth It's the Strategy, Stupid Disruption Threat Value Created A Reality Check But Is This Really What Investors Need? Finally, a Report for the Sector Notes Chapter 13: Strategic Resources & Consequences Report: Case No 2—Property and Casualty Insurance Sector Synopsis It All Starts with Strategic Assets The Resources & Consequences Report: Customers New Products—Innovation Agents—Still Important Operations—Resource Deployment Penetrating the Costs Black Box Resource Preservation Value Created Notes Chapter 14: Strategic Resources & Consequences Report: Case No 3— Pharmaceutics and Biotech Strategy and Strategic Resources Investing in Innovation The Resources & Consequences Report: Resource Investments Innovation Strategic Resources Resource Preservation Resource Deployment-Operations Value Created Notes Chapter 15: Strategic Resources & Consequences Report: Case No 4—Oil and Gas Companies Accounting Limitations Resource Investments Strategic Resources Resources Threats Resource Deployment—Operations Value Created Notes Part Four: Practical Matters Chapter 16: Implementation How to Elicit the Proposed Information Pfizer Responds to Analysts' Pipeline Questions Why the Pipeline Expos? An Important Role for the SEC Industry Associations Could Help, Too But, of Course, Managers' Cooperation Is Indispensable Competition and Litigation Concerns For Consideration: Lighten the Regulatory Burden Takeaway Notes Chapter 17: So, What to Do with Accounting? A Reform Agenda Revitalizing Accounting I Treat Intangibles as Assets II Reverse the Proliferation of Accounting Estimates III Mitigate Accounting Complexity Takeaway Notes Chapter 18: Investors' Operating Instructions Analysis Focused on Strategic Assets Assessing Enterprise Performance and Competitive Edge: The New Approach First Step: Taking an Inventory of Strategic Resources Second Step: Creating and Maintaining Strategic Assets Third Step: Successful Deployment of Strategic Assets Takeaway Notes Epilogue: Advocacy Needed Author Index Subject Index End User License Agreement List of Illustrations Chapter 2: And You Thought Earnings Are the Bottom Line Figure 2.1 Predicting Companies' Earnings—A “Winning” Strategy Figure 2.2 Pitting Earnings Against Cash Flow Strategies Figure 2.3 The Consequences of Missing or Beating the Consensus Earnings Estimate Figure 2A.1 Cash Flows Are Increasingly More Accurate to Predict than Earnings Figure 2A.2 Analysts Predict Cash Flows More Accurately than Earnings Chapter 3: The Widening Chasm between Financial Information and Stock Prices Figure 3.1 Share of Corporate Market Value Attributed to Earnings and Book Value Figure 3.2 Share of Corporate Market Value Attributed to Earnings Figure 3.3 Share of Corporate Market Value Attributed to Book Value Figure 3.4 Share of Corporate Market Value Attributed to Multiple Financial Indicators Chapter 4: Worse Than at First Sight Figure 4.1 The Unique Contribution to Investors' Information: Financial Reports, Analysts' Forecasts, and Nonaccounting SEC Filings Chapter 5: Investors' Fault or Accounting's? Figure 5.1 Declining Ability of Reported Earnings to Predict Future Earnings Figure 5.2 Increasing Impact on Earnings of Transitory Items Chapter 6: Finally, For the Still Unconvinced Figure 6.1 Analysts' Ambiguity on the Rise Chapter 7: The Meaning of It All Figure 7.1 Decreasing Volatility of Corporate Sales over Time Chapter 8: The Rise of Intangibles and Fall of Accounting Figure 8.1 The Intangibles Revolution Figure 8.2 Decreasing Accounting Relevance by Vintage Year of Public Companies Chapter 9: Accounting: Facts or Fiction? Figure 9.1 Increasing Frequency of Estimate-related Terms in Financial Reports Figure 9.2 Increasing Amount of Extraordinary and Special Items Relative to Net Income, All Companies, 1950–2013 Figure 9.3 ROE Prediction Errors Are Higher for Companies with Above-Median Number of Estimates Chapter 10: Sins of Omission and Commission Figure 10.1 Increasing Frequency (Left Axis) and Impact (Right Axis) of Nonaccounting Events in 8-K Filings, 1994–2013 Figure 10.2 Nonaccounting Events Leading to Higher Earnings Prediction Error Chapter 11: What Really Matters to Investors (and Managers) Figure 11.1 The Strategic Resources & Consequences Report Chapter 12: Strategic Resources & Consequences Report: Case No I—Media and Entertainment Figure 12.1 SIRIUS XM Inc.: Resources & Consequences Report Figure 12.2 Media and Entertainment: A Strategic Resources & Consequences Report Chapter 13: Strategic Resources & Consequences Report: Case No 2—Property and Casualty Insurance Figure 13.1 Customers' Box Figure 13.2 Insurance Company Operations Figure 13.3 Property & Casualty Insurance: A Strategic Resources & Consequences Report Chapter 14: Strategic Resources & Consequences Report: Case No 3—Pharmaceutics and Biotech Figure 14.1 Pharmaceutical and Biotech Companies: A Strategic Resources & Consequences Report Figure 14.2 Pipeline Product Candidates Chapter 15: Strategic Resources & Consequences Report: Case No 4—Oil and Gas Companies Figure 15.1 Resource Investments Figure 15.2 Strategic Resources Figure 15.3 Resource Deployment—Operations Figure 15.4 Strategic Resources & Consequences Report: Case 4—Oil and Gas Companies* Chapter 16: Implementation Figure 16.1 Number and Percentage of Product Pipeline-Related Questions Raised by Analysts During Pfizer's 2001–2015 Earnings Conference Calls Chapter 18: Investors' Operating Instructions Figure 18.1 Residual Cash Flows Measure Outperforms Conventional Ones List of Tables Chapter 1: Corporate Reporting Then and Now: A Century of “Progress” Table 1.1 United States Steel Corporation Consolidated Income Statement Table 1.2 United States Steel Corporation Consolidated Balance Sheet Chapter 16: Implementation Table 16A Major Enhancements in Pfizer's 10-K Disclosure About Its Product Pipeline, 1994–2014 The End of Accounting and The Path Forward for Investors and Managers BARUCH LEV FENG GU Medical devices, development Merck joint development Q3 sales, decrease Mergers and acquisitions (M&A) Message, information Metacloud Technology Momentum (operations) Monetary information Morgan, J Pierpont MV See Market value National Income Accounts Near facts Nestea Netflix analyst questions customer recommendation algorithms services strategic assets Net income (NI) extraordinary/special items, increase report New products, innovation NI See Net income Nonaccounting data, presentation events frequency/impact, increase impact SEC filings Noncoercive disclosure initiative, manager cooperation Nonfinancial S&P 500 companies, focus Non-GAAP customer information Non-GAAP disclosure problem Non-GAAP earnings, merits Nontraded assets/liabilities, marking-to-market Nontransactional business events, impact Number of shares outstanding (NSH) Occam’s razor Off-balance-sheet financing Oil/gas companies, Strategic Resources & Consequences Report accounting limitations operations, sensitivity reserve-replacement ratio resource deployment, operations resource investments example resources, threats risk strategic resources example value creation Omission, sins One-time items On-the-market drug portfolio, sustainability Operating analysis Operating expenses Operating strategic assets Operations acceleration/momentum sensitivity Operations, resource deployment Organizational capital Organizational knowledge, accumulation Patents classification expiration follow-on patenting Pfizer acquisition portfolios problem Path dependence PC See Property and casualty PCAOB See Public Company Accounting Oversight Board Penetration gains Pepsi Performance measures, annual median absolute prediction error Pfizer company strategy competitors credit, enhanced transparency drug launch earnings conference calls, Q&A section expected financials, earnings conference call FDA decisions, impact first-in-class product growth prospects Johnson & Johnson’s, comparison joint development patents pipeline-related questions, number/percentage product pipeline, 10-K disclosure enhancements R&D expenses response (analyst pipeline questions) restructuring cost ROE sales, expiration 10-K filings transparency, enhancement Pharmaceutics, Strategic Resources & Consequences Report Physical capital Pipeline exposé, reasons pipeline-related questions, number/percentage questions, Pfizer response test data, usefulness Policies-in-force data Post-financial crisis Premium prices, charging Price to earnings ratio (P/E ratio) Procter & Gamble, consumer product business Product pipeline candidates enhancements Products growth launch Profitability maintenance measures ratios, inflation Progressive advertising year-on-year revenue growth reports Property and casualty (PC) business risk Property and casualty (PC) firms, dominance Property and casualty (PC) insurance, Strategic Resources & Consequences Report sector synopsis Proposed information, elicitation process Prosensa Holding NV, drug failure Public companies financial analyst tracking vintage year, accounting relevance (decrease) Public Company Accounting Oversight Board (PCAOB), enforcement actions Quantitative easing Fed termination Quarterly buy-and-hold abnormal return Quarterly earnings releases Quarterly reporting, elimination (consideration) R2 See Adjusted coefficient of variation Real assets Real estate sales, turnover Regression analysis, example Regulation Fair Disclosure Regulatory burden, lightening Regulatory risk Reinsurance Reinsurers, company exposure Relevance, loss Reported earnings components release understatement Reported financial information, role (documentation) Reporting See Corporate reporting consequences frequency Reports, information (uselessness) Research and development (R&D) accounting capitalization decrease expenditures in-process-R&D program total expenditure Reserve life index Reserve-replacement ratio Residual cash flows, usage Resource-based theory Resource prices changes Resources See Strategic resources deployment operations investments example mapping Strategic Resources & Consequences Report preservation threats Restructuring cost Retention percentage Return on assets (ROA) Return on equity (ROE) increase metric prediction demonstration errors Return on income (ROI) Revealed preferences Revenues accounting deferred revenue innovation revenues matching recognition rules revenue-cost mismatch, occurrence Reverse-engineering Richels, John Risk development risk diversification hedging insurer purchases management mitigation strategies similarity types Risky assets, managerial presentation Roche, royalties Rockefeller, John D Roosevelt, Theodore Royal Bank of Scotland (RBS), restructuring cost (expectation) Royal Dutch Shell earnings household name Q3 call Sales, general, and administrative (SG&A) curve expenses Sales, prediction Same-store sales Sarbanes-Oxley Act (2002) Sarepta Therapeutics, Inc., stock increase Schlumberger, SPM arrangement Schwab, Charles M Science-based providers, patents Sector synopsis Securities Act (1933–1934) Securities analysis, focus Securities and Exchange Commission (SEC) enforcement actions filings nonaccounting filings Regulation Fair Disclosure regulations/enforcement actions Security Analysis (Graham) Segment report, informativeness Sell-side financial analysts Services, launch SFAS No 1974 Shareholders trust value, detracting Share prices, informativeness (decline) Short-term earnings, increase Short-term investments, contribution Sirius XM disruption threat operation, quality Strategic Resources & Consequences Report reality strategy subscribers franchise, lifetime value growth Snapshot Southwest Airlines, business processes Special items, amount (increase) Special-purpose entities Standard & Poor’s 500 Index, benchmark return Standard & Poor’s Insurance Select Industry Index Standard & Poor’s SEC Filings Database Starbucks, brand (value) Stock prices correlation financial information contrast link, deterioration information Stocks options expenses risk Strategic assets creation/maintenance deployment operating strategic assets operation portfolio, maintenance usage Strategic resources inventory, taking investments, considerations oil/gas companies pharmaceutics/biotech preservation/renewal proposal Strategic Resources & Consequences Report agents, importance customers examplef innovation investment investors necessity operating instructions media/entertainment, Case No sector synopsis Sirius XM new products, innovation oil/gas companies, Case No accounting limitations resource deployment, operations resource investments resource investments, example resources, threats strategic resources strategic resources, example value creation operations, resource deployment pharmaceutics/biotech, Case No in-line products box market share, loss patent expirations product pipeline product pipeline, candidates regulatory changes resource deployment operations resource preservation strategic resources strategy value creation property/casualty insurance, Case No insurance company operations sector synopsis resource investments Sirius XM value creation Strategic transparency Strategy articulation Subscription-based enterprises, returns Summa de Arithmetica, Geometria, Proportioni, et Proportionalita (Pacioli) Summary measures Sustained competitive advantage Symptoms, focus Talent, uniqueness Tangible capital, U.S private sector investment Technological feasibility Technology improvement providers, patents Total claim payments, GAAP Total periodic expenditure Total sales equivalence M&A effect, impact Trademarks, information Trading strategy, computation Transactions impact third-party transactions Transitory items, impact (increase) Transparency, enhancement Triple bottom line Triple entry bookkeeping Uncertainty, increase Uncollectible receivables Underwriting cycles risk United States corporate investment, pattern United States Patent Office (USPO), patent classification United States Steel Corporation annual report, publication balance sheet (1902) cash flow statement, requirement (absence) consolidated balance sheett consolidated income statement financial operations, summary footnote section, example growth, internal generation (founder belief) loss profit and loss statement (1902) reports differences risk/litigation/environment issues, discussion segment report, informativeness Unrecognized business events, increase Unrecorded events, impact (increase) Used-car market Value creation intangibles, impact measurement differences media/entertainment oil/gas companies pharmaceutics/biotech property/casualty insurance vehicle Verizon, results (announcement) Volatility decline, acceleration decrease See Businesses; Corporate sales turbulence Wal-Mart, business processes Warranties provisions Workforce employment World Gold Council, working group formation XBRL Xerox, brand (value) WILEY END USER LICENSE AGREEMENT Go to www.wiley.com/go/eula to access Wiley's ebook EULA ... 1994–2014 The End of Accounting and The Path Forward for Investors and Managers BARUCH LEV FENG GU The Wiley Finance series contains books written specifically for finance and investment professionals... prices and future earnings, hence their relevance to investors Last, our only book agenda is to outline to investors and lenders the information needed for assessing the performance and potential of. .. around the turn of the twenty-first century? ?and Part II of the book will pinpoint the reasons—as the edge of the earnings over the cash-flow strategy narrowed significantly, and 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