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In this Apr 2005 issue of On Target :
Reputation Risk Management
What's On
Bookshelf
Reputation Risk Management : A new direction for Management Accountants
The age of the corporation (since 1850) led to the enormous emphasis on the determination of profit - hence the acceptance of arbitrary cost allocations. Now the focus has widened. Owners, investors, creditors, bankers, government now all need leading indicators. Accounting - especially financial accounting - is still preoccupied by lagging indicators.
Such a preoccupation with the past is akin to “navigating by looking at the wake created by the ship”. This is only possible, if one is sure one is going in the right direction, and if one is sure there will be no unexpected ships, icebergs and floating debris crossing the ship's path. Such a backward looking preoccupation is unacceptable to corporate risk managers who must look ahead to evaluate the impact of future conditions on the continued viability of their organisation.
The Financial Statements prepared and audited in today’s economic environment can be traced to the industrial era, when tangible assets such as machinery were the engines of growth. In this era, financial accountants endorsed or invented rules based on the historical cost doctrine that yielded values which had no counterparts in commercial reality – often book valuations were sheer fictions, and thus managing the risk associated with those valuations became a meaningless exercise.
When companies failed spectacularly due to the mismatch between commercial reality and reported values, the reason for failure was pinpointed to the irreparable damage to the company’s reputation due to the lack of adequate risk management procedures, resulting in a failure ultimately traced to a defect in an organisation’s products, services, information systems or external auditors.
Consideration will, therefore, be given to the nature, recognition, and measurement of information-era assets. The engine(s) that drive information-era enterprises include knowledge, innovation, communication, learning, and innovative abilities. However, such assets are still systematically excluded from our industrial-era balance sheets; thus understating the total “capital” of the enterprise. Therefore, currently “short-term monetary capital maintenance” is the focus instead of "long-term comprehensive capital maintenance”. This also provides temptation to managers to reduce some of these assets for the sake of short-term earnings. For example, in earlier times, advertising was seen as an expense rather than a variable that enhances a Brand’s future earnings potential (i.e. an asset). Thus there was a temptation amongst managers to increase short-term profit by reducing the advertising spent. Today’s managers may similarly reduce the maintenance carried out on a tangible asset (e.g. aircraft), or reduce the training given to a intangible asset such as a knowledge worker (e.g. aircraft maintenance technician). If as a consequence the aircraft crashes, this could irreparably damage the reputation of the airline. In certain instances, such cost savings (e.g. on safety equipment for workers) could result in jail terms for directors.
Figure 1 below illustrates the issues involved. The available tangible and intangible assets are the preconditions required for the inducement of sales (the consequences). These preconditions act via an intermediate variables of contextual capability and brand capability (or organisational reputation) to generate both present and future sales potential. The present value of such sales potential is therefore the “value” of the contextual capability that gives rise to the brand/reputation capability. It is this brand/reputation capability which must be managed.
[ Diagram Comes Here]
Considering Figure 1, it is important to contrast tangible and intangible assets, contextual capability, brand (reputation) capability and the resultant capability value. Assets are “what one has”, much like a Ferrari racing car (tangible asset) or Michael Schumacher’s driving skills (intangible asset). Contextual Capability is what can be achieved in a particular situation (or “what one can do”) when these asset categories are combined in a contextual situation, i.e., win the World Championship. Brand/Reputation Capability is the esteem perception created in potential customers’ minds about the Ferrari brand as a consequence of winning the world championship. Capability Value is the economic value of the capability (i.e. the current and future monetary value to Ferrari via sales, having a Brand Reputation of winning the formula one championship). Any diminution of that reputation due to poor risk management techniques, ultimately results in the diminution of an organisation’s value, and if this process goes unchecked, or has a significant avoidable disaster, an Enron type corporate collapse could result.
The ICMA has commissioned a project to test the proposition that not only can risk be managed and valued, but also its associated reputation value can be incorporated in the financial statements. The outcome of the project is to provide a valuation model based on the premise that risk management should not be based on what the organisation has, but instead what the organisation can do, i.e. its capability to manage and enhance its reputation in order to ultimately generate incremental future cash flow, and hence value. Under such a valuation model, consideration will be given to the approach that auditors can take to determine an organisation's strategic capability of sustaining and generating value via reputation enhancement. Consideration will also be given to the role of the Risk Manager, and how an empowered open-book approach to communicating and financial reporting can provide significant motivational benefits in risk reduction and reputation enhancement that ultimately result in increased value.
What's On
April 2 - June 18, 2005
Advanced Management Accounting & Advanced Strategic Management Accounting 12-day Seminars (4th Batch) in the Philippines by Business Sense Inc. and ICMA
April 2-9, 2005
Advanced Management Accounting & Advanced Strategic Management Accounting 7-day Seminars (2nd Batch) in Lebanon conducted by cmalebanon and ICMA
April 16 - May 28, 2005
CAT Batch 2 in the Philippines by cmaphilippines and ICMA
April 2, 3 & 16, 2005
Strategic Business Analysis course continues at the Graduate Business School, Monash University
April 17, 24, and May 8, 2005
Advanced Management Accounting training at ICMA Secretariat, Melbourne [conducted by the Global Business School]
May 7, 2005
Strategic Business Analysis exam at the Graduate Business School, Monash University
May 14, 15, 22 & 29, 2005
Advanced Strategic Management Accounting training at ICMA Secretariat, Melbourne [conducted by the Global Business School]
June 11- August 27, 2005
Advanced Management Accounting & Advanced Strategic Management Accounting 12-day Seminars (5th Batch) in the Philippines by cmaphilippines and ICMA
Book Shelf
Although researchers in the area are quite active, an area of research that is sometimes forgotten about is accounting education. There are a number of journals in the area that have been published for some years and at least one new journal is being published (I am thinking of the Australian Journal of Accounting Education). This month, a few articles of interest from the latest issue of Accounting Education (December, 2004).
In “Encouraging better learning through better teaching: a study of approaches to teaching in accounting”, Lyn Leveson from La Trobe University reports on qualitative research into aspects of the teaching experiences of academics teaching accounting in Australian universities. The article discusses two orientations to teaching – teacher-centred/content-driven and a student-centred/learning orientation. The key difference between these is essentially whether teaching in the discipline is viewed as a matter of transmitting facts and procedures or of encouraging students to develop their own accounting concepts and perhaps to even change their world view in the process. The results are discussed in relation to some of the practical realities of day-to-day teaching.
An article adopting a more quantitative approach, the strongly theorised ‘approaches to learning’ framework, is “Approaches to learning in accounting education” by Ursula Lucas and Rosina Mladenovic. This model stresses the context of learning and teaching, and highlights how student factors and teaching context, and students’ approaches to learning affect the learning outcomes achieved. The implications of deep versus surface approaches to learning and methodological issues are discussed.
Related articles in this issue are an article “Encouraging a deep approach to learning through curriculum design” by Linda English, Peter Luckett and Rosina Mladenovic, and “Changing the learning environment to promote deep learning approaches in first-year accounting students” by Matthew Hall, Alan Ramsey and John Raven.
As book review editor for the Institute’s Journal of Applied Management Accounting Research, I am always looking for people interested in writing book reviews. I have a steady flow of books for review but would like to hear from anybody interested in reviewing them. The books cover a wide range of topics. (Please don’t send unsolicited reviews without contacting me first.)
Bill Richardson
Please feel free to share anything that you have found interesting. You can send your ideas to: Bill Richardson, Dept of Accounting & Finance, Monash University, PO Box 197, Caulfield East VIC 3145.
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