Value Based Accounting proposes new principles and standards to be used in preparing financial statements for publicly traded companies. These principles and standards may, with modification, be used for private companies, and non-profits and governmental bodies.

Value Based Accounting has been used by accountants, businesses and the capital markets for many years but paradoxically has not yet been used for financial reporting. The foundation of value based accounting is the valuation which is the present value of net expected cash flows. Valuation is the dominant method supporting financial decisions such as shareholder investment decisions, management capital allocation decisions, pricing decisions, creditor decisions, or M&A decisions. It has been proposed as a financial reporting basis many times over the years but has taken a back seat to Generally Accepted Accounting Principles (GAAP) implementation.

There is one developed and complete valued based accounting model: Accounting For The Future. The text below refers to that implementation.

Contents

• Basic objectives

• Fundamental qualities

• Basic concepts

• Assumptions

• Principles

• Constraints

• The AFTF Setting

Basic objectives

Financial reporting should provide information that is:

• useful to management, creditors, regulators, and to present and potential investors in making rational financial decisions.

• helpful to management, creditors, regulators, and to present and potential investors in assessing the amounts, timing, and uncertainty of prospective cash receipts.

• about economic resources, the claims to those resources, and the changes in them.

Fundamental Qualities

To be useful and helpful to users, financial statements must be:

• Relevant: relevant information makes a difference in a decision. It also helps users make predictions about past, present and future events (it has predictive value). Relevant information helps users confirm or correct prior expectations (it has feedback value). It must also be available on time, that is before decisions are made. • Reliable: reliable information is verifiable (when independent auditors using the same methods get similar results), neutral (free from bias), and demonstrate representational faithfulness (what really happened or existed).

• Comparable: information must be measured and reported in a similar manner for different enterprises (allows financial statements to be compared between different companies).

• Consistent: the same accounting methods should be applied from period to period and all changes in methods should be well explained and justified (allows financial statements of the same company to be compared between different periods). • Complete: all components of value, including intangibles, must be accounted for. AFTF handles automatically incorporates intangibles since today’s intangibles are tomorrow’s cash flows. In contrast, GAAP is massively incomplete.

Basic Concepts

To achieve basic objectives and implement fundamental qualities AFTF has five basic assumptions, four basic principles, and four basic constraints.

Assumptions

• Economic Value Assumption assumes that decisions are best supported by measures of economic value as measured by present values of expected cash flows. This contrasts with GAAP accounting measures which are often not economic values.

• Entity Perspective assumes that value measures should be entity specific (from the viewpoint of the entity) as opposed to a cost basis, market or liquidation value or “Fair Value” as currently defined.

• Going Concern Assumption assumes that the business will be in operation for a long time. This validates the use of present values of expected cash flows. Expected cash flows take into account all contingencies in proportion to their liklihood, including sale, merger, or liquidation.

• Monetary Unit Assumption assumes that values can be relevantly measured in current monetary units. It is not necessary that the currency be stable or that inflation effects be negliible. The discount rate (cost of capital) automatically takes into account expected inflationary effect on dollar or inventory values for the specific entity. This supports economic valuation and enhances comparability.

• Periodic Reporting Assumption assumes that the business operations can be recorded and separated into different periods (most common periods are months, quarters and years). This is required for comparison between present and past performance. AFTF supports periodic reporting but the progress and status of the entity reflects a more complete view. To this end the progress of a company is measured as value added, i.e., the change in value. This corresponds to a “balance sheet” definition of income. Unlike GAAP the AFTF income and balance sheet are meaningfully coordinated.

Principles

• The economic value perspective requires companies to account and report based on capital market values rather than acquisition costs or fair value for all assets and liabilities. This principle provides information that is relelevant and reliable (being subject to the AFTF Dual Validation diciplines). • AFTF replaces the GAAP revenue recognition principle with the Recognition of Value. This is a two step process involving: first, the recognition of expected cash flows and, second, the measure of those cash flows as present values. Both expected cash flows and their measure are subject to strong AFTF disciplines that insure maximal representation and reliability.

• With AFTF matching is unnecessary. This avoids accounting allocations such as depreciation which are artificial and arbitrary. In fact there can be no accounting allocations with AFTF thus eliminating a major source of abuse and fraud. Since AFTF is purely prospective, there can be no prior period restatements. AFTF also eliminates the undesirable asset/liability asymmetry which distorts economic values and impaires decisions. For example, expected cash inflows are fully recognized, not capped at the level of expense, as with GAAP.

• The AFTF full disclosure principle states that any information reasonably expected to affect a shareholder decision must be incorporated into managements expected cash flows. There is no exception or escape clause.

Constraints

• Cost-benefit relationship states that the benefit of providing the financial information should also be weighed against the cost of providing it. AFTF unifies accounting so that the cost is spread. For example, management accounting is coordinated with AFTF financial reporting. In fact, AFTF is an outgrowth of management and shareholder decsion support systems. AFTF simplifies accounting so that cost are reduced. Benefits to users of fiancial information will result from the enhanced relevance and reliability that AFTF provides.

• Any information reasonably expected to affect a shareholder decisions is material.

• AFTF accounting applies the same principles, methods, procedures and measures for all industries. There are no Industry specific accounting procedures or measures. This maximizes comparability.

• While conservatism may forestall the occasional bankruptcy, it systematically destroys or hides information. This cannot support optimal decisions and prevents diversity from flourishing and natural selection from operating. This does far more damage than the occasional bankruptcy. There is no conservatism principle in AFTF. In fact, it is precluded by the use of expected values.

The Value Based Accounting Setting

Value Based Accounting has a long history of supporting financial decsions. It has its origins in the Austrian School of economics. For example, Eugene von Boehm-Bawerk wrote “Let us put the rule in general terms. Where goods permit of alternative methods of utilization and are capable of affording greater or lesser marginal utility in them, the use which has the highest marginal utility provides the measure of its economic value”. This is just as true today as it was 120 years ago. Whereas GAAP pays lip service to economic value, it does not support economic value with its measures, such as “fair value”. AFTF is based foursquare on economic value. In modern times there have been efforts to introduce the value concept into accounting. Notable among these attempts has been Harvey Kapnick’s impassioned plea for the development of a value based accounting model. See VALUE-BASED ACCOUNTING EVOLUTION OR REVOLUTION by Harvey Kapnick, Chairman Arthur Andersen & Company, February 17, 1976 at: http://newman.baruch.cuny.edu/DIGITAL/saxe/saxe_1975/kapnick_76.htm FASB has published useful studies on value based accounting measures (see The FASB Project on Present Value Based Measurements, An Analysis of Deliberations and Techniques, February 1996, 146 pages. See also Present Value Based Measuremnets in Accounting, December 1990, 133 pages). In April 2001 FASB published a Special Report, Business and Financial Reporting, Challenges from the New Economy: that report cites two proposed accounting models the undeveloped but copyrighted CICA Total Value Creation System and the more fully developed AFTF model. There are many other FASB publications examining issues of prospective accounting, intangibles, recognition and similar issues that relate to value based accounting.

In 1998, Humphrey Nash published the draft proposal Accounting For The Future (AFTF), which was designed “to facilitate, accelerate and formalize an accounting evolution already in progress.” This draft proposal outlined a complete value based accounting implementation with disciplines to insure relevance and reliability.

The draft proposal and related essays may be found at: http://home.sprintmail.com/~humphreynash/index.htm