Baruch LevThe End of Accounting and the Path Forward for Investors and Managers (Wiley Finance)

First a disclosure, I’m a business (NOT accounting) professor and I research, study and teach strategy, knowledge management and human capital (for a few years or decades). Studying Intellectual Capital is how I became aware of prof. Lev’s studies on the subject. Also, I usually do not write reviews, but in this case, I thought I should as a service to people like me who are frustrated with the lack of understating of the knowledge-driven economy, and the lack of valid and reliable indicators of it, specifically, of human capital or talent.In my humble opinion, Profs. Lev and Gu have done the impossible (for accounting professors) and this is to suggest in plain English why their profession is at risk of becoming irrelevant to investors and managers. They have done that methodically and rigorously, suggesting that the vast majority of the information created by the current in-use accounting method is irrelevant at best, and sometimes plain harmful. I have suggested the same for many years, but now I have the numbers to support such positions which are provided by highly respectable accounting professionals.But their book goes much further. The book suggests an industry specific framework (which is revolutionary for accounting) of reporting and management of tangible and intangible assets, as well as needed modification in legislation of economics to enable efficient and effective management of assets and investments. The book also provides four detailed examples of industries that illustrate the use of their proposed framework. All that in language that is easily understandable by readers that are not accountants. This though provoking book is written in a fashion that will not put even non-accountants to sleep and it portrays enough figures with examples to keep it relevant, practical and interesting. Their explanations are clear, their examples are relevant and compelling, and their writing style is dynamic and sometimes even funny. The two weaknesses of the book that I could identify are that it is probably not applicable to most SMEs, and could have done a better job discussing Human Capital (and/or talent). Regardless, this book makes a huge contribution to the intellectual and practical tool-kit of the forward-thinking policy makers and businessperson and I highly recommend it to everyone. I personally plan to use it in my teaching and lecturing about the new knowledge-driven global economy.It took an accounting professor from Harvard more than a decade to convince top management that there is more to managing a company than financial numbers (Kaplan) and provide them with some practical tools to do that(the Balanced Scorecard; with Norton). I hope that the two professors from NY will have better luck, since we do not have a lot of time.

As a portfolio manager in an era where the economy is getting increasingly digital I have, over time, learned to ignore GAAP financials more and more as I realized they were not really capturing what was really going on in the businesses. Consider the absurd-sounding P/E ratios of Amazon (300+) and Netflix (190+) suggesting that these companies are not earning even as they monopolize their industries and sectors. I have learned to ignore the supercilious head-shaking of countless media articles suggesting that these stocks must be bubbles just about to crash - "just look at the P/Es!".So it was a pleasant surprise to encounter some support from an unexpected source - two *accounting* professors acknowledging that their profession is losing relevance by sticking to GAAP methods as more and more of the economy becomes intangible.In the first section of this highly readable book they document their painstaking efforts to establish and quantify this loss of relevance and explain where the problem lies. Here is an example from the book: If you spend on marketing to develop a brand, like Coke did, it's not an asset on the balance sheet according to GAAP, but if you *buy* the brand, it will be proudly displayed on your balance sheet. This is because the marketing is immediately expensed as part of SG&A. In fact, the *least* important assets to Coke - undistinguished commodities such as physical buildings - are what appear as assets on the balance sheet instead of its true strategic assets.As the professors note: As "software, biotech, and Internet services, came into being during the 1980s and 1990s ... the major value drivers shifted from property, plant, machinery, and inventories, to patents, brands, information technology, and human resources. The latter set, all missing from companies' balance sheets because accountants treat intangible investments like regular expenses (wages, or interest), thereby distorts both the balance sheet and income statement... Asset and equity values of intangibles-intensive businesses are seriously understated, but their profitability measures (ROE, ROA) often overstated, while the earnings of firms with increasing investment in intangibles are diminished, due to the full expensing of intangibles. Every aspect of the financial report is adversely affected by this dated, industrial-age treatment of intangible capital.The latter half of the book suggests the authors' solution: adding fact-based metrics to GAAP statements that attempt capture some of the fundamental drivers of actual value creation of a business. The problem, of course, is that these metrics vary depending upon the type of business. The authors provide four different industry-specific examples of such metrics in an integrated report form that is structured to capture the creation and maintenance of business value (for example churn and customer-acquisition metrics for consumer franchise type businesses). To be sure, under pressure from investors companies already provide some of these metrics in 8-K releases (non-GAAP) and during analyst conference calls, but due to lack of standardization, these are not consistent or comparable across companies and not subject to audits by independent CPA firms.I highly recommend this well-written and timely book to all investors and analysts, but it is essential reading if you are analyzing a company whose fundamental drivers happen to be intangible (software, patents, drug pipeline, brand etc). In fact, the situation the authors are addressing is only going to get much worse as cloud-based software becomes prevalent, with its upfront costs being completely out of sync with revenues spread many years into the future. Last but not least, I found the book to be a fun and easy read, not something I expected from the notoriously dry subject of accounting!

Well researched book. Although the topic is technical, the authors break down the subject matter in easier to understand chapters. Their proposed alternative framework is interesting and compelling in many respects. Well worth your time to consider their arguments.

The authors collect and present a lot of hard evidence for the declining relevance of US GAAP to stock markets and investment decision-markers, from their own research and others'. They also offer a convincing theory for why this has happened: Our form of financial reporting developed for the industrial economy and therefore has a heavy focus on hard physical assets but has not adapted well to the knowledge economy, where intangible assets and R & D are the drivers of value creation. And unlike most GAAP critics, they actually put an interesting and textured alternative on the table, in the form of their proposed Strategic Resources and Consequences Report.I assign this book in my "capstone course" for Master of Accountancy students because it's so effective in shifting them from taking the accounting standards as inscribed on stone tablets from Mount Sinai to considering them as the product of difficult and flawed human choices. The writing style is also lively and fun, a welcome break from the leaden prose you usually see in this area. Whether you ultimately agree or disagree with their proposed solutions, it's hard to dispute their case that traditional accounting has a serious problem.