No Accounting for the End of the World?

Jacob Soll’s book “The Reckoning: Financial Accountability and the Making and Breaking of Nations” makes a good case for economic progress being firmly based on the ability to account for that progress. Although he does not show direction of travel (or cause to effect) with certainty, there is a common sense from his historical analysis from ancient Greece to more recent times in the theory that progress is based partly on an ability to undertake double-entry book keeping. This measures progress but also provides the degree of transparency that ensures “buy-in” from society.

 

This may not be a riveting “eureka” moment for many and Soll’s dallying with more metaphysical comparisons about the debits and credits of a good life being reflected by the righteous in the way that good businesses and people (like Josiah Wedgewood of pottery fame who not just promoted cost accounting but used the principle of accounting to balance their sins and good deeds) do their accounting is somewhat stretched. However, there seems ample evidence that at both a corporate / organisational and national level, economic progress is assisted greatly by the ability to count your profits and losses – to show how progress is being made.

 

Soll refers to corruption in the past that resulted from both poorly kept accounts (at corporate and national levels) and those clever enough to hoodwink auditors and investors through manipulation of accounts.

 

From the analysis, it is clear that investors need good data to make informed decisions and that citizens need to know how governments spend their money – not just for the sake of transparency but to provide worthwhile and useable information. In the majority of developed nations, corporate accounting is subject to GAAP (generally accepted accounting principles) or equivalent; in other countries there is a wide disparity of accounting standards or a lack of them – in Afghanistan, it will hardly be a surprise that there is no accepted principle of accounting and very few qualified accountants from there.

 

Despite the developed world’s professional standards, this does not prevent disasters on the scale of the 2007-8 banking crisis or Enron or a host of other “accounting” failures. Often, auditors don’t see the problems and may even see them and do nothing.

 

On a national basis, the same is true. While it is hard to judge the efficacy of national accounts (which are the subject to revision for many years), it is hard to believe that any country which does not work hard to make its national accounts transparent is one where real economic progress is being made or where opacity is not hiding something sinister.

Back in 2010, Global Witness highlighted this in its report “Oil Revenues in Angola” which documented the problems that Sonangol (Angola’s state oil and energy company which was then considering a public stock listing) had in reporting its revenues. That report, one of the few independent reports in a sector that is riven with corruption, argued for greater transparency, improved systems and independent auditing to the highest standards for an organization through which Angola’s wealth derives. Soll would argue that its secrecy and lack of transparency and independent auditing shows all the hallmarks of a corrupt society. But, pressure on Sonangol to provide more and better information (better accounting) is a key approach.

Numerous, other examples exist in many countries – many where natural resources exist that should benefit the population but where the “resource curse” is made possible by lack of proper accounting to high standards, properly audited and verified.

Similarly, the Dodd-Frank Act in the USA opened up country-by-country reporting to reveal how much revenue was entering such countries. The USA (and hopefully with the EU to follow) are attempting to go around the opacity of nations (and their lack of accounting capability) to find the real accounting data through those that have that ability and are subject to our own norms of accounting – the major energy companies. In this way, good accounting may be accessible by the back door to show citizens of the affected nations just how their Governments provide for them (or don’t).

 

A recent example of this is shown by an analysis made by Richard Murphy (the progenitor of country by country reporting) on recent data issued by Barclays Bank. It shows, through analysis of that data, how Barclays shields its profits from the UK Exchequor.

 

 

 

 

Value accounting – can we properly Account for Natural Resources?

 

One of the latest “opportunities” for accountants is accounting for natural resources – our natural capital. It is believed that if we make up a balance sheet of all our assets (and liabilities) then we will better know by valuing them what impact we are making on them. We naturally sympathize with a society that is striving to understand its failings and what to do about them. There is no question that if it was possible for governments (nationally and internationally) to properly assess value in our natural capital, then we could (somehow) impose some sort of value adjustment to problems caused by companies and governments when doing the things they do that adversely impact our natural capital or trade-off costs and benefits and make better decisions.

 

There is a natural and realistic desire in some governments to properly account for their natural capital. For example, The Scottish Forum on Natural Capital aims to focus on its natural capital and

 

“To deliver on its goals, the Scottish Forum will:

  1. Calculate the monetary value of Scotland’s natural capital and the cost of depleting it. This will involve coordinating experts including accountants, people from business, academics and policymakers.
  2. Communicate to a broad range of businesses and other stakeholders the risk of depleting Scotland’s natural capital and the huge economic value from protecting and enhancing it.
  3. Set up collaborative projects to deliver tangible action to protect and enhance Scotland’s natural capital.”

 

 

The calculation of that value and the link between that and effective action are major challenges. This is because the pricing mechanism for such resources does not exist. Accounting is based on the ability to reach a value determination on goods and services. It is not always right but much of double entry book-keeping methodology is based on market prices – the prices actually paid for goods and services. Market prices provide information on those goods and services that allows a profit and loss account and balance sheet to be derived.

 

Now, even existing and well understood basic accounting is often flawed or wide open to judgement. An example from the recent past: in the days of high inflation, companies (that anyway provide accounts that are usually out of date by the time a user receives them) were encouraged to undertake inflation-based accounting in addition to actual costs. Oil companies still provide two sets of accounts (one takes the data back to the latest oil prices). Which is correct? Neither (although only actual costs are used by taxation authorities)– but, they may be aids to better informed decisions.

 

Accounts are always an approximation of reality. So, for example, accounts show labour costs (the costs of people who work in a business or organization) as costs. Yet, of course, people are only recruited to add value. Unfortunately, there is no balance sheet valuation of the benefits that they can provide. Back in the 1970’s, it was fashionable to consider whether people should have a value assigned to them on the Balance Sheet (much like footballers used to be valued on the Balance Sheets of football clubs). This proposition lasted only a short time and people are not valued on a balance sheet – except in those companies with traded shares where “goodwill” (the difference between the stock value of the company and its balance sheet value) contains an undefinable figure for people. Google’s share price (usually viewed as a multiple of earnings – its P/E which is currently around 30) takes account of its extraordinary people talent – but, in a way that the market is willing to trade – a form of market pricing.

 

When the accounting mechanism is brought to natural capital, it is much harder to “account” for it – there are limited pricing mechanisms.

 

At a micro-level, companies can provide information on where their natural risk lies (e.g. how they source materials upon which they survive, where the risks are and what they are doing about it) but some of this is pricing, much of it is risk analysis. From the latter (just like any risk analysis) actions can be taken to minimize risks and maximize opportunities.

 

Companies also produce “externalities” – they impact the environment, for example, through CO2 emissions, use and abuse transportation systems, can destroy environments. So, clean-up costs need to be established when developing projects along with the minimization of health hazards and environmental degredation. Governments in many countries can work with businesses to save the environment and recast it. In the developing world, this is harder. Many instances occur whereby companies ravish areas of natural beauty and poison locations with the side effects of their production processes and do not pay the consequences. This is often a corrupt bargain but becomes the norm where natural resource extraction and its “value” overcomes the perceived value given to those dependent for their lives and health on the land: from China to DRC, from mining to forestry.

 

The key problem is linking the micro activities to the macro (governmental) responsibility for the environment. The notion of valuation at least focuses the mind. The question is whether valuing natural capital (and the wide range of – usually erroneous – assumptions that have to be made in a non-market priced environment) is useful and whether such valuations can be used to make decisions – even whether there is a use for such decisions on a quantity basis at all. For decisions based solely on price (where all the risks are not taken into account) will be wrong except where there is a market-based pricing formula available (and, of course, perfect pricing relies on perfect information on both sides – which never occurs). We can “see” how Barclays used low tax jurisdictions (see the TJN report referred to above) to shield profits and decisions can, in future, be made as a result. Valuations of natural capital are far more tenuous.

 

The drive to valuing our “natural capital” in business jargon (through pricing) is centering our attention on this critical area. However, at this early stage of natural capital ideas development (although not at an early stage in the degradation of the planet) we should be understanding what we want out of it.

 

What if all the alligators in the world were to be destroyed because enough people were willing to pay the price for alligator skin handbags and shoes? Would this be acceptable because we “paid the price”? Clearly not as the value of preserving such an animal is not easily factored into the price – who assesses it and who sets it when the “value”of having alligators is unpriceable. That is why ivory sales are (in the main) banned. There is no price allowed in the system for the elimination of elephants from our natural environment – we have made a collective decision to try to stop it rather than pricing it.

 

This suggests that the “value” placed on part of our “natural capital” is not quantifiable in business terms – even if the costs of certain degradations (and “externalities”) are.

 

Not only do we need to ask the right questions, we have to start with the answers we want or the history of Easter Island is just repeated on a massive scale.

 

There is a place for good accounting – and good accounting should know its place.

 

The Corporate Paradox

 Chimeric Corporations

This week, Danny Alexander has announced that the UK government will not allow companies that have proposed tax schemes that have been found to be unlawful to bid for government contracts.

The G20 announces that governments across the world will work together to ensure that companies pay the proper rate of tax in the countries in which they do business.

Why now, after over 500 years of the joint stock / limited liability company are governments beginning to attack the privileges of the multinational – companies that operate across borders but ask us to believe that what they do is for our good as consumers and for the good of their shareholders?

Paradox: any person, thing, or situation exhibiting an apparently contradictory nature.”

Company: “An entity, usually a business, created by a legislative act or by individuals who have agreed upon and filed articles of incorporation with the state government. Ownership in the corporation is typically represented by shares of stock. Furthermore, a corporation is legally recognized as an artificial person whose existence is separate and distinct from that of its shareholders who are not personally responsible for the corporation’s acts and debts. As an artificial person, a corporation has the power to acquire, own, and convey property, to sue and be sued, and such other powers of a natural person that the law may confer upon it.”

(www.yourdictionary.com)

Worldwide, the campaign to properly tax companies hots up. 500 years after the Dutch East India Company issued shares (and joint stock companies can be said to have been formed well before that date), the part that companies play in society is still not resolved or even understood by most. Many argue that companies should not even be seen as independent entities for tax purposes but, rather, we should see the people behind them (shareholders and staff, mainly) as due for tax on receipts from companies.

That argument treats society as a game – where the simulated rules can be played out on a computer (a bit like econometricians think of economics). It is not credible in reality as businesses make decisions as businesses and act as independent entities as complex adaptive systems within the overall societal environment. Those calling for zero tax for companies ignore the fact that the biggest fund providers to politicians are businesses and business coalitions. Business (through companies) may well be the main instigators of economic progress in a market-oriented world. We now believe that the market (the nearest equivalent in economics to biological evolution) works better than the alternatives. Companies, which are provided with risk limitations through joint-stock ownership, are central to the market.

But….Is the Company Real?

Well, companies can be defined as a collection of people joined together for a business enterprise. Under laws such as the 2006 Companies Act in the UK, companies of various types are given legal definition in their own right. They have privileges and obligations under the law – even though directors of companies may also have individual responsibilities should the company not perform within the law.

The paradox is that companies are (in law) independent and “living” but, in fact, are, of course, artificial. This proves a difficult concept for individuals in society and for lawmakers, but the history of humankind is bound up with people joining together in groups and governments (from dictators to democracies) trying to legislate for them.

Companies are merely an artificial group legislated into being amongst many others that operate directly with individuals and other artificial and legislated groups (such as other companies and trading with governments). They represent a part of our social fabric as a paradox of society – an artificial group which binds together its individuals into group decisions and group impacts on the rest of society.

A company is a complex adaptive system (CAS)

Initially, a company is formed by key individuals that are hard to separate from the company itself – it may be one person who sets up a business. The business is formed to provide a good or service to society and to reap certain rewards in return. John Kay wrote in 1998  about why a company exists and his thoughts on what makes a good company (these days, a sustainable business).

It is estimated that 70% of companies fail within five years of start-up. Those that survive, become in a relatively short period, very different from the individual that started them. As soon as managers are brought in to assist, the company becomes more “complex” and decision-making is more group oriented but not centralized. The company becomes a system unto itself where most decisions are taken by its staff at all levels and continuously.

If a company goes “public” (with its shares traded), then there is also a divorce between the owners and the managers. Owners operate in the stock market casino – with little or no relationship to the company except insofar as it pays dividends or the share value rises or falls. This separation of ownership and management (and the rewards due to each – a special problem in the finance industry where employees at the top level have usurped the risk parameters and receive high returns for no capital risk) is a potential friction and another level of complexity that society still wrestles with (see John Kay’s more recent work for the UK government).

The complexity of a company’s make-up does not hide the fact that a company operates as a distinct entity – a complex adaptive system (CAS) made up of individuals but (like a City) operating without central direction in ways that impact those around it in a multitude of ways. Companies impact through enterprise and innovation, through motivation, through marketing, through involvement with other companies, through its customers and the environment. It does not operate as individual activities of each of its staff individually but as a collective – as a CAS.

Companies and Society

This has been recognized for centuries and most now understand that anything like a company – despite the corporate paradox – has to be treated in law and taxation as if it had a life of its own. Such treatment includes taxation as much as health and safety, labour laws, environmental laws, trade description laws (e.g. not supplying horse meat instead of beef), data protection and customer protection. Society’s interaction with companies means that staff, consumers and suppliers and anyone else affected by companies (such as people those impacted by companies located in their area, those who oppose the lobbying of companies etc) require that companies are treated like the rest of us – society demands that companies face legal requirements and that includes taxation.

The G20 has now committed to proper tax treatment but our governments need to go further. Companies provide innovation and are the mechanism that a market economy uses for prosperity – at least in pure GDP-related terms (another issue).

To make this real, we have to understand that society sees companies as real entities that have a full part to play in the society of the 21st century – not an artificial entity set up but a full system in itself that has legal and moral authority and responsibilities.

To tax is not an issue – of course companies have to be taxed and taxed fairly and properly in the same way that companies should be held to account over natural resource exploitation, health and safety laws and over reputation (no horsemeat in products unless advertised as such). Only in that way will the rest of society (increasingly aware of its rights) enable companies to reap the benefits of their success and be enabled to continue to innovate sustainably.