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Ideas Made to Matter
5 forces remaking accounting
For years, the accounting industry has been viewed as a time-honored practice whose core responsibility is to help businesses maintain accurate and timely records of their finances.
But as a host of emerging technological and societal trends continue to have a bigger effect on the industry, accountants are playing new roles in helping companies track and report their finances.
Specifically, innovations like artificial intelligence, cryptocurrencies, and regulatory technology (“regtech”) are changing the future of accounting. At the same time, practitioners are increasingly being asked to price intangibles such as a company’s brand, technology, human capital, and culture.
And then there’s climate change — a challenge big enough to potentially alter the fundamental nature of the practice, as more and more companies begin measuring factors related to environmental, social, and governance (ESG).
“For the longest time, the purpose of a company was to provide returns for its equity investors and debt investors,” said accounting professor at MIT Sloan. “ESG is saying that the purpose of a company is broader than just its investors — it's society at large. That means that the measurement has to in some sense reflect that, and that's a huge fundamental change.”
The one constant amid much change: Knowing exactly what to measure will be essential to making progress.
“Rewards [for companies] are going to be greater in instances where you can measure the company’s performance,” Shroff said.
Here are five areas where accountants are stepping up to that challenge:
ESG and climate impact
More than ever, investors care about a company’s ESG performance and companies are under pressure to show the positive impact they’re making. A report from Moody’s Investor Services showed global flow to environmental, social, and corporate governance concerns increased to $80.5 billion in the third quarter of 2020, up 14% from the previous quarter. And when BlackRock chief Larry Fink urged companies to eliminate greenhouse gas emissions by 2050, investors paid attention.
“Businesses are increasingly recognizing that maximizing shareholder value involves more than profits,” saidassistant professor of accounting at MIT Sloan. But because ESG measurement and reporting aren’t currently standardized on a balance sheet the way that earnings are, this remains “a new frontier for accounting.”
Many companies measure their environmental impact by focusing on their carbon emissions and the specific actions they’re taking to reduce them, such as planting trees that will absorb carbon from the environment, Shroff said.
“Carbon emissions is a natural thing for people to think of, and I think partly it's because we tend to focus on what we can measure, and we can measure carbon emissions,” Shroff said.
Toward that end, the creation in 2011 of the Sustainability Accounting Standards Board aimed to help by creating uniform standards that give accountants guidance on how to translate risks into numbers. An alternative standard, the Task Force on Climate-Related Financial Disclosures, developed a framework to help public companies accurately disclose their climate-related risks and opportunities.
Artificial intelligence and machine learning
Artificial intelligence is touted as a faster, more accurate way to analyze data, and research shows its growing prevalence in accounting. In fact, a recent Ernst & Young survey showed that 53% of finance leaders believe that more than half of finance tasks currently handled by people could be performed by AI over the next three years.
Shroff predicted that “AI is going to significantly affect the ways in which companies detect fraud or any form of manipulation.”
Shroff especially sees AI having an impact when companies prepare their financial statements and conduct an internal audit to ensure that there are no instances of fraud. AI can also transform the standard way of bookkeeping to “help companies better reduce the risk of errors in financial reporting, whether it's intentional or unintentional.”
“I think as technology develops, I can see AI changing quite significantly the way in which record-keeping, the bookkeeping part of accounting, is done,” he said.
Blockchain and cryptocurrencies
Cryptocurrency is gaining so much traction with financial institutions that it just might form an entirely new asset class. In fact, a Bitcoin ETF’s recent trading debut was the second-highest traded fund ever.
Accounting for the value of a cryptocurrency can be tricky. Generally accepted accounting principles consider cryptocurrency an intangible asset calculated as such: If the value of an intangible asset goes below what a company paid for it, then the asset is impaired, and a company writes down the value. But if the value of an intangible asset goes up, above what was paid, then the company is not allowed to write up the value of the asset.
Shroff said that an easier way to account for a cryptocurrency — and one that is echoed by other industry watchers — is to treat a cryptocurrency investment as a security. Shroff said “these currencies have observable prices” and that for any public company investing in crypto, it’s “no different than investing in the stock of another company.”
“There are separate accounting rules for that, which at least in my opinion, are more reflective of what a crypto investment should be accounted as,” Shroff said.
Going forward, Shroff said it’s essential to think about the best way to account for cryptocurrency, given that it will “grow in popularity” as “companies want to diversify and hold some cryptocurrency as part of their treasury.”
In recent years, financial institutions have doubled down on their compliance-driven investments in technology (known as regtech). Twenty years ago, firms primarily hired financial experts and increased spending on auditing when they were impacted by a regulatory change to make sure that they were in compliance with rules such as Sarbanes-Oxley.
Now, however, technology is increasingly being used to provide real-time monitoring and tracking of compliance with industry and securities regulations as the compliance burden (and related fines) increase. Regtech can also be used to detect disruptive events in global financial markets, anticipate price movements, identify blockchain fraud, generate tax reports, and much more.
“Banks are facing increased scrutiny, particularly surrounding how much capital they have, as well as a range of consumer financial protection issues,” saidan associate professor in accounting at MIT Sloan.
As such, regtech is booming. Sutherland notes in a new paper that in 2019, public U.S. financial institutions spent nearly $10 billion on regtech investments compared to just $2.2 billion on auditing. Going forward, he added, regtech expenditures are expected to grow annually at 40%.
In the broker-dealer setting, for example, “regulators want to see that you have enough capital and that you're properly segregating customer and firm assets,” Sutherland said.
Regtech helps firms demonstrate that they’re keeping these controls, not just at the end of the quarter when they’re putting out financial statements, but “every single moment of the quarter,” he said. Regtech “really lends itself to better record-keeping, better data management, and better reporting solutions.”
Is it possible to put a price on Apple’s ecosystem or come up with a value for the data scientists that work at Tesla? If it sounds difficult, that’s because “intangible capital by its very nature is difficult to measure,” said Xie, noting that “accounting focuses primarily on historical or book value, rather than current or market values.”
But as intangibles continue to grow in value, whether it’s human capital, tech, brand, or culture, solutions must be found. It’s important to account for intangible assets because they are so valuable that they can play a large role in a company’s long-term success or failure.
“Today, the largest companies are so knowledge intensive that most of their assets are intangible, and I'd say that is probably some of their most valuable assets,” Shroff said, noting that this is especially the case with tech companies.
“When a company grows this internally, there's no value assigned to it,” and its worth is “hidden to the accountant,” Shroff said. “For accounting not to become obsolete in a world that's led by tech, there's a need to reconsider how we think about intangibles, just as how we were thinking about climate and social issues.”