ANTHONY H. CATANACH JR. is an associate professor in the School of Business at Villanova University, as well as the Cary M. Maguire Fellow at the American College Center for Ethics in Financial Services. His professional experience includes five years as an audit manager with KPMG and six years in the financial services industry. Dr. Catanach has received numerous awards for his publication, teaching, and curriculum innovation efforts. He has authored numerous articles on a variety of accounting, finance, and management issues, as well as several business education texts..
How frequent should corporate America generate accounting reports? As is well known, we currently produce financial statements every three months and one of these reports is audited by an independent auditor. Some would like to pick up the pace and perhaps even supply data on a daily basis. But why do they hold this view? Don’t they realize that more data do not imply better information; possibly, the data could even be counterproductive as analysts and investors would drown in oceans of data because there are too many dots to connect. (See Malcolm Gladwell on data overload.)
Dena Aubin explored this topic recently. Michael Young and several accountants thought it about time that firms provided accounting reports on a continuous basis. The argument seemed to be that the technical problems have been solved, as Cisco Systems created a “virtual close” almost 10 years ago, so let’s start having continuous accounting reports. However, none of those interviewed took the time to think about the issues. After all, the technical challenges are nothing compared to the reporting and auditing issues.
This, of course, assumes that it is good to have accounting data on a moment by moment basis. Given the incredible focus on short-term results and the many criticisms about some investors not taking a long-run perspective, we wonder why anybody wants to induce further myopia.
What are the benefits of knowing daily sales for Wal-Mart? If Tuesday’s revenues are greater than Monday’s sales, should the stock price go up, stay the same, or go down? Nobody knows because there is no context for the data. Remember that information is useful data that has been processed, analyzed, and refined in some fashion, and more data do not necessarily imply more information. In fact, it is quite possible that individuals and the system could be so overrun with data that nobody really knows what is happening and the economic system falters as thoughtful information-based decision-making degenerates into reactionary impulse.
Even if there are benefits, there also are hardware and software costs, as well as communication and and personnel issues to be addressed. Cisco is not going to supply its product for free! With tangible costs and intangible benefits, it certainly isn’t clear that society should push for continuous financial reports.
We also should keep in mind that even if sales and cash flows could be reported on the day they occur, many other things could not be assessed so quickly, including the value of intangible assets and goodwill and any financial instruments employing Level 3 measurements (remember Wall Street in 2008!). If we cannot efficiently conduct impairment tests on a daily basis, then we can never produce meaningful daily income statements. And even if we could, any such financial statement probably will not be consistent from one period to another if for no other reason that accruals and deferrals likely will not be applied on a daily basis.
Even if one could produce daily financial statements, there remains the problem of comparability. It is hard enough now to compare quarterly statements of different firms whose seasonal effects vary, but now let’s try to compare daily financial statements of CBS with Ford. This is nonsense. Even restricting such analysis to firms in the same industry will not guarantee comparability as there is too much daily variability.
Let’s now consider auditing this “moment-by-moment” report generating machine. It isn’t clear to us that the reports are auditable, except for the cash flows. Worse, how does a business concern construct viable internal controls to handle the transactions and events in such an environment? Given the pitiful state of some firms’ internal control systems, the extra strain would make a mockery of the audit process.
Having the technical skills and the technical machinery to allow daily or hourly financial reports is not sufficient for enabling continuous financial statements. No, either the accounting reports become dumbed-down or we toss accrual accounting out of the window. And audit firms have too much trouble auditing corporations now—witness the scores of restatements and accounting scandals—that they would have no chance of ever doing it right in a continuous reporting environment.
We pity the SEC if this day ever comes. The SEC does not have the resources to effectively monitor the reports by registrants now, nor vigorously enforce the reporting rules. We foresee near impotence of the SEC in a continuous reporting environment.
Finally, we emphasize our earlier concern. Even if all of these problems could be adequately resolved to the satisfaction of all, would society be better off having a constant barrage of accounting data supplied to the investment community? We seriously doubt it, as the factoids would not constitute actionable information and would clog the system with a lot of clutter. If you are not convinced, just ask any manager how much they enjoy and value the hundreds of emails that add daily clutter to their inboxes!
This essay reflects the opinion of the authors and not necessarily the opinions of The Pennsylvania State University, The American College, or Villanova University.
J. EDWARD KETZ is an associate professor of accounting in the Smeal College of Business at Pennsylvania State University. He has a bachelor’s degree in political science, a master’s degree in accountancy, and a Ph.D., all from Virginia Tech. Professor Ketz has been a member of the Penn State faculty since 1981. He also has taught at the University of Connecticut and the University of Maryland. Professor Ketz has authored and edited 17 books including Hidden Financial Risk (Wiley, 2003) which examines the corporate culture and the institutional setting that engendered recent accounting scandals. Dr. Ketz has been cited in the popular and business press, including The Wall Street Journal, The New York Times, The Washington Post, Business Week, and USA Today. He also has appeared as an accounting commentator on CNN, National Public Radio, and Bloomberg Radio.
Thanks for your column. I recently attended a conference on the ‘future of reporting’ in which more frequent / continuous reporting was discussed in a few panels. I talked informally afterwards with a highly-respected CFO of a firm on the cutting edge of reporting technology. He cited the same relevance and reliability issues that you discuss, concluding that financial reporting, when technology allowed, would make the most sense:
a) regularly on a monthly basis at most; and
b) on an ad hoc basis when a material event impacts the firm (e.g., an event requiring Form 8-K disclosure).
To him, more frequent reporting would produce too much information with too little benefit.