Looking Forward: Thinking Fiscally & Moving Laterally With Core Principles of Finance
Stockholders, creditors, managers, and many other employees make decisions by the numbers; accounting is commonly known as “the language of business”. The various functions performed during accounting and management is subject to follow certain rules and standards. Accounting provides tools to better forecast and guide decisions with the purpose of minimizing risk, cutting costs, and maximizing profits for stakeholders. Using accounting practices to produce financial statements allows us to look at a sort of story about a firm’s financial position at a specific point and time. The firm can achieve better gains or can suffer losses depending on many factors including the way the financial statements are prepared. Financial statements should enable the accountants and managers to make informed decisions. The cold hard facts are that many brilliant individuals take advantage of such accounting tools and practice what is called “cooking the books” in order to maximize profits or to ensure hefty bonuses.
Serious problems arose for American business in the late 1990’s because many scandals involving greed and corruption rocked the business world. Unethical accounting practices contributed to the debacle. Incidentally, many top executives and CEOs landed in jail. The scandals were a wake-up call to the accounting profession. Raising awareness, State and Federal boards began passing tougher oversight regulations. I believe much is left to be done and I am a proponent of an ethical free market capitalistic system which spurs competition and innovation. White collar crime is a problem and a major contributor to our current global economic crisis. I know we can do better and I believe in business and I believe there are new answers for maintaining stronger economies in the future.
Talk is coming out from think tanks that simple solutions to our global economic crisis will come from somewhere outside the traditional economic loop. The phenomenon of group think loses its grip outside traditional channels. Simple, ethical, accountable un-politicized or jaded ideas to provide real opportunities for moving forward can occur where the later has failed.
I realize the change we need to implement in finance is found in the basic accounting equation. It has become my opinion that corporate finance practices are in need of change in order to do two things: to allow the global economy to stabilize, and secondly, balance out more fairly the wage earning gaps throughout firms. This will put more well earned money in the pockets of the working class thereby allowing for more purchasing power which bolsters weakened economies.
These changes affect the pay scale for top level management and it will also affect other stakeholders; but, this plan to adjust and redefine the basic accounting equation will allow for the continuation of commerce as we know it whereas continuing without these measures the economies of the world will not weather the coming shockwaves with market corrections which are due as debts are due.
We forget to remember that without consumer buying power industry doesn’t have a chance. Big government, big banks, and big corporations should meet in the middle. Small businesses also have an enormous part leading us in the direction we head into next. There isn’t much motivation for global banking hedge-mongers to support anything which might go against their immediate bottom line. When their bottom line is affected, those who clamor for more profit at any cost, only then will the moneygrabbers and powerbrokers come to the surface to affect the real change necessary, and even then it will be altered once again slanted to an unstable advantage if left unchecked. Obviously we should not count on them to bail out our industry sectors just as we should not have to bail the banking sector out. It seems fishy. We should be able to work together and come to a reasonable solution. Here is a simplified version of my plan: We will redefine Wages Payable (+L) to become known as Human Capital (-A). This means we will move Wages Payable from its present situation in the basic accounting equation and from being entered into the basic accounting equation as a Liability, to being an Amortized as an Asset (-A).
I propose the Amortization of the adjusted entry, Wages Expenses (+E, -SE) and Wages Payable (+L) which thereby redefines Wages Expenses as a type of Stockholder’s Equity (+SE). Presently companies can create what’s called “Goodwill” and they can sell and buy goodwill. This is the most frequently reported as intangible assets…which encompasses lots of good stuff like a favorable location, an established customer base, a great reputation, and successful business operations”. The Human Resource Capital should go through Amortization which is “the name given to allocating the cost of intangible assets over their limited useful lives”. Human Resources, or Human Capital, are Intangible Assets with limited lives. Time is money and unique life experiences are acquired at no small cost to create and sustain that particular Human Being, whose skills and competencies come with a certain personhood and make up an exchange of assets with various time values defined as Assets (-A) and have a limited life. Intangible Assets which have an “unlimited life” are not the same as with Intangible Assets having a “limited life”. Even the unlimited life of an Intangible Asset is “tested” at least annually for possible impairment; comparatively, the new situation (accounting entry) for Human Capital under the rule of GAAP (for an example), Amortization should also be scrutinized by such measures or subject to oversight to achieve balance and fairness. But I digress; “Most companies do not estimate a residual value for their Intangible Assets because, unlike Tangible Assets which can be sold as scrap, Intangible Assets usually have no value at the end of their useful lives”. Following the changes I am proposing, at the end of an employee’s contract, the balance would be zero. For example: employed as a manager of a Wal-Mart store, based on my negotiated single year contract totaling $36,000, the monthly entry could look similar to this: Assets = Liabilites + Stockholders’ Equity
JH -3000 (-A) Amortization Expense (+SE) -3,000
dr Amortization Expense (+E, -SE) 3,000
cr JH (-A) 3,000
These are simple illustrations of the concept which redefines the accounting entries: Presently Human Resource (Capital) is defined as a Liability (+L)
Assets = Liabilities + Stockholders’ Equity
Wages Payable (+L) +3,000 Wages Expense (+E) -3,000
dr Wages Expense (+E, -SE) 3,000
cr Wages Payable (+L) 3,000
Both equations follow the rules of the basic accounting equation because they balance out as they should. The main point being: Humans are not liabilities. Cutting costs, expenses and lowering liabilities is a primary function of the business model; the very nature of a liability (Wages Payable) means to keep the Human Capital costs at the very minimum. That is the effect properly carrying out the role of managing a business. What is a cost? The value of what is given up in the exchange for something else. What human beings bring to the equation is not a cost it is an Intangible Assetwith Limited Life. Human Capital should not be a journal entry under Liability, a cost to be cut in order to maximize profits. Like any resource, in this case Intangible Assets with a Limited Life, should have values attributed which vary by degrees. It is a very simple concept really: we are going to treat people with the dignity that we treat other Intangible Assets such as with Limited Life; Trademarks, Copyrights, Patents, Licensing rights, Franchises, and Goodwill. The argument will come to be about what a human being brings to a business. Think of a computer without the software. The physical body is something that is secondary to the equation; however, with the skills, competencies, experience, and things which are difficult to measure such as intuition and unrealized potential those things make up the Asset which is Human Capital. Humans really do have untapped abilities and potential which is worth something innately. This is just a part of the case we are facing today; people are being repressed, having their wages suppressed for some time now, the system must be improved, it must be adjusted. The good news is that changing the equation will actually stimulate the economy and improve economics and in a relatively short span of time. The simple adjustment (or redefining )of the basic accounting equation will come with much less hardship, a less painful transitioning than any other option or the effects of doing nothing. Even more grossly negligent action would be to continue kicking the can down the road, running it till the wheels fall off, or putting Band-Aids over deeply cut wounds which would fester.
I also believe that when exploring how to pay for and/or compensate the Human Capital stakeholders will consider advantages and disadvantages of Equity and Debt financing. I do not think it wise to continue to look directly to the banking sector for fiscal support/investment because of the current crisis; incidentally the banks have too much power and leverage and for the health and security of our global economies therefore I believe it best to look to Equity financing and not Debt financing. “Whenever a company needs a large amount of long-term financing executives will have to decide whether to obtain it by issuing new stock to investors (called equity financing) or borrowing money from lenders (debt financing) and by using Equity Financing, which does not have to be repaid, the company could obtain the financing it needs”. Competition will influence whether to pursue additional equity or debt financing depending on the circumstances. Much expert opinion and testing will come adding great detail and many improvements to this basic outline.
Amortized Human Capital is fair and sensible; it is a practical and ethical way forward. The bottom line is, now is the time to implement this change. Presently, companies can create, sell and buy “’goodwill’ the most frequently reported intangible asset…which encompasses lots of good stuff like a favorable location, an established customer base, a great reputation, and successful business operations”. This proposal is a remediation between the ideals of capitalism run amuck and a increasingly chosen path towards socialism. At the heart of people, if properly informed, neither of those outcomes is desirable which is why we must make this adjustment I am proposing.
God speaks to us in our conditions and our situations in life and the cold hard reality is that we have a major economic crisis hanging over our heads and our brightest minds, our leadership cannot come up with any meaningful solutions out of this economic wreck. We cannot continue to run our economies in ways to which the wheels are about to fall off. The discourse however must continue and the solution lies in the private sector to innovate our way out and then by a grass roots approach we must create policy and pass legislation to inact these new economic principles to the present accounting rules. Period.
This proposal comes with the notion that Corporations will acquire talent and build contracts for acquiring talent and the people (Human Capital, as the entry name shall be) will negotiate terms, per-say, a five year contract, at such and such amount for such and such a time, which would then undergo Amortization and be entered into the financial statement in incremental amounts per period. In other words “spread on a straight-line basis over each period of useful life in the process of Amortization. Presently “The accounting rules that apply to the use of intangible assets, after they have been purchased, depend on whether the intangible asset has a limited or unlimited life”.
Preparing a firm’s budget this way would stabilize the Global economy by incidentally creating firmer accountability practices and fostering better fiscal sustainability. It also goes in toe with the empowerment demands by the people; Occupy Wall street, Arab Spring…. Global connectedness requires a better, quicker, and more thoughtful response from upper management in business and banking. The nation’s businessman and bankers are extraordinarily talented at organizing and implementing policies and affecting change on grand scales. I know we can get this done.
Kelly, M., McGowen J. (2013). BUSN 5th Student Edition. South Western, Cengage Learning.
South Western. Mason, OH
Phillips, F., Libby, R., Libby, Patricia (2011). Fundamentals of Financial Accounting 3rd Edition.
McGraw-Hill, Irwin, New York.
We will also use this endeavor as a platform for my new economic proposal. I’m going to adjust the basic accounting equation where humans are presently counted as a cost to be reduced, to be cut as is the nature of profit seeking capitalism. I will simple redefine Human Resources (wages payable into the equity portion of the basic accounting equation to an equity entry with a time-value which that’s what is being invested into the company of course, so people can invest time and money or one or the other. The New Bank Paradigm will dramatically improve the economics and finance issues without hurting freemarket capitalism and it will garner better wages for the people while better incentivising competition and rewarding that in a fashion which is just. The middle class will benefit the most and thus stimulate the economy as we need and thus the corporations will perform better by posting higher earnings.