Thursday, March 1, 2012

Accounting and Creativity - A Surprising Combination

The term "Creative accounting" has often been used as a term for accountants using deviant means to misrepresent information or in some way change financial data to hide theft or to otherwise trick investors into believing something different than what is true... but even out side of these cases, accounting is sometimes, erroneously, believed to be a field completely devoid of creativity or innovative thought.

Well, this idea is completely mistaken. While the everyday accountant may not be required to use creativity in his every day work - as an artist might - the field of accounting is one that is purely brought forth from creative minds and is possibly the most creative field in business.

The fact of the matter is - there are no laws of accounting. In physics someone discovered that F=m*a and that E = M*c^2, but these scientists did not invent the rules of the universe. In economics, the change in supply in demand based on changes in price is a measurable, real phenomenon. Even in art, certain color palettes naturally work well together or bring about certain emotions - but this is because of a natural occurrence, not due to any innovation on the part of the artist...

The point is: There are NO natural laws of accounting.

There is no way to study the world and determine that debits will always equal credits, or to figure how much value an asset represents for the future of a company. Every aspect of accounting has come about because of creative minds making intricate rules to help provide useful information.

The key jobs of accounting in business are to tell investors how much money a company is expected to make in the future, to tell managers exact figures about the company's assets/abilities to make strategic decisions, to ensure that, even in corporations of over 1 million employees, all money is being kept track of and used as intended, and finally to have all of this information comparable between companies of any size. I am going to briefly - and hopefully without getting too technical - explain the some of the amazing ways that these feats are handled through wonderfully innovative accounting, and explain some of the most creative changes to accounting in the last 30 years.


 I would say that the most impressive feat of accounting is the idea of income. Income, as accounting defines it for a company, is not simply it change in the amount of cash that a company had from the start until the end - it serves as an accurate estimate of how much money the company is going to make in future years. Any investor can look at the income statement (another invention of accounting) and see what caused the gain or loss and by how much, and can use the resulting data to gain more information, such as how much the company is returning per dollar or assets (RoA) or per share (EPS). This data can then be compared with others in the financial market to determine whether giving money to the company in the form of loans, bonds, or stocks is a worthwhile investment.

Other brilliant creations of accounting include the way that depreciation is handled. A piece of equipment or a building that a company uses is only good for a certain number of years, and while it is paid for up front it gives the company value over that entire time. What this means is that when the equipment is bought there is no loss of profit, but the item gets "depreciation," which are losses of profits each year. These losses also make the equipment written down as being worth less value than when they were purchased, such that the item will be worth its salvageable value after its expected life runs out. This on its own is fairly innovative, and ties into the way that accounting is able to accurately predict future gains of the company, even with expenses where no cash is lost (such as the depreciation expenses).

In recent years, the biggest changes to the Generally Accepted Accounting Principals (GAAP) came from the Sarbanes-Oxley (SOX) Act, in response to outrage over the illegal practices at Enron and Worldcom, and of the auditor firms that allowed the actions. These changes were again often very technical, but in laymans terms they were able to show more accurate data of the company's future value to investors and prevented against ability for fraud through several layers of check and balances in the accounting system. There were also great changes related to international financial accounting in regards to valuation of currency realizations and in non-realized gains from stock or even derivatives holdings.

Once again, the rules were re-written by brilliant people, making information through accounting even more easily available and regulated.

So to summarize, accounting may not start with great leaps of innovative work, but in a similar way that lawyers become the judges that make the laws, accountants create these principals and there are intricate, wonderful rules created by accountants that allow for unprecedented information analysis in our day and age. The next time you are doing your taxes, looking at stock prices, reading that a company is experiencing a gain/loss this quarter, or trusting your money in a bank, take a moment and thank the innovative minds that created these systems and the accounting rules that make our world function

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