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— Industry Insight —
 A root cause of our country's financial predicament is the failure of our financial statements, prepared in accordance with generally accepted accounting principles, to provide the information needed to assess risk and rewards. The dollar numbers shown on balance sheets and income statements are a single dimension presentation of multidimensional economic organisms. Explanatory text in the financial statements adds information but does not change the numerical presentation. Consider the architectural blueprints that describe a physical structure. These drawings are in three dimensions: a "plan" showing the bottom of the structure viewed from the top; a "section" showing slices of the structure; and an "elevation" showing the structure viewed from a side. One can understand the structure only by looking at it in three dimensions.
In sharp contrast, present-day financial statements for an enterprise
show a single balance sheet and a single income statement with a
computation of net income. Further, there are a variety of accounting
conventions that can be employed in producing these single dimension
financial statements that are in accordance with GAAP but that will
show dramatically different balance sheets and income statements for
the reporting period. Accounting for executive stock options is a clear
example. If the option compensation is shown as an expense, the
enterprise shows lower profits or a loss; if the issuance of options is
treated as a capital adjustment, reported net income is not reduced.
In the recent past, both accounting methods were sanctioned by GAAP. Members of Congress stated that a proposed accounting rule that would require showing the options as compensation would injure startup companies and prevent them from raising capital. Let us insert a "Full Stop" sign at this point. We are describing a business unit seeking to raise capital. How can a rational society allow the choice of a method of accounting by an enterprise to determine the allocation of economic resources. Economically identical enterprises are evaluated differently because of choices of methods of accounting. A chameleon is the same organism even though its color changes. In today's climate, the only way to describe an enterprise is through multidimensional accounting in which financial statements show balance sheets and income statements under various accounting conventions and relevant supplementary information is provided in understandable numerical form. The secretary of the Treasury and the chairman of the Federal Reserve Board stated that they did not have the information necessary to control "excesses" that recently surfaced. How can the public expect to have such knowledge? We must gather and present economic information about a business in
a fashion comprehensible to executives and directors, to government
authorities and to the investing public. We can no longer have our We have seen governmental efforts to reach the moon, and we have observed private industry's accomplishments in computer technology. A similar effort must be put forward to produce tools to describe and navigate economic events. We cannot look to the accounting profession to provide the funding or research necessary to develop multidimensional financial statements. The task should be assigned to a bipartisan governmental commission with the budget and staff necessary to think through issues involved and the methods of presenting in numerical and comprehensible multidimensional form the information to guide and control the economic engines of capitalism. Knowledge is power, and we must acquire knowledge. Let us not cast blame on executives and directors who did not change course based on risk analysis when the tools to do so transparently were not available to them. They were navigating a supersonic jet with a sextant and no radio. Let us now give them the needed tools of analysis. Donald Schapiro taught legal accounting at Yale University Law School and has served two terms on the Financial Accounting Standards Board advisory committee. |
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