Adolf J. H. Enthoven
Accurate economic information is necessary for every nation; certainly as necessary for developing as for developed countries. And since accounting statements, drawn up in the right way, cover the entire field of economic analysis, the necessity is felt throughout the economy. Corporate reports serve the individual enterprise, consolidated statements of the banking system and flow-of-funds accounts portray the national monetary and financial structure, while the national accounts are used to shape a country’s over-all economic policy. Governments look at the aggregates to decide fiscal, monetary, and other foreign and domestic economic policies. All these types of data have a common denominator—the accounting statement; and the question is how such information can most accurately serve these economic needs.
In developing countries, financial statements for agriculture, industry and commerce, for sectors of national production and consumption, and for movement of goods and services are often deficient. In the Introduction to Professional Accounting in 25 Countries, a valuable study published earlier this year by the American Institute of Certified Public Accountants, it is observed that “… in some countries the standards expressed through legal or professional channels represent more of a statement of goals than achievements, and the reader must consider whether practice conforms to precept. He should be aware that such conformity does not always exist.” The Introduction stresses that a well-developed accounting profession cannot exist in a vacuum, but is dependent on a business and financial climate which creates a demand for its services. While it is undoubtedly true that a highly evolved, competent, and respected profession will be better able to live up to its desired standards if the economic system is well matured, we face the fact that in most nations of the world the economies are either at a standstill or in transition toward economic progress. Accountancy tends to be very rudimentary in many of these countries—yet it is badly needed.
It is needed, indeed, to play a double role in economic development. First, effective accounting is a prerequisite to the efficient use of capital invested. Second, accurate and informative accounts create an atmosphere of confidence for the flow of capital investment, and thus encourage not only savings, but the effective use of savings. Both roles are important in a nation’s economic programing and the national accounting on which that programing is based.
Accountancy in the Public Sector
The importance of accurate financial data in the preparation of national accounts is obvious, and in highly developed countries good accounting practices play an important part in making such data available. It is the lack of those basic financial data that makes the compilation of national accounting data one of the most difficult statistical problems faced by developing nations. Accordingly, the cooperation between the economist and accountant in such countries should be very close. The accountant’s function in national accounting is not only to secure better information from the basic economic units and to assess the analysis, classification, and description of the accounts, but above all to look at the financial data, not in isolation, but against the background of the entire economy. Accountants should be concerned that information gathered on inventory valuation, depreciation, and capital goods is genuinely related to the realities of the national economy.
A country’s economic planning is, of course, closely tied to its national accounting. Making decisions in economic planning is a process that relies heavily on the information gathered at the grass roots of public and private activity. When the financial information accumulated at the industry or other sectoral level is inaccurate or unrealistic, as it so often is, the development program for such a sector is likely to be distorted. This is especially unfortunate when the sector plays an important role in the economy.
Proper cost accounting within an industry is needed not only to measure the efficiency of the individual business but also to compare the efficiency of different industries. Cost accounting, in testing the relationship between prices and costs, sheds light on the combination of the various factors of production. It can also help to locate the causes of major discrepancies between similar units, and thus serve as a basis for correcting these discrepancies. For determining a country’s import policy a clear view of costs and cost components is essential. Accurate public accounts and effective national plans cannot, in short, be prepared without what may be called economically educated modern accountancy.
… and in the Private Sector
The role of the accountant in the private sector, which in developing countries is likely to be relatively weak, although no less important, is perhaps less obvious, and it is for that reason that I emphasize it here.
Efficient management needs accurate and up-to-date data on a company’s financial status, on the results of its operations, and on the availability of inventories and production capacity, as a basis for its own decision making and future policy. In turn, corporate reporting and disclosure of information to the financial community plays an important part in instilling confidence and interest in investors and in stimulating the development of capital markets. Necessary loan and equity capital is not likely to be forthcoming either from domestic or foreign sources unless investors or lenders have a good idea of the status and prospects of the enterprise. And foreign sources are often very important. The underdeveloped nations depend for a high proportion of their capital formation on the inflow of foreign investments, but foreign investors want the same kind of significant, accurate, detailed information that they are accustomed to obtain in their own countries.
It is just in the developing countries that capital formation for productive use most needs to be enhanced. Too often personal and even company savings are exported or plowed into unproductive activities, so that sound, effective capital markets cannot develop. Although part of the cause may lie in the country’s monetary or fiscal policies, which are often an actual deterrent to good accounting practice, many countries have no proper capital market for mobilizing such savings precisely because there is no financial reporting of a nature to give confidence to investors.
In the absence of risk capital, companies in underdeveloped areas have to rely heavily on bank loans, often at high rates of interest, or on self-generated financing. Yet it is risk capital that is badly needed. New enterprises often cannot get off the ground because of the shortage of such capital. Governments frequently have to step in to make good the shortage, thereby unduly increasing public control of private enterprise, to the further discouragement of potential private investors and entrepreneurs.
The accounting profession in developing nations can thus do much to stimulate confidence in the private sector and to help to mobilize sterile savings. The adoption of economically sound and realistic accounting techniques and auditing procedures for all sectors, as well as cooperation with financial institutions (banks, stock exchanges, etc.) and semipublic agencies, would be a great help toward this goal. Successful private investment will breed more private investment.
The accounting system in an organization should, of course, state the proper balance sheet values and measure profit accurately. But a modern accounting system will go far beyond this kind of bookkeeping. It will facilitate the evaluation of efficiency, productivity, and growth. Such evaluation is vital for both operational and planning purposes; it provides the true role of modern “managerial accounting.”
The lack of a well-organized general and cost accounting system, with adequate procedures and internal controls, is one of the great weaknesses of most organizations in developing nations. Accountancy, as an independent and management function, can help to make these other functions more efficient.
A good cost system can give management a clear classification of costs, identify nonoperating costs, and appraise the efficiency of the organization’s departments and sub-units. Such knowledge of each industry, division, or department is required for the correct allocation of scarce funds and resources to those segments that are most important for the enterprise and the whole economy. For the individual organization in the developing nations, precise knowledge of costs is particularly important because costs tend to play a greater role in setting sales prices than they do in a fully competitive market economy.
Inventory controls and calculations of the productivity of capital equipment are other important determinations which accountancy can help to make. Sometimes, technologically advanced machinery is obtained for a labor-intensive industry which could produce more effectively with less up-to-date equipment. (See “Good Enough for Developing Countries?” by Albert Waterston, in Finance and Development, Vol. I, No. 2, September 1964.) In such instances the purchase of the right machinery would not only benefit the purchaser but might have the advantage of conserving precious foreign currency.
The developing nations are in dire need of new industries, and international organizations such as the World Bank and the International Finance Corporation already assist extensively in providing loan and equity financing to these countries. In preparing and appraising such projects, the need for qualified accountants is great. Countries that seek access to the world’s money markets must be fluent in the language of these markets, and that language is accountancy.
The accountant’s function in development, whether in the private or the public sector, should, however, not be limited to what might be called technical improvements in business methods. A brief look at the interdependency between economics and accounting will help to clarify the larger role accountancy could and should play in the process of economic development.
Accounting can be considered a tool of economic thought, but with its own set of rules. As an economic tool, accountancy has to concern itself with the underlying concept of economics—the question of value. An important question of value in financial data is whether true value is most accurately represented by values calculated with reference to the past (e.g., the cost of an imported machine, perhaps ten years ago, when the exchange rate, shipping charges, and the role of the machine in the factory may all have been different) or by values which have current and prospective meaning in relation to the whole economic sphere. Assets acquired years earlier are often still amortized at a historical rate, while the actual current value of their contribution to output has changed because of advances in technology or changes in prices, or both. Current monetary units may differ widely from historical units. Conventional accounting, being based upon monetary data, claims to be safer than current value accounting, but the latter is more meaningful in terms of what the men running a business—or a country—really need to know. Under stable economic conditions, with fairly stable prices and limited technical development, the discrepancy between historical and current value may not be great. In a volatile developing economy it may be large enough to cause serious problems. A distorted picture of costs and profits based on circumstances that have changed not only hampers the future of the individual business unit but also distorts those socioeconomic sectors dependent on it.
Accounting principles, concepts, and practices have a meaning only if they are constantly tested against the economic background. Since the objective of a business organization is to maintain continuity of production without eroding its capital structure, it is important to consider as profit only that portion of the surplus that can be consumed without impairing productive capacity. Any major deviation from this standard can impair the delicate capital structure and continuity of a company. Since developing nations are often plagued with heavy inflationary strains and are subject to rapid technological changes, the determination of what increase in net assets is consumable is exceptionally important.
In the economy as a whole, to ignore the effect of inflation or deflation on the value of capital assets may reinforce the inflationary or deflationary pressures, while accounting practices based on, for example, replacement (current) values, tend to have a leveling effect. In this way accounting practices can affect the monetary order and the business cycle.
The essential thing is that accounting rules must not be rigid, but should be adapted to the real requirements of the economy. On the other hand, care should be exercised that accounting rules are not constantly revised under the influence of short-term tendencies and distortions in the economic environment.
Some Practical Proposals
These principles that I have been discussing are important, and perhaps necessarily a long way from being put into effect. Any accountant who propounds them should accept some responsibility for practical suggestions about how to begin to move toward them, and I have a few.
As an addition to the volume Professional Accounting in 25 Countries an analytical description should be undertaken of the status of accountancy and of accounting practices in a number of developing countries. The whole economic framework should be taken into account in this survey.
At the same time, it might be useful to investigate whether accounting training centers in various areas could serve a useful purpose. Such training centers could not only train professional and industrial accountants, but could also be a center where businessmen could get assistance in setting up good accounting systems.
The accounting institutes in the developed nations might consider the extent to which they could give technical assistance to the profession elsewhere in the form of manpower, consultation, or other means.
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Accountants will have to become more aware of the economic meaning and uses of accountancy than before and should be equipped to assist in economic analysis and programing. The role of accountancy in the future might well extend itself to the whole economic sphere, and proper accounting information might even create something of a revolution in our economic thinking and policies. One thing at any rate is sure: a greater exposure of accountants to economic realities, and, conversely, a better insight by economists into the nature of accountancy, are among the urgent needs of world economic development.