I’ve recently started studying for the chartered accountancy. And, without shame, as a Philosophy and Psychology major, I must admit — I love accounting! Traditionally, accounting is deemed as a job that is lacklustre and unexciting. But spare me two minutes, and I’ll change your view on accounting.
Contrary to popular belief, accounting is not purely about numbers — it’s a mental model of systems thinking.
Before that, let’s take a step back and understand what systems thinking is. Simply put, systems thinking is a method of analysing how entities in an ecosystem or environment behave and interact with one another.
These “interactions” are simply processes that allow for a chain reaction of activities to take place. This is done by studying how entities behave, what relevant inputs and outputs are needed, and how these outputs are reprocessed or aggregated to produce a final desired outcome.
Accounting is a form of applied systems thinking — one that allows us to track how resources are transacted. It allows for us to track not only interactions that happen in real time (cash transactions), but also allows to track transactions beyond current time (credit transactions).
To put simply, accounting adds another “dimension” to understanding how transactions take place. This not only allows for better traceability of resources owed/spent but at the same time, allows for better management.
Take this real life scenario — normally, businesses are often viewed in terms of how much profit they generate — and how that translates into cash. Indeed, that’s how we conventionally measure our personal finances — by the amount of cash we have in our bank.
But, with accounting , businesses can be viewed from a lens consisting of extra dimensions:
- How the profit/loss generated impacts their current cash flow (in other words, how much cash they currently have at hand).
- How the profit/loss affects their current assets and liabilities. In other words, how much the profit/loss have not translated to cash at hand — but rather to what they are still currently waiting to convert to cash, tracking the amount that was spent to run the business, and what resources are owned back to capital providers.
This extra “dimension” has allowed for the ease of traceability of resource transactions and capital. For instance :
- For those running their own business, accounting allows for a clear cut distinction between the personal resources that the owner has for their own use, and, what they have put into the business (and consequently, what they deserve from putting those resources and time into the business).
- Accounting also allows for mixed ownership of businesses. This is done by enabling us to track how much capital owners have allocated, and what is due to back to each and every single capital owner involved.
Accounting is then a language that enables the framework of tracking and understanding transactions between different entities in an economy, a form of systems thinking applied to understanding how the economy works.
But does accounting really matter?
Still not excited about accounting? Well no one is — but allow me to convince you why accounting matters more than ever.
Accounting allows for financial reporting. And financial reporting is crucial as it not only demonstrates how well a corporation is performing financially, but is also gives a snapshot as to where it stands in the current economy.
This is important as it not only gives an indication of how it is performing financially (shareholders care about this), but also whether employees, other creditors, the wider public could expect a corporation to keep running. In other words, accounting directly allows us to keep companies accountable in terms of how they use their financial resources.
Accounting provides an underlying language for us to track the company’s financial resource state. And, if these tracking systems are done wrongly (either deliberately or mistakenly), it can possibly lead to corporate malpractice and ultimately a collapse of a corporation.
And, as we know, the collapse of large corporations can impact other “entities” in the system. For instance, the collapse of Enron has undoubtedly had large negative impacts not only on its shareholders and employees, but had negative impacts on the communities around them.
Accounting then enables us to track whether companies are performing well, and to judge a company is using resources in a sound manner. In other words, accounting enables us to hold companies accountable for the resources they posses (that’s why auditors are important!)
And best of all, I believe that accounting could be an important piece in helping us solve fundamental environmental and societal issues we are currently facing.
The environmental crisis is staring dead into our eyes now. And, in some ways, this is because we’ve always taken the fundamental assumption and approach of :
- An anthropocentric relationship with nature. Humans have always thought that we’re endowed with special abilities and gifts as a species. Indeed, Aristotle famously maintained that “nature has made all things specifically for the sake of man” and that the value of non-humans are only instrumental to humankind. We are arguably on top of the food chain — does that necessarily indicate that we are entitled to more resources from nature, in comparison to other species?
- Assuming that natural resources are unlimited. Well, we might say that we don’t think that’s logically true — natural resources are limited, we know that. But the way we consume and produce disregards how finite natural resources are. Indeed, only in the past two decades or so we’ve started worrying about whether there’d be enough oil, or let alone water to consume. It’s only when we realise we are facing a shortage of something do we only start paying attention to it. In other words, we start paying attention to it when we attribute economic value to it (due to shortage of supply).
These two fundamental assumptions, I would argue, are evident in how accounting is currently done — translating to a large shortcoming of current accounting.
Current accounting fails to take into account the cost of depreciation of natural, human and social capitals — in other words, it is mismeasuring profits by overstating them (as current production costs do not take into account environmental costs). The environmental consequences of production and business processes by corporations are not reflected in their accounts.
Further, current accounting fails to account for any investment and expenditure of a corporation in improving the environment. This translates to corporations gaining no credit as they capitalise and expenditure for doing beneficial work to society.
Why is that?
Well, undoubtedly, it’s difficult to measure environmental resources and social good — particularly so when we do not attribute any direct economic value to it. And, the fact that shareholders do not value them (yet), gives no incentives to corporations to attempt to measure it — and report it.
Accordingly, we have no standard way to track the effect that corporations have on the environment, and, society around them — because there is no common language. And if there is no common language (like accounting), then, it is difficult to report on them.
And, if it is difficult to report on them, it is difficult to keep them accountable — in terms of the damage done on the environment and negative impacts of business practices on the society. And, inversely, to reward companies that have spent resources on rehabilitating the environment, and benefit societies around them.
Shareholder primacy is the current paradigm that acts as the sole driver of corporate environment, structure and practices — in other words, corporations ultimately are driven by how much financial returns they can generate for their shareholders.
On an optimistic note, shareholders are starting to pay more attention to factors beyond financial performance (see ESG). This is because these factors are an indicator of how risky the company’s practices are in the long term; especially within the context where there are more ethically-minded consumers, and, rising concerns about environmental issues.
Consequently, corporations (like BASF, ING Group and Standard Bank) have started seeing value in integrated reporting — a form of reporting that goes beyond reporting financial performance. Such form of reporting tries to paint a more holistic picture of the performance of a company — not only in terms of financials, but also its efforts in reducing environmental damage/waste and investing in human capital.
Naturally, reporting and measurement standards for environmental and societal value have also started to emerge and is currently being developed (see International Integrated Reporting Standards, and, Global Reporting Initiative). But, all these are still in its infancy — leading to a slower adoption.
And, unsurprisingly, there are many associated challenges with this form of reporting. The most pressing challenge being — difficulties in building the infrastructure required to capture environmental and societal reporting. This is due to a lack of experience in non-financial data capturing.
In other words, there is no agreed common language of measuring environmental and societal performance — which makes it difficult for companies to report on. Consequently there is a lack of transparency of the impact of business processes — which then makes it hard to keep corporations accountable in these areas.
Coda : Challenging Conventional Accounting
As initially laid out, accounting is a form of systems thinking. The current paradigm of accounting now is primarily to track financial performance and report them. Financial performance is important as it is what shareholders ultimately care about. In other words, it is what ultimately drives corporations.
Hence, if we can tie financial performance in with societal and environmental measures — we can push corporations and shareholders to value societal and environmental performance.
But, as mentioned, there is still a lack of standards on environmental and societal performance — it’s difficult to measure such impacts? And we also need to bridge bridge financial performance with environmental and social performance — as it is key to keeping companies accountable beyond financial resources.
Hence, if have a humanities, social sciences or environmental science background, do consider studying accounting — we need forward thinking accountants who can not only understand financials, but also societal and environmental measures.
Training in accounting will not only train you to understand financial performance, but also help you understand how corporations work in a more systematic way. Top this off with your background in humanities, social sciences and environmental science, and you’ll be helping transform corporations to measure value in a different way — one that is beyond financial performance.
And, for those of you who breathe by the “debit” and “credit” language (i.e., chartered accountants and auditors), integrated reporting is inevitable (check the state of integrated reporting and the rise of value of ESG measures). And, I would argue, is the key to staying relevant in the age of Artificial Intelligence and automation. This is because integrated reporting will require more reasonable judgement than current financial reporting.
In many ways, societal and environmental performance data capture and evaluation is more subjective than financials. Hence, for chartered accounts, tying in societal and environmental performance with financial performance will require more reasonable subjective judgement.
And, for auditors, the risk areas are often ones where there is a large exercise of judgement and subjectivity involved — in other words, to properly audit an integrated report will also require more reasonable judgement. The subjective nature of such judgements required will mean that they are way harder to codify (due to irregularity) — and hence, harder to automate.
Together, with more minds working on developing and implementing integrated reporting, we can help keep corporations more accountable.
This enables the transition to a more inclusive definition of profit (beyond just financials), and, aid companies to see value in measuring performance beyond financials — by also taking into account their impact on the environment and human capital.
This acts as an incentive for companies to reinvest in human capital, and, reduce environmental damage — all of which can help mitigate the state of world we live in now.
Thank you for reading this lengthy article! It's about accounting as well — so well done, you've sat through a bump car ride. I'm always looking to interact with people who are interested about building a more inclusive economy — reach out to me here on Linkedin!