The End of Accounting and the Path Forward for Investors and Managers (Wiley Finance) | Baruch Lev

Summary of: The End of Accounting and the Path Forward for Investors and Managers (Wiley Finance)
By: Baruch Lev

Introduction

Welcome to the world of ‘The End of Accounting and the Path Forward for Investors and Managers,’ where you’ll explore the outdated nature of public company financial statements and their decreasing relevance for modern investors. This book summary will journey into the unchanged accounting practices and how they struggle to adapt to the rapid shifts in the economy and various sectors. Discover why accounting is resistant to change, the concept of ‘path dependence,’ and how intangible assets are impacting the investment landscape. Be prepared to uncover the reasons behind the declining usefulness of financial reports and the potential solutions for this longstanding issue.

The Resistance of Accounting Data to Change

The 20th century witnessed profound changes in almost every aspect of society except public company financial statements, which remain remarkably static. Despite the revolutionary changes that occurred over time, accounting systems did not evolve accordingly. Annual reports have become significantly longer, yet most of the added content is meaningless fluff. The reasons behind the reluctance of accounting data to change are shrouded in mystery. Although ideas such as triple-entry accounting were proposed, they never gained traction. The adherence to double-entry bookkeeping despite its age and limitations has contributed to the absence of innovative accounting systems that could better reflect the ever-changing business models, operations, and values of modern companies.

The Evolution of Investing

In the past, financial reports were the go-to source of information for investors. However, with the emergence of sophisticated research, this has changed. Despite this, corporate earnings remain a crucial aspect of evaluating companies. Exxon, as a case in point, has maintained its profitability for years, making it easy to predict its future earnings using simple calculations. Surprisingly, such predictions often outperform expert forecasts. Nevertheless, investors should remain aware that reported earnings may contain estimates. The rise of earnings forecasting has led to a decline in the significance of reported earnings, with earnings surprises having a considerable impact on stock prices. For instance, IBM’s poor quarterly earnings announcement in 2013 led to a 7% drop in share prices due to fundamental problems with their business model.

The Flaws Within Earnings Calculations

Companies’ earnings are calculated by taking into account unusual, one-time charges that can create volatility in the bottom line. These charges reduce the reliability of earnings as a predictive tool, making it difficult for investors to rely on them. Additionally, traditional accounting has no rules to isolate the effects of one-time charges, which can create false signals for shareholders. Intangible assets contribute heavily to business value, yet they are not fully reflected in corporate financial reports. As a result, sophisticated investors have learned to not react strongly to missed or beat earnings forecasts. While there is a measurable difference in performance, it is not significant enough to warrant press coverage of earnings calls.

Investor Irrationality

Investors may be the cause of unstable financial markets, not accounting practices. The dot-com bubble of the late 90s showcased how investors were putting money into companies with no assets or earnings, leading to price bubbles. However, if irrationality was the new norm, stock prices would be untethered to fundamentals. This hasn’t occurred. Facebook’s IPO was viewed pessimistically by investors, leading to a fall in share prices.

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