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Board Members Facing Public Scrutiny Should Bone Up on Finance, Accounting
What you don't know can't hurt you. That old adage may be true some of the time, but not for people serving on boards of directors and
audit committees in the wake of recent scandals that have tarnished the reputation of corporate America.
If nothing else, the never ending page-one stories of accounting shenanigans have underscored how financial decisions – both the questionable and
the downright illegal – can ruin a company. Moreover, board members who do not understand the increasingly complex financial transactions
that companies engage in are placing their firms, and possibly themselves, in serious legal and financial jeopardy, according to faculty members
at Wharton and the University of Chicago's Graduate School of Business.
There is another, perhaps more subtle, message stemming from these scandals as well – that aggressive accounting, even the
keeping of different "sets of books," does not always constitute fraudulent behavior. Robert E. Mittelstaedt Jr., vice dean
and director of Wharton Executive Education, says that the news media, shareholders, the public and even some board members
do not realize that deciding what should go into a financial statement is typically anything but objective and clear cut.
"Rarely are there exact, agreed-upon numbers reflecting annual and/or quarterly revenue and profits," Mittelstaedt says.
"If you're running the proverbial lemonade stand, it's clear what you spent on supplies and what your revenues were.
It's a pure cash business. But if you are manufacturing capital goods like ships, airplanes or large computers and you
design a new product, how much of that design cost do you amortize across the expected production over the next five or 10 years?
The assumption you make about how many units you might sell affects how much you expense during any given period.
If the sales environment changes, it may mean you have to change your financial statements."
In the minds of most people, saying that a company is "keeping two sets of books" is merely another way of saying that
the company is engaged in wrongdoing – that one set of ledgers represents the truth while the other represents creative
legerdemain for shareholders or the IRS. Yet it is not uncommon at all for companies to juggle two or more sets of books
at the same time, all of them valid but telling a different story.
"Companies always keep several sets of books," says John Percival, adjunct professor of finance at Wharton.
"To most people that sounds like companies are 'cooking the books', but most people don't realize the limitations
of trying to measure, in a scientific way, the outcomes we're talking about here.
GAAP [generally accepted accounting principles] tells you to keep records one way, tax law another way
and regulators a third way. And sometimes, to be honest, you may keep even another entirely different
set of books for internal purposes. It's not that you're trying to hide something, but you have to measure
things in a way that accurately reflects [financial transactions]. None of this is well understood
by business writers and it's not well understood even by many managers."
Roman L. Weil, professor of accounting at Chicago, is a stern critic of the lack of accounting and finance knowledge
held by board members, especially members of audit committees. Weil also has been critical of CEOs who do
not demand that some board members exhibit a willingness to learn more about finance and accounting.
Weil says that he, in turn, has been criticized by chief executives for insisting that board members work
to attain a certain level of financial expertise.
"People who have served on corporate boards have vision, wisdom, strategic insight, people skills
and good decision-making skills, but they are not necessarily technically adept," Weil says.
To read the rest of this article, visit
http://knowledge.wharton.upenn.edu/articles.cfm?catid=2&articleid=800
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