1. Agenda—Week 10 Review of the reality to report (Abstraction) model Accounting for intellectual capital...and by implication, for many of the non-quantifiable but important assets of organizations Reporting in ways that people think—how can we match the reporting of information to the receiving of information Accounting is not neutral—how we account, report, audit...influences decisions and society Accounting for long-term sustainability… considering economics, broader human systems, and natural systems Open time for questions

2. Accounting model…AIS version Business Activity (Something happens) Filter—criterion for: Processing, valuing, aggregating Interpretation, biases ABSTRACTION Observe and Record Report Decision Making (Something Happens)

3. Filters, processing Filters—what do we observe and record –Determines what can be used for future decisions, evaluations, controls…without leaving the system Processing—how we combine the data –Determines what information is available for decisions, further restricts the content and availability of the information

4. Presentation and interpretation, biases Regardless of the content of the report, the communication is limited by: –the perspective of the report, –the clarity of the transmission, and –the attributes of the reader Ways of reporting the info –Presentation format –Content versus Context…context matters

5. Filter Criterion for identifying what is included in the accounting information system—relevant to stakeholders, broadly construed Who are we accounting for? accounting to? –Stakeholder, societal audiences…who cares about GM? –Regulated v. voluntary disclosures What are we missing in accounting information? –Historical cost –Social, natural aspects –Representational faithfulness

6. Comprehensive example…intellectual capital Long history (if you have a short memory) of attempting to quantify the value of human assets –What is the present value of the future benefits of the people who work for us? Notion of intellectual capital is a more nuanced and deeper view of human assets… Pioneers have started in the attempt to produce statements of value to decision-makers and stakeholders

7. Skandia companies Formalized the position of “Director of Intellectual Capital” in 1991—Leif Edvinsson “Controller of Intellectual Capital” in 1994 Note the term “controller” Annual supplements, quarterly reports internal and external Business Navigator—a framework for thinking about intellectual capital

8. Skandia Business Navigator Not intended to provide a quantitative value for components of intellectual capital Balanced overview Systematic processes and measurements Provide information to management to support creation of future value Current attributes that support future value—leading as well as lagging indicators

9. Navigator components Somewhat analogous to “balanced scorecard” Five components –Financial –Customer –Process –Renewal and development –Human

11. Relationship of components Financial...imperative for survival Customer...goal to please and support Process...how activities are arranged to support and please customer Renewal and development...infrastructure to create/support/develop processes Human...attributes that make all these possible in the long run, and the short run

12. The accountant’s place Design—assist in setting up effective, efficient, controlled systems for capturing, processing, and reporting the data…filter… Standards—creating, evaluating, monitoring the metrics for capturing intellectual capital Certification—provide a means for assurance services related to intellectual capital Navigation—assist in evaluating, identifying patterns, producing data to answer questions adapted from Intellectual Capital (Edvinsson and Malone, 1997)

13. FINANCIAL FOCUS Net operating income (MSEK) 1,1301,2151,2581,399 Market value (MSEK) 19,20620,09220,70221,504 CUSTOMER FOCUS Customer satisfaction index (max. value = 100) 695856 n.a. Average lease (years) n.a.8.68.5n.a. Average rent (SEK/sq.m.) 9519609701,041 Telephone accessibility (%) 607160n.a. HUMAN FOCUS Employee turnover (%) 10.010.17.97.7 Average years of service with company 12.010.010.110.2 College graduates/ total number of office staff (%) 363231 PROCESS FOCUS Occupancy rate measured by area (%) 93.791.889.789.3 Financial occupancy rate (%) 96.294.993.091.2 Costs per sq. m., Sweden (SEK) 304274276272 RENEWAL & DEVELOPMENT FOCUS Property turnover: sales (%) 8.11.16.10.4 Change and development of existing holdings (MSEK) 235311333313 Training expense/ administrative expense (%) 0.81.01.51.0

14. Another view of Intellectual Capital Celemi Leave the balanced scorecard behind Three classes of intangible assets –External (customer), internal (organization), competence (people) –Total equity>visible equity (capitalization > book value)…duh… Estimated value is imprecise Change in intangible assets is measurable –Invisible revenues—generally implicitly accrued –Invisible investments—generally explicitly expensed

15. Classes of assets Three classes of intangible assets –External—reputation, customers, image...web of relationships –Internal—processes, organizational, patents, concepts, systems...infrastructure –Competence—skills, capabilities...people

16. Attributes of asset all classes Growth and renewal—what are we doing to improve, build, recreate the IC... Efficiency—how well are we using the IC that we currently possess... Stability—how likely is the IC that we currently possess will be around in the future...

17. Example... External structure –Renewal and growth Organic revenue Image-enhancing customers –Efficiency Sales per customers –Stability Repeat orders sales percentage 5 largest customer sales percentage

18. Current reports—Denmark Clients & market.htm Organisation.htm

19. Brief example—Triple bottom line Environmental and social aspects of business operations are gaining importance –Wal-Mart $500M investment—reduce GHG, fleet emissions, more… –GE Ecomagination Reduce GHG by 1% by 2012 Increase GHG intensity by 30% by 2008 TBL—Economic viability, environmental stewardship, social equity –What criterion must exist to capture the important data? –Who is the audience?

20. Processing, valuing, aggregating How data are combined impact what can be reported and, ultimately, used to form an understanding of the business reality. Let’s consider the statement of cash flows…direct v. indirect methods

21. Statement of Cash Flows FAS 95 recommends the direct method…specifically identifying such things as cash from sales, cash to suppliers…rather than a reconciliation—the indirect method Identified accounting systems as impediments to implementation of requirements The Board received 450 comment letters, most from bank lending officers--an accounting information user--who favored requiring the direct method for the cash flow statement. Corporation accountants, on the other hand, favored the indirect method due to excessive implementation costs. They appealed to the board because they could not currently obtain gross operating cash receipts and payments directly from their accounting systems. Over 90% of listed companies use the indirect method

22. Statement of cash flows--Australia The direct method of presenting cash flows arising from operating activities reports gross cash inflows and gross cash outflows. This information can be obtained either by using an accounting system which directly records and analyses the cash flows in relation to each transaction, or by adjusting sales, cost of sales and other items in the profit and loss account for non-cash items and items which do not relate to operating activities. This Standard requires the direct method of presentation in the statement of cash flows because this method provides information that is not otherwise available in the balance sheet and profit and loss account. It provides a more useful basis for estimating future cash flows than a method of presentation that discloses only the net amount of cash flows arising from operating activities.

23. Types Of Measures Direct—absolute measures (revenues of $2000) Relative (ratio)—one data item compared to another data item (revenues of $2000 per store) Indexed—related to a standard or baseline, e.g. trend analysis (revenues increased by 15%) Lagging—measures of output, end-process measures, record effects, reflect past performance Leading—in-process metrics of performance, proactive, reflect current status/activities, predict future performance

24. GAAP—Representational faithfulness Faithful to what? Does GAAP define relevant business reality? What is the role of the AIS in relation to GAAP? Truth tellers—identify truth, Liars—deny the truth Bureaucrats—indifferent to the truth Corresponding to reality v. accordance with standards

25. Presentation format Impact the interpretation and usability of the info Narrative Rows and columns Chernov’s faces Business instrument panel SmartMoney investment tool –Map of the Market.htmMap of the Market.htm Types of measures

26. Making Information Usable Credible –What users value and trust Accessibility –Physically –Cognitively Engagement –Must be noticed…thru format, medium, presentation… –Idiosyncratic to the observer Transparent—particularly for unfamiliar information –Clearly connected –Clearly constructed –Clearly collected

27. Accounting is NOT neutral…context matters Income Statement—Choose your format… Corporations maximize owner wealth Revenues2,000 Materials( 900) Labor( 400) Taxes( 150) Interest( 200) Net Income 350 –Distributed to: shareholders 350 Corporations optimize societal wealth Revenues2,000 Materials( 900) Net Income1,100 –Distributed to: employees 400 government 150 creditors 200 shareholders 350

28. Accounting is NOT neutral— Context matters Value added statement –AltronAltron How do we look at “profit”…what do we maximize/optimize Which stakeholders are privileged?

29. Accounting for long-term sustainability Voluntary Addresses social and environmental issues Irregular distribution Inconsistent format Unpredictable content

30. Why a report? PR Stakeholder information Cultural imperative True belief Some evidence that being responsible has positive impacts on shareholder return

31. Corporate Social Responsibility Environmental reports –http://www.shell.com/home/Framework?siteId=homehttp://www.shell.com/home/Framework?siteId=home –http://www.interfacesustainability.com/http://www.interfacesustainability.com/ –http://www.interfacesustainability.com/metrics.htmlhttp://www.interfacesustainability.com/metrics.html Voluntary v. mandatory disclosure Triple bottom line v. financial reporting Motivations for reporting –Legitimacy, reputation, enlightened, reduced risk Attestation, verification, certification

32. Human behavioral issues How does CSR impact people, companies, society? How do companies react? What are the drivers for CSR? Walmart, Nike, Electrolux, BP…

33. Abstraction Business Activity (Something happens) Filter—criterion for: Processing, valuing, aggregating Interpretation, biases ABSTRACTION Observe and Record Report Decision Making (Something Happens)

34. See you on Monday, Dec 3... Test starts at 5:45pm, will finish at 7:45pm Bring a blue book Open book, open note Grades will be available on-line, 11 th or 12 th I will throw away all materials by about January 15 th