Financial Update (Third Quarter 2002)
Accounting Reforms Not Enough
Corporations Called on to Help Solve Accounting Problems
he solution to the kinds of problems that led to the unraveling of Enron, WorldCom and other large corporations cannot come exclusively from reforms in the accounting industry, according to Susan Schmidt Bies, a recent appointee to the Federal Reserve System’s Board of Governors. In addition, business executives must take steps to address this challenge, she told a gathering of the Atlanta Fed’s board of directors and local business and community leaders.
Bies observed that today’s accounting principles are predicated on the economy of a century ago, when manufacturing and retailing dominated and when the earnings process ended at the sale of a product. In contrast, for the service companies dominating today’s economy, the earnings process actually begins when the sale is closed.
As a former banker with First Tennessee in Memphis, Bies is familiar with this paradox. When bankers package loans and sell them but still service these loans, they have to recognize the earnings stream over the entire life of the loan. Failure to recognize the ongoing nature of such transactions would be like expecting Alcoa to book revenue from a plant on its opening day, she quipped. This type of approach clearly needs modernization, she said.
In addition, business leaders need to take steps within their organizations — such as implementing solid risk management systems. Many corporations, especially banks, have taken such steps. However, the short-term nature of the quarterly reporting system does not reflect the longer-term nature of these businesses’ risk management calculations, according to Bies. For investors in service companies like banks, finding out how future alternatives could affect earnings would be more meaningful. Bies applauded the fact that many companies are already providing supplemental reports detailing such information to securities analysts. She suggested that more businesses do so — and that they share this information more broadly.
Bies ended with a warning: If businesses don’t exercise leadership along these lines, others will take on this role — but with a narrow approach focused on more regulations.