CFOs and their finance and accounting function have been distracted from being their coveted strategic partner role because they are mired with regulatory and compliance work. That is now changing. They are embracing business analytics.
The history of accounting
I will substantially oversimplify the history of accounting mainly for the purpose to provide perspective for a new era I anticipate will soon (or at least eventually) emerge. Here is all you need to know about accounting’s history:
1492 – The Italian Franciscan friar, Luca Pacioli, devises double-entry bookkeeping to track sailing ship cargo and for merchants.
1890s – Alexander Hamilton Church designs managerial cost accounting practices to mirror the industrial scientific revolution techniques of the famed industrial engineer Frederick Winslow Taylor.
1910 to 1985 – Accounting’s Dark Ages. Regulatory laws enacted in the USA following the Great Depression vaults financial accounting performed by chartered accountants to protect investors to dominate managerial accounting developed by engineers to support analysis and decisions.
1985 – Professors Robert S. Kaplan and Robin Cooper publish research about activity-based costing (ABC). Kaplan co-authors the book, “Relevance Lost” soon followed by “Relevance Regained.”
2001 – the Enron Corporation scandal. New regulatory laws are enacted, most notably Sarbanes-Oxley.
2002 to 2010 – Accounting’s Dark Ages resume. I have suggested to Professor Kaplan, who trained me on ABC when I was with KPMG consulting, that he should write a third book in his series, “Relevance Re-lost.”
Accountants shift from financial to managerial accounting with analytics
So what is now the current situation regarding the health of accounting? Sadly, financial accounting (i.e., external compliance reporting; for valuation) remains dominant over managerial accounting (i.e., internal reporting; for creating value). You can read more in my blog “Does financial accounting deserve superiority over managerial accounting?” I am predicting a reversal shift in importance of these two branches of accounting and possibly a punctuated leap. In this shift organizations will advance beyond managerial accounting to managerial economics to support analysis and decision making powered by business analytics such as correlation and regression analysis.
Doug Hicks, founder and president of his consulting firm, DT Hicks & Company, who is one of the most astute practitioner sages of accounting is excellent at assessing the future potential of managerial accounting. He has coined the term “leadership accounting.”
Hicks has observed that the demands of external reporting, regulatory compliance, and financial administration have kept accountants from performing their role in driving economic value. In addition, GAAP-based financial and performance measurements obstruct accountants from contributing to economic value. Hicks views “leadership accounting” are these: to drive economic value (i.e., generating increasing income); to involve strategy management (actions with performance metrics and targets); and to apply principles-based managerial accounting (e.g., reflecting cause-and-effect relationships) to support analysis and decisions.
Decision Maker versus Decision Leader
Hicks describes a “decision maker” as one who has the ultimate responsibility for a decision. This contrasts with a “decision leader” as someone who ensures the quality and capability of decision making for all employees. The darkest time is before the dawn.
Hicks observed that the CFO and management accountants are well-positioned for a “decision leader” role because they already have much governance and oversight responsibilities. Further, they are the closest role of an economist for most organizations.
The “decision leader” role is to prevent dysfunctional managerial methods and incentives. This includes debunking the false assumption that financial accounting conventions result in valid economic data appropriate for decision making. It does not. Applying traditional standard costing for GAAP reporting to investors may be acceptable, but managerial accounting, including activity-based costing (ABC) principles should be used for internal analysis. I expand on this in my article “The Shift to Predictive Accounting.”
Accounting’s Dark Ages
I predict that the field of managerial accounting will lift from the stagnation since the early 1900s and re-balance. The shift in the CFO’s emphasis from financial accounting to managerial economics (e.g., incremental / marginal cost analysis in the “relevant” range) is now enabled with commercial software, such as from my employer SAS, to financially model physical operations.
As evidence, I participate on task force for the American Accounting Association comprised of leading university accounting faculty. The task force’s mission is to define reforms to accounting course curriculum correct this imbalance and prepare business students with competencies to manage organizations, not just to audit and prepare financial statements for regulatory agencies and investors.
As further evidence read my IIA Research Brief for the International Institute of Analytics on “Trends and Visions of Analytics in the CFO and Accounting Function.”
Just as the Dark Ages evolved into the Renaissance era, the shift to place much greater value on managerial accounting is sure to come.