Q: For many of us, our only experience with accounting is the dreaded tax season. But accounting touches nearly every aspect of business, and both shapes and is shaped by new advances in technology and information management. How does accounting go beyond our common understanding of bookkeeping and number crunching?
A: Accounting plays an essential role in various aspects of the economy. My research and teaching focus is financial accounting. I think of it as an area that studies the role of information in the business world. Accounting information is much more than just the outcome of bookkeeping records. It refers to a broader set of information that you can get from a firm’s mandatory disclosure such as its financial statements, as well as its voluntary disclosure such as earnings announcements and conference calls. It reflects a systematic way of how the insiders (company executives and managers) communicate with outsiders regarding the financial performance of a firm.
There is a lot embedded in the accounting information of a firm, and different stakeholders seek different use of such information. For example, investors use accounting information to access the fundamental value or growth opportunity of a firm, which is critical in making investment decisions. Similarly, creditors use accounting information to access the financial health of a firm and decide whether to extend credits. Accounting information is also often used in contracts and even the political process. For instance, firms often tie CEO bonuses to accounting numbers which helps shareholders to assess CEO effort levels.
It is not only important to understand how accounting information is used, but also useful to know how such information is produced, disclosed, and disseminated. A lot of elements can come into play—for example, the underlying economic activities of the firm, accounting information system, corporate governance, managerial incentives, auditors, taxes, and even technologies.
Take disclosure as an example: managers would often like the investors to perceive that the firm is doing well. Therefore, they have incentives to disclose strong accounting numbers. However, the same managers may not want the competitors to notice that the firm is lucrative, which may discourage them from disclosing too much. Sometimes firms are struggling to break even or to meet analyst forecasts. Managers will then have incentives to manipulate earnings a bit so the numbers look pretty. But if they go too far, auditors or even the U.S. Securities and Exchange Commission (SEC) may step in and question the accounting practices. Technology also shapes how firms disclose their accounting information. Managers electronically file their accounting reports and disseminate accounting information in various outlets such as social media. All of these complicated factors come into play when the accounting information is produced and disclosed.
—Ivy Feng is an assistant professor in the Department of Accounting and Information Systems at the Wisconsin School of Business.