Can Accountants be Trusted with the Future of Accounting?
The Origins of Accounting: From Medieval Ledgers to Modern Valuation
Browsing one of the few surviving copies of the first edition of Luca Pacioli’s 1494 Summa de Arithmetica describing 15th-century double-entry bookkeeping is a giddy feeling. This book, and the even older Medici family ledger books in the historic collections of accounting records at Harvard Business School’s Baker Library, prompt deep contemplation of the origins of our discipline.
The earliest use of accounting in business was probably to record executory contracts, receivables, and payables, while the corresponding use in government was to record tax dues, collections, inventory, and expenditures. The inventions of paper and paper currency in China, Hindu numerals in India, and the transfer of this technology by the Arabs to Europe gave accounting its biggest boost. Accounting subsequently evolved in medieval Europe to facilitate delegation, decentralization, and the separation of ownership from management.
1. Delegation, Joint-Stock Enterprise & The Beacon of Capital Allocation
Whenever there is delegation of power or separation of management from ownership, it necessitates rigorous performance evaluation. Whether with Venetian merchants in the fourteenth century or English East India Company managers in the eighteenth century, accounting played a crucial role in measuring and driving performance. “What gets measured gets managed” – accounting ushered in the rise of joint-stock companies owned by dispersed shareholders and streamlined performance for massive organizational hierarchies.
When shares in those corporations had to be traded, the valuation role of accounting information came to the fore. The best and brightest minds were attracted to newly formed joint-stock companies, striving to make fortunes through energy and enterprise. Risk capital flooded into these ventures because of their operational productivity and the liquidity of their shares. Accounting reports were the beacons that directed capital and hardworking talent to the most productive enterprises of society.
2. The Emergence of Auditing, Information Asymmetry & The Role of Trust
As soon as accounting numbers were used for performance evaluation and valuation, they were inevitably “managed” to dress up performance. Auditing emerged on the heels of accounting reports specifically to enhance the credibility of accounting figures. The explosive power of credible information to facilitate commerce in products, services, and complex financial instruments is foundational to capitalism.
George Akerlof’s Information Asymmetry Paradigm:
The Nobel laureate George Akerlof demonstrated a powerful thesis using a simple economic model: When the seller of a product possesses superior private information and the prospective buyer is conscious of this information asymmetry, it can destroy the market entirely. If the buyer is privately informed, a symmetrical market breakdown occurs.
Reducing information asymmetry causes markets to explode, economies to boom, and delivers prosperity across society.
The story of Alibaba’s success in China illustrates the economic power of reducing information asymmetry. Alibaba entered Chinese e-commerce late, trailing eBay. Yet Alibaba recognized that buyers and sellers did not trust one another due to institutional and legal voids (buyers feared defective goods; sellers feared payment default). Alibaba systematically instituted innovations in escrow payments (Alipay), seller ratings, and merchant certifications.
Result: Alibaba became the world’s largest and most profitable e-commerce company, while eBay languished. Today, with over 40% of product reviews on popular e-commerce sites suspected of being fake, independent auditing of e-commerce algorithms to detect and deter fake reviews represents a natural frontier for our profession!
3. Capital Markets: Insider Trading & The Relevance-Reliability Dual Mandate
The same dynamic governs capital markets. Insider trading by privately informed buyers and sellers elevates a firm’s cost of capital and chokes productive investment – insider trading is far from a victimless crime. Independent audits and periodic financial reporting dismantle insider advantage, provided financial statements are informative.
For financial statements to be relevant, accountants and auditors must be exceptionally trained, competent, and empowered to exercise deep professional judgment reflecting the economic substance of complex, evolving transactions.
Reliability stems from integrity, objectivity, and fierce independence, enforced by strict professional codes of conduct and bolstered by legal sanctions from regulatory bodies and courts against deviant behavior.
The Decennial Scandal and Rule-Tightening Cycle:
Whenever complex business models fail during market downturns, outsiders cannot differentiate between honest bad luck and executive accounting shenanigans. In response, regulators impose tighter, rigid accounting rules to restrict “professional judgment”. Audit and litigation costs temporarily drop. But as rigid compliance stifles economic growth, rules are relaxed, clever accountants engineer new loopholes, scandals re-emerge, and the cycle repeats with even more suffocating rulebooks.
4. Are We Losing the Plot? The Soviet Union Analogy & Loss of Talent
The Peril of Rigid Rule-Based Accounting:
If tighter, mechanical rules were the genuine solution to our woes, the old Soviet Union should be our role model. In that system, centralized accounting rules mandated the exact useful lives all enterprises were required to use for calculating asset depreciation. There was zero accounting fraud and zero room for professional judgment – but there was also zero relevance.
In such a world, why would ambitious, talented youth ever join the profession? Financial statements would be 100% reliable arithmetic exercises, but completely irrelevant to capital allocation.
Financial statements reduce information asymmetry and compress the cost of capital only when they reflect professional judgment rather than the mechanical application of arithmetic rules that disregard economic reality. If accounting standards cannot differentiate between expenditures that generate long-term intangible value (such as R&D) and those that do not, innovative firms will choose to delist and go private rather than endure public market short-termism.
The Paradox of Self-Defeat: Why Do Auditors Lobby for Stifling Rules?
This strange behavior stems from fear – auditors dread being perceived as in cahoots with clients and fear having their reputations destroyed when a client misstates financials. Because auditors are compensated by the very clients they audit, perception and reality of independence collide.
- Mandatory audit partner and audit firm rotation.
- Strict prohibitions on non-audit advisory services.
- Eliminating financial conflicts of interest among partners and employees.
- Empowered independent audit committees setting audit fees.
- Rotating Regulatory Re-Audits: Appointing independent audit firms to re-audit a sample of public companies (similar to the Audit Bureau of Circulation / ABC). The threat of re-audit exposure would powerfully bolster auditor objectivity and independence.
5. The Future of Accounting: ESG Assurance & Distributed Ledger Technology
If we design accounting standards that prioritize relevance and informativeness while ensuring genuine auditor independence, the future is extraordinarily bright. The frontier opportunities awaiting the profession are profound:
Providing independent verification across Environment, Society, and Governance (ESG) disclosures – an arena ripe for professional credibility.
Leveraging blockchain and distributed ledgers to make transaction authentication substantially cheaper, faster, and immune to retroactive alteration.
The fundamental choices before us are stark: Do we want to attract the best minds to our profession or do we want to certify that we have mechanically checked that stifling rules have been followed? Do we want to enhance the credibility of information in all walks of society or are we content to play a passive role, simply surviving on the statutory monopoly our profession enjoys in financial accounting?
The answer, my friends, is in our collective hands. ■■■