Nov 2009

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<itemid>107476</itemid>

<eventtime>2009-11-19 20:43:00</eventtime>

<logtime>2009-11-20 01:43:18</logtime>

<subject>Problems with Accounting</subject>

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I wrote a few weeks ago about some fundamental assumptions in our society that are wrong. Specifically, how Communism largely failed because it ignored basic human nature and Capitalism didn’t. I also pointed out how Capitalism only kind of does, and a lot of what our society does is fairly subjective. Now I’d like to talk about something that is NOT subjective. Here is an element of human nature; people are going to game the system. So if you set up the rules one way, people will behave accordingly. Of course there will be people who break them, but there will be just as many people who follow the system and simply use it to maximize their advantage. People rant all the time about corporate short sightedness and greed. Indeed, I’ve done the same thing. Shareholder governance is a problem as are the ‘elite’ cadre who all knew each other in school and vote each other onto each others boards and give each other big fat salaries that each other approves from each other. Sound like Incest? Does to me. But that is not the problem I want to address…. I am talking about the Fundamentals of Accounting. There are specifically at least two issues that need to be addressed. Accounting considers employees a Liability and ignores the value of Branding. The reason for this is simple. By the rules of accounting, we only care about ‘real’ numbers, ie what the company could be sold for on the open market, hypothetically. You see the flaw there. First of all, the market is totally subjective. Second of all, they’re making the numbers up out of thin air or anticipation. Of course those numbers are at least partially realistic in the sense that these are very EDUCATED guess and the subjective opinion of markets is very real in the sense that someone will often pay money for the thing, often at the guessed price. But the ‘fundamental’ principal of accounting does not deal in ‘real’ numbers. Accounting is far more than simply counting the number of Wheaties boxes in your inventory or even simply what the price is of that; and what the price those wheaties will sell for. That’s the thing they teach you in math class. Those ARE real numbers (assuming the price of Wheaties does not change). Accounting is a lot grayer than that though, because a lot of the decisions are based on categorization of management choices. Sure, they are ‘boring’ or ‘conservative’ or ‘realistic’ but let me assure you, after taking my financial management class, I learned that those financial statements and accounting statements are just like accounting. They are all a game trying to juggle the rules to their advantage. There is nothing inherently wrong with this, but it is also a hypocritical system. For example, proper accounting does count say….a tractor. It counts the tractor itself (the physical tractor) as an asset because it is a thing that can be sold by the company that can generate money. Furthermore, you can count the income that the tractor will generate or that it MAY generate as future income. At the same time, the tractor does have costs that depreciate, which are technically a liability. However, because the tractor generates more money than it costs in terms of maintenance, it still gets to be called a depreciating asset. Well…like tractors, employees generate money for a company. A company cannot make money without employees (unless it is some kind of automated robotic factory and even then, SOMEONE has to call the robot repairman when it breaks down). But employees are a liability, not an asset. In fact, by how companies do their accounting rules, Employees are usually their BIGGEST liability, so board members when exercising ‘due diligence’ automatically cut their biggest asset first…lay offs. Now not all companies are this stupid, but when they DON’T lay people off they take a risk with their shareholders by getting sued. Guilty until proven innocent. And yet…I am an asset, not a liability. Unlike the tractor, the company does not project my future earning because I might leave at any time. After all, I’m not a slave or anything. And yet….the tractor could break down at any time too. In fact, when not being laid off by stupid management, the vast majority of employees do not leave the company unless retiring or they’re dead. People LIKE to stay in their jobs, or at least for a period that can be quantifiably measured. If the average volunteer turn over rate is 4.5 years, why not project the income generated by that employee for the company as an asset instead of a liability? I’m sure an accountant would come up with a clever answer as to why they don’t but the fact is, that everything that they do beyond ACTUAL bean counting is also subjective. Furthermore since the vast majority of US are affected by THEIR rules, then it should be THEM who are forced to change them. I am an asset, not a liability. By the way, there is often an exception to this. Sr. Management is often counted as an asset, not a liability. The outrageous salaries they are given is justified because of income that they might generate for the economy. We outnumber these people millions to one and yet we put up with this nonsense every single day. The rules of accounting must be changed. The second, more basic problem is fundamentally stupid. Anyone in marketing or management understands the value of a companies brand. A brand is an ‘intangible’ because it is subjective After all, the cost of glass to make the coke + the labor + the cost of manufacture are all ‘quantifiable’. That makes up .12 cents or so of that coke bottle but they charge 1.00ish because people will buy a COKE vs. Kroger generic cola. You don’t see Kroger Generic Cola being advertised on television. That is because of the ridiculously high value of the Coke Brand. Accounting KIND OF takes this into account, but it pretends that it is totally subjective and really only counts any value of a brand as ‘goodwill’ if a company is bought for something other than rock bottom prices. Let me give you an example. Let’s pretend that the Coke Brand (the right to call something a coke) is worth around $40 billion. That is to say if I went to the CEO of Coke and said, “I want to buy the brand of Coke, how much do you want for it?” And that is the price I’d get. The CEO of Coke knows how much it is worth. They spend billions on advertising to make it work. But on the coke balance sheet, do you want to know how much this $40 billion shows up as? Nothing. Nad. Zero. Zilch. The costs it pays for liability to maintain that brand are listed. The salaries of the employees who work in the marketing department are listed. The income generated BY the brand is listed, but the fact that the brand itself is worth $40 billion? Not at all. Bear in mind, btw, that if Coke buys $2 billion worth of stock in another company, that totally subjective value placed on the stock is counted as an asset. Now let’s say the PHYSICAL value of Coke’s stuff, the plants, the trucks, the materials to make coke etc, if I sold them all at auction, its worth say…$3 billion. So if I BUY coke for $40 billion, then accounting does recognize the value of the brand, but it calls the difference between $40 billion and $3 billion ‘goodwill’ and calls it $37 billion. It is ‘goodwill’ because I ‘graciously paid’ an extra $37 billion for the right to call something coke. Oh, and guess what? It is only on my balance sheet for a year. And Good will? It’s a liability, not an asset. Because I ‘overpaid’ by $37 billion. So let’s sum up shall we? “phantom earnings” created by Overpaid CEO’s: Asset Trucks: Asset Employees who make the company work: Liability Value of the Company’s Good Name: Non existent or a Liability. And we wonder why company’s see no value in acting like ‘corporate citizens’ even though they have all the rights of a human being but none of the responsibilities except paying taxes. Yes, we don’t let them vote but they can do pretty much everything else including hold IP forever. Yeah, that makes a lot of sense. Accounting must be changed. We live in our society. We abide by its rules and those rules should be made to benefit US, not the other way around.

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