Management
Accounting & Financial Control (R 66)
Lecturer: Prof. Henning Kirkegaard
Copenhagen Business School, Denmark
Exam Date: Dec 21, 1999
Project Report
Dynamic Accounting To Predict Future Cash Flows
A Tool For Management Decisions
Group no. 5
Group members:
Jonni Leporanta (FIN)
Muhammad M. Bhatti (PAK)
Nadarasa Subramaniam (SRL)
Thomas Steppuhn (GER)
Table of contents 1 Introduction 3
1.1 Overview and Task Definition 3
1.2 Brief Description of the Current Accounting System 4
2 The Problems of the Current Accounting System 5
2.2 Problems with Defining Terms 8
2.2.1 Assets 8
2.2.2 Liabilities 9
2.2.3 Owners Equity 9
2.3 The Problems with Financial Statements 10
2.3.1 Static, Instead of Being Dynamic 11
2.3.2 Out Of Date, Instead of Up To Date 11
2.3.3 Unclear, Instead of Being Clear 12
2.3.4 Incomplete, Instead of Being Complete 12
3 New Dynamic Accounting Theory 14
4 Description of the LogiCase Model 19
4.1 Introduction and Tasks of the LogiCase Model 19
4.2 Implementation 20
4.2.1 Registering Data 20
4.2.2 Structuring Using Cases 21
4.3 Features of LogiCase and Use of the Data 23
4.3.1 Liquidity Prediction 23
4.3.2 Generation of Traditional Financial Statements 26
4.3.3 Tool for Financing and Investing 26
4.3.4 Dynamic Control of Payments 27
4.4 Requirements, Environment and Comments 27
4.4.1 Interpretation of Data 27
4.4.2 Inclusion of All Data 27
4.4.3 Accounting Department 28
4.4.4 Entering Wrong Data 28
4.4.5 Training 28
4.4.6 Is Dynamic Accounting the Perfect Solution? 29
4.4.7 Size of the Company 29
4.4.8 Valuing Fixed Assets 29
4.4.9 Discounting of Cash Flows? 30
4.4.10 Possible Danger 30
5 Conclusion and Future Perspective 32
List of References 34
1. Introduction
1.1 Overview and Task Definition
The following project is divided into five parts which we would
first like to describe briefly.
Chapter 1 consists of a description of the current accounting
system.
In chapter 2, we will try to point out the lacks of this system
which occurred in recent times. Hopefully, we will succeed in
convincing the reader that a new system is hardly needed in order
to provide objectively measured and clearly defined information
describing the financial consequences of the actions of
organisations - therefore managers would be able to make correct
decisions.
In chapter 3 we will introduce you to this new dynamic accounting
system and describe it in more detail. To analyse how this new
model can be implemented, we are going to describe such a system
in practise which will be our task in chapter 4. Furthermore, we
want to point out the benefits and potential problems using such
a system. At this place, we would like to thank Mr. John Eskaebek
and Mr. Søren Ølund, the executive directors of the company
SEFF Systems A/S for providing us with information about their
new LogiCase system which is based on the dynamic accounting
model. Our chapter 4 is based on this information.
In chapter 5, our last chapter, we're finally going to summarise
and conclude the whole outline of our project followed by showing
up a future perspective.
1.2 Brief Description of the Current Accounting System
Double Entry Bookkeeping (DEB) is an accounting system which has
been in practice for about 500 years. In the DEB, transactions
are entered into financial statements twice, once at the point of
realisation and the second time when the amount is paid. So it
basically treats the financial transactions in two periods of
time, which are at the point of realization and at the point of
payment.
Before we go into further details of DEB, we will see the
differences between countries, how different countries are using
the DEB. We will give you an example of the differences of
accounting practice of countries following the standard of
Continental Europe (Germany, France, Belgium, Greece, Italy,
Portugal, Switzerland and Japan) and countries following the
Anglo-Saxon standard (USA, Canada, Great Britain, Ireland,
Australia and New Zealand, The Netherlands and Singapore). There
you can find a difference of objectives between these two groups
of countries. Some of the differences are shown below.
Continental European Countries:
· Accounts are prepared to provide information about the
company's financial situation to creditors, tax authorities and
investors
· Dominance of the prudence principle is followed
· Tendency towards lower extent of disclosure
· Tendency towards higher hidden reserves
· Taxation influences the financial accounting
Anglo-Saxon Countries:
· Useful information for investors to make decisions
· True and fair view
· Tendency towards higher extent of disclosure
· Tendency towards lower hidden reserves
· No mutual influence of taxation and financial accounting
(International Accounting, Peter Walton, Page 8)
2. The Problems of the Current Accounting System
In so many occasions, companies have faced serious financial
difficulties that lead them to be insolvent just after publishing
annual financial statements and auditing reports, which assured
that these companies had been in a very stable and healthy
condition. Almost after every collapse, the failures were
explained as typical incidents. In several cases, the
responsibilities for these failures were ironically transferred
to the manager, either as he/she had made some forgeries, or as
he/she had been careless and irresponsible. The investors,
shareholders, creditors, banks and suppliers, who had financed
these bankrupt companies, were forced to take the
responsibilities for their own losses. In some cases, the
auditing firms were also forced to take the responsibilities, as
they mislead the people by publishing a wrong picture of the
company. For instance, in 1990 the seventh largest American
accounting firm, Laventhol & Horwath, filed for bankruptcy,
largely due to the number of damage claims facing the firm. Two
years later another large firm in USA, Panell Kerr Forster,
underwent a massive restructuring of liability, closing or
selling 90 percent of its offices.(Peter Walton, p.66)
Here our intention is not to find out who should take the
responsibilities for such failures, but to figure out to what
extent the current accounting methods have become inefficient in
showing a "real picture" of a business enterprise - a
picture based on objectively measured and clearly defined
information describing the financial consequences of the actions
of organisations. Thus the existing financial statements fail to
provide the manager with relevant information to make correct
decisions with financial consequences for the company. Actually
the traditional accounting method was a wonderful method to
obtain a "real picture" of a business enterprise, when
it was invented nearly 500 years ago. At that time, the number of
business activities was very small, and the amount of
transactions was not large in terms of money.
Furthermore, transactions on credit or business activities such
as import, export or invoicing which delayed the payments made or
received were not made or at least not made as frequently as in
current days.
Nowadays, the world has become one large market, where
competition is tougher, and transactions take place much faster.
Thus, managers are being forced to make decisions within a
shorter period to exist in the industry. Therefore the current
accounting methods should provide adequate data and information
to take the correct decisions on the firms future strategy. In
this regard, even though the current business environment has
entirely changed from those days, in which the traditional
accounting methods were introduced, we have been using the same
old accounting concepts, principles and methods. If we look at
these points in little more detail, we are able to understand how
these methods mislead the users. There are several reasons for
the inefficiency of the financial reporting. We identify that the
problems, which are associated with financial reporting, mainly
lie on the following two areas:
· The problems with defining terms
· The problems with financial statements
In the following section, we are trying to point out the lacks of
the current accounting system concerning the above mentioned
points.
2.2 Problems with Defining Terms
Financial statements are not conceptualised which means that the
available basic terms and concepts are not defined clearly but
are based on assumption, speculation and belief.
These basic concepts are useless e.g. the concepts of
"assets", "liabilities" or "equity"
are not understandable or are even misleading and can be
misunderstood - which means will be misunderstood.
We will go a little bit more into detail with those concepts in
the following sections.
2.2.1 Assets
Even though in the traditional accounting system, assets are
classified into fixed assets, e.g. machines or buildings and
current assets, e.g. inventory or cash, nobody really knows what
an asset is. There is no precise and well defined content of the
concept of assets.
One big problem in the "concept of assets" is, that
there is no standard in valuing them which means that a unique
asset can be valued completely different from country to country.
IASC allows assets to be valued at acquisition cost or production
cost though valuation above historical cost or current value is
also allowed. In contrary, in the US valuation above historical
cost is not allowed. The same goes for Germany as well where
valuation above historical cost is not allowed. (Peter Walton,
p.326)
Valuing assets based on e.g. historical costs usually means that
the "book value" of the asset does not reflect its
"real value", e.g. the market value.
2.2.2 Liabilities
In the current accounting system, liabilities are probable future
sacrifices of economic benefits arising from present obligations
of a particular entity to transfer assets or provide services to
other entities in the future as a result of past transactions or
events. (FASB)
Liabilities are divided into current liabilities, accounts
payable, taxes payable, accrued expenses, deferred revenues and
current portion of long term debt but still no one understands
the "concept of liabilities" because of a lacking
precise and well defined content of it. (Accounting and text
cases Robert N. Anthony)
2.2.3 Owners Equity
Equity or net assets is the residual interest in the assets of an
entity that remains after deducting its liabilities. ( FASB )
Equity can be divided into the two categories of paid in capital
and retained earnings but it still remains a concept that is only
defined as the difference between two other concepts - no matter
what name you give it. The concept of equity is an unrealistic
concept because the amount reported as equity consists of amounts
of capital from two different sources, e.g. capital by equity
investors and profit by the company itself.
2.3 The Problems with Financial Statements
According to the FASB (Financial Accounting Standards Board), the
purpose of the financial reporting is to provide information that
is useful to the different parties such as present and potential
investors, creditors and others. In practice, there are a number
of interested parties such as shareholders, creditors, suppliers,
banks, financial institutions, employees, managers, competitors
and the government authorities, who can be interested in using
these financial statements in order to decide about their future
business with the particular business enterprise. The financial
statements can generally be divided into three different parts:
· A profit and loss account
· A balance sheet
· A report and notes
While the profit and loss account describes the performance of an
enterprise, the balance sheet describes the financial conditions
of the enterprise. The report and notes consist of comments,
specifications and additional details. In this regard, the
financial statements should provide the perfect and trustworthy
information on the firm's performance and financial conditions,
but in reality, the financial statements are untrustworthy, as
they contain the following draw backs. (Henning Kirkegaard, p.85)
· Static, instead of being dynamic
· Out of date, instead of being up to date
· Unclear, instead of being clear
· Incomplete, instead of being clear
In the following sections, we will give you reasons why the
current financial statements don't provide their readers with
"perfect" and trustworthy information and are thereby
unreliable.
2.3.1 Static, Instead of Being Dynamic
The concept of periodicity refers to the fact that accountants
measure cash flows over regular calendar periods, such as a year,
a quarter, or a month. The key problem lies in the fact that the
cash flow is generally relatively difficult to measure during the
completion of a certain project. Traditional financial statements
don't provide a dynamic system to survey cash flows of certain
projects while they are not finished yet, e.g. the life time of
certain projects usually doesn't fit into the regular financial
reporting periods.
There is no reason for only being interested in and surveying the
financial situation of a company in fixed and static periods of
time such as a calendar year or a month. Those fixed periods of
time have nothing to do with reality.
2.3.2 Out Of Date, Instead of Up To Date
The profit and loss account and the balance sheet are used to
describe a past story of the company, as it contains a past
period. The balance sheet is like a snapshot of a firm, and this
snapshot describes how the financial conditions of this firm were
at that particular moment. Financial statements can help to know
only about the past story of the firm, but they can never help to
show the present or predict the future performance and conditions
of the company. To predict the future financial situation of a
company by using traditional financial statements, you have to
assume that past data can give you information about the firms
future - this can not be possible in the real world as things are
always changing.
2.3.3 Unclear, Instead of Being Clear
The financial statements are always very difficult to understand
for a non-expert or an ordinary investor, as there are number of
complicated terms and methods, which are used according to law
requirements. For instance, when we calculate the value of the
inventory, there are different methods such as FIFO, LIFO, HIFO,
NIFO, and market value. In different situations, firms are
required to use a different method. One other thing is that
number of terms, which are used in accounting, have a different
meaning in the real world. For instance, the word debit is based
on the Latin word debitum which means some thing due to. How can
be acceptable that cash in the hand or in the bank is required to
enter in the debit side of the accounts. Here is a second
example: How can we argue to an ordinary person that while the
loans are being entered on the credits side of the account, the
profits and revenues should be entered on the credit side?
2.3.4 Incomplete, Instead of Being Complete
The financial statements do not tell us about the whole story of
an entity, because they only focus on the transactions or
activities, which can be measured in terms of money. As it was
stated earlier, there are so many activities such as invention of
new technology, penetrating new markets, new strategy
formulation, which can take place in the business entity. These
activities can change the firms marketing and earning
possibilities, but these activities are not included in the
financial statements.
As we know, when we prepare the financial statements, performance
and financial position of the firm are being described in terms
of money. Actually there are so many subjects related to the
firm's performance, which are not explainable in the money value.
If a firm, for instance, has a group of skilled employees, who
can possibly lead the firm to be in the leading position, it is
not possible to show that in the financial statements, as it is
only described in terms of money. On the other hand, if such kind
of skilled employees leave the company, it should be considered
as a great loss from the company's point of view, but it is also
impossible to show in the financial statements.
One more point is that some agreements a company has to fulfil
are not included in the traditional financial statements, e.g.
salaries to employees which have to be paid even if a company
finished its activities. Such "hidden obligations" are
not shown in the system which makes it incomplete.
3. New Dynamic Accounting Theory
New accounting practice should grant users of financial
statements access to objectively measured and clearly defined
information to give a description of the financial consequences
of the operations of an organisation.
The above mentioned financial consequences can be described
completely and consistently by classifying information about
positive or negative payments into four logical categories i.e.
adding two new measurement points which are expected and agreed
to the existing realised and paid. The result will be a logical
chain of events including four points of measurement which
describes the transaction all the way from the expected stage up
to the point when payment is made or received.
As we have explained earlier in our work traditional financial
statements and accounting registration methods fail in providing
us with essential information about the financial position of a
company because they contain some serious defects.
The most dramatic consequences of these defects are unforeseen
financial disasters leading to heavy losses for stakeholders of
enterprises that seem to be perfectly "healthy"
according to their financial statements but suddenly face an
unexpected bankruptcy.
The dynamic accounting model is a tool that describes the
payments made and received in an organisation using four points
of measurement: expected, agreed, realised and paid. Thereby
every transaction of an organisation is classified into a certain
state in a logical chain of events from expected to paid
according to it's "maturity".
This means that expectations and agreements about future payments
are included in the information system. This is a major
difference from the traditional accounting registration that is
limited to only registering historical transactions, e.g.
realised or paid transactions that already occurred.
In a dynamic accounting model, agreements that an organisation
has made are included, e.g. wages that the organisation has
agreed upon to pay to the people working in it. In a traditional
financial statement these kind of agreements are not included
even though they make an obligation for the company once they
have been agreed upon. By including these kind of agreements we
are closer to present a complete picture of an organisation's
activities.
All transactions with financial consequences - even uncertain
transactions like agreed or expected - are included already at a
stage when they are first known. Combined with the information
technology and data processing techniques possibilities of today
it is possible to generate an up-to-date picture of a company's
financial position.
The financial position of an enterprise doing business in the
modern world changes all the time and by entering the
transactions that have financial consequences for an organisation
when these consequences are first known enables a user (e.g. a
manager that wishes to make responsible decisions) to get a
dynamic picture of the company's financial position that
immediately reflects changes in the financial situation of a
company.
When including financial consequences of expected and agreed
actions one has to accept that prediction errors between the
different points of measurement are likely to occur and in some
cases will occur for certain.
For example, the budgeted income (expectation result) of a
project is 100 Polish Zlotys. The company makes an offer and
reaches an agreement on delivering the project for 95 Zlotys
which results in a prediction error 5 (100 - 95) .
Prediction errors can of course occur between all the different
points of measurement and can be described as:
Expectation result = Agreement result + prediction error
Agreement result = Realisation result + prediction error
Realisation result = Payment result + prediction error
Therefore it is of highest importance to immediately update the
balance of payments when new information on a future payment is
obtained. If we return to the example above this would mean that
once an agreement to deliver the project for 95 Zlotys has been
reached the value of the future payment in the information system
must be changed from expected 100 to agreed 95.
Even though we have to accept a situation where prediction errors
will occur between the different measurement points it is still
better to have information available that a manager can act upon
than facing unpleasant surprises in form of liquidity problems,
or even an unexpected bankruptcy because of not having the
information needed to do something about the situation.
When comparing the information that can be obtained from this
kind of dynamic information system with the information of
traditional company accounts it is quite clear that the
information in the dynamic system is much more useful for a
manager wishing to make clever financial decisions and wishing to
be able to act upon things while it is still possible.
New dynamic accounting theory presented by Henning Kirkegaard
does not discard the Double Entry Bookkeeping system - instead
the new model is based on DEB. That is why Mr. Kirkegaard calls
this an evolution into accounting instead of revolution - his
suggestion for a scientifically viable accounting is as follows:
"Accounting is theories (ideas) and methods (procedures) for
describing, explaining and predicting the financial consequences
of the activities of an organisation."
The new dynamic accounting model helps to predict the liquidity
of a company. As Henning Kirkegaard explains the concepts of
profit and liquidity in an example of Rubin's Vase model where he
tries to explain that either you can see the background or the
two faces, which he links to the profit and liquidity. This means
if you can see the profit of a company then the liquidity will be
in the background and if you look at the liquidity then the
profit will be in the background. So it means that we have only
two choices either we can focus on the profit or on the liquidity
but both are not presentable at the same time. Which can
contradict the real life. In the real life knowing the profit and
liquidity are both very important for the stakeholders.
Now we will come to the brief distinction between a company's
state of solvency and liquidity. There are four situations, a
company can be in with respect to the liquidity of that company.
1. Solvent and liquid
This is a situation where a company is able to pay all its
credits and claims. Companies in this stage are normally doing
fine and they are not noticed in the media and in the eyes of
their creditors as well.
2. Solvent and illiquid
This is a stage where a company is temporarily unable to pay its
creditors. This means that company is liquid for a short period
of time. But the company is solvent in the long run. Presently,
many companies can't survey their current liquidity and are
forced to deal with temporary illiquidity. This is one situation
where dynamic accounting or if we call it liquidity accounting
comes into existence.
If a company can get an early warning before getting to this
stage of solvent and illiquid, it can be golden information for
that enterprise. Action can be taken in time to solve the
temporary illiquidity problem.
3. Insolvent and liquid
This is a stage where a company is able to pay its debts in the
short run. But their debts in the longer run are larger than
their assets. Companies in this stage are temporarily able to pay
its creditors. Companies in this stage have very less chances to
survive. Coming to the Dynamic accounting model, if a company in
this situation get an early warning of permanent insolvency, and
the company can be liquidated as fast as possible to prevent
further damage for its creditors.
4. Insolvent and illiquid
Enterprises in this stage cannot pay their bills temporarily nor
in the longer run. Instead their debts are much larger than their
assets. The firms in this stage end up in bankruptcy.
After having described the current accounting system in the first
part, having analysed its problems in the second part and having
presented you a new dynamic accounting model in theory to
overcome these problems in the third part, we will describe the
implementation of the new model in a software solution and
analyse how it works out in the real world in the following
chapter.
4. Description of the LogiCase Model
4.1 Introduction and Tasks of the LogiCase Model
The LogiCase system is a software solution based on the new
dynamic accounting model and is produced by a small Danish firm
called SEFF Systems A/S. This company is located in Farum, north
of Copenhagen. The aim of the Logicase Model is to
· Create a basis for management decisions, which is always
updated with the latest information available in the entire
organisation.
· Create a reliable and trustworthy prognosis of future
liquidity.
· Create reports and charts for profitability surveillance on
all levels where it is demanded.
· Create an early warning system on the organisation's ability
to meet all financial obligations.
In practise, a tool like this must
· Be usable by users with no accounting skills - i.e. offer a
friendly and intuitive user interface
· Provide useful information to the users feeding information
into the system
· Be capable to produce the traditional financial statements
· Live up to existing accounting standards and integrity
· Flawlessly interface with existing financial systems
4.2 Implementation
4.2.1 Registering Data
All decisions having financial consequences now or in the future
are entered into the system whenever and wherever they are first
known and have an amount attached to them. The financial
transactions which occur in the organisation are entered in their
logical sequence e.g. the four points of measurement:
· Offers, expectations etc.
· Contracts, orders, agreements etc.
· Invoices received or issued
· Money received or paid
Basically, after entering the amount and the stage of the
transaction as mentioned above, the user finalises the set of
data by entering the date when the payment is expected to take
place. This data has to be entered only once - there is no need
to enter a "counterbooking" for each of the
transactions like in DEB. This "feature" of checking
transactions within DEB was very useful in the times where no
modern information technology was available to avoid human beings
to make errors in counting numbers - computers don't make errors
like these. Therefore, redundant information like double-entries
can be avoided.
4.2.2 Structuring Using Cases
For implementing this system the model divides all transactions
into six categories, which are called base-cases to build up the
framework. Each of these cases can have an unlimited number of
sub-cases, depending on the business of the company using the
model. The sub-cases are called case-types and allow to get more
into detail of the company. These case-types can be changed by an
authorised person if necessary e.g. something in the business
structure changes. This arrangement of accounts grants a
structured, modularised and organised branch-like structure. All
case-types are given new systematic numbers. If necessary, the
DEB account numbers are additionally assigned in order to be able
to let the system produce the traditional financial statements
required by law. See also chapter 4.3.2, generation of the
traditional financial statements.
The base-cases are:
1. Projects
2. Income/Earnings
3. Expenses
4. Investments
5. Financing
6. Taxes and duties
These base-cases are fixed and don't have to be changed, whereas
the case-types within the base-cases are dynamic and vary from
company to company depending on the structure of the firm and its
business.
Here is an example of how the first branch of the cases could be
structured for a company in the film-industry.
1. Projects
Projects are the core-business of the company.
1.1 Movies
1.2 TV-fiction
1.3 Documentary films
1.4 Commercials
2. Income/Earnings
All payments from other than core-activities received or
receivable belong into this category e.g.
2.1 Equipment renting
2.2 Consulting fees
2.3 Miscellaneous income
3. Expenses
All expenses from other than core-activities paid or payable
belong into this category e.g.
3.1 Rent
3.2 Salaries
3.3 Office expenses
3.4 Marketing
4. Investments
4.1 Buildings
4.2 Company cars
4.3 IT- systems
4.4 Investments in other companies
5. Financing
5.1 Share capital
5.2 Bank loans
5.3 Liabilities
6. Taxes and duties
6.1 Income tax
6.2 Value added tax
6.3 Import duties
4.3 Features of LogiCase and Use of the Data
4.3.1 Liquidity Prediction
After the financial consequences are registered into the system
with a payment date it is possible to generate real time pictures
of the company's liquidity. The company's liquidity can be viewed
separated by single projects, group of projects and it is also
possible to view the total liquidity with all projects included.
Additionally, it is also possible to distinguish between the
logical chain of events for every decision to see an overall
picture with all events included.
This liquidity prediction provides the company with an early
warning system capable of identifying financial situations of
being in danger of illiquidity. Because all information is
included - not only information concerning realisation and
payment like in DEB but also expectations and agreements -
unpleasant surprises in form of running out of funds can be
avoided and action can be taken in time to overcome this
temporary lack of money. Above mentioned actions could be e.g.
taking short-term loans, postponement of payments or investments
and receiving payments in advance. Obtaining such information and
being able to react in advance is vital and of greatest
importance for a company.
This system allows you to "simulate" best-case and
worst-case scenarios and all states in between not only for
projects but also for possible outcomes of different management
decisions. We assume all expected, agreed and realised projects
to be fully paid in the best-case scenario considering projects.
This means that there are no prediction errors between the
different points of measurement. Similarly the worst-case
scenario concerning projects analyses the situation where none of
the expected, agreed and realised projects will be paid - the
prediction error is highest. Even though those extremes are very
unlikely, they provide the user with a "corridor"
having all other states in between.
In addition, possible outcomes of different management decisions
to avoid liquidity problems can be analysed.
In general, you have the following outcomes:
· n expected projects; n will not be paid (worst case scenario)
· n expected projects; n-m will not be paid; m<n (scenario in
between)
· n expected projects; 0 will not be paid (best case scenario)
First, you analyse scenarios you are interested in. If there
occurs a lack of liquidity, you can analyse the different
possible opportunities to handle the situation.
Example of a company's liquidity profile. Note the horizontal
line in the graphs shows the present day.
Figure 1
Only realised and paid transactions are included in this profile
which means the information you gain from this liquidity profile
can also be obtained from the financial statements of the DEB.
Note that there is also a possible error in prediction because
realised transactions are not certain. No problem in the
company's liquidity is visible.
Figure 2
Now all the agreed transactions are included as well which makes
the picture of the company's financial situation more complete
but still, there is no problem visible.
Note that the prediction error is slightly higher.
Figure 3
Now all the available information about present and future
transactions is included. Obviously, the possible error in
prediction might be at its highest but now a possible lack of
liquidity (in this example in the period 14 to 17) can be
detected and action can be taken in time.
4.3.2 Generation of Traditional Financial Statements
The LogiCase system produces a dynamic balance sheet including
expected, agreed, realised and paid projects. This balance sheet
is more or less a balance of payments, like a trade balance
showing the net result of the positive or negative cash flows in
a company at a certain moment. Despite of this it is not only a
tool for internal management decisions but also enables the user
to extract the data needed for producing the traditional
financial statements like the traditional balance sheet and the
tax calculations. That is why each of the transactions are given
two separate account numbers - just as described earlier in this
chapter - one for the internal system and one for the financial
accounting (traditional reporting) purposes if necessary. Every
time a transaction moves from the stage agreed to realised it
will automatically get an account number belonging to the
traditional bookkeeping system and is thereby recorded in the
official financial accounts.
4.3.3 Tool for Financing and Investing
The LogiCase systems provides a future liquidity profile of the
company which means that if we have extra liquidity at a certain
time in the future, this liquidity can be used for investment
purposes giving you opportunity benefits because the extra
liquidity can be invested whenever possible. The liquidity
profile can also tell you the time-period that the money can be
held in those investments. When considering how to finance
investments the liquidity profile shows you whether it is
possible to finance the investment with the extra liquidity or if
external capital is needed.
4.3.4 Dynamic Control of Payments
An additional feature of the LogiCase model is the ability to
overview your payments when they fall due but have not been paid
yet. An authorised person receives a signal that a payment has
not been paid or received yet and certain action can be taken to
tackle this. We consider this to be a very smart feature to
attain permanent control of current payments.
4.4 Requirements, Environment and Comments
4.4.1 Interpretation of Data
Interpretation of prediction data can be possible source of
errors => time-lag. Human can make errors in interpreting the
data. Interpretation of data is something, which you learn by
time and experience. More experienced people can make better
predictions.
4.4.2 Inclusion of All Data
All information in all four stages of expected, agreed, realised
and paid relating to financial consequences should be entered in
order to get a complete and reliable picture of the company's
liquidity.
4.4.3 Accounting Department
A well functioning accounting department is required which means
that people in the accounting department are well prepared and
well educated. They are well informed with latest information
technology, since IT is a prerequisite of this system. It is also
important that communication inside the department is well
functioning. While we talk about the well functioning, that every
one who is using this system is well aware of the system and
knows how to enter the data and how to retrieve the data as well.
4.4.4 Entering Wrong Data
Control needed hardly to prevent misuse of the system, which is
open-structured where, wrong information entries possible.
Different people can update or acquire data differently. It is
always possible to manipulate with any system or it may also be a
wrong doing. If some wrong information is entered it will give
the wrong liquidity profile. In order to get a up to date
liquidity it is necessary data entered is correct.
4.4.5 Training
Since the system is dependent on new information technology and
new as well, it is necessary that people are trained before they
start using this system.
A very small error in data entry can create a huge chaos e.g. if
a payment is delayed and it is not corrected in the system.
Companies using the system should establish rules about how and
when to enter data. Support and education within company very
time-intensive and costly. New "philosophy" has to be
adopted to make the system work in practise
4.4.6 Is Dynamic Accounting the Perfect Solution?
Dynamic accounting system can never be a "perfect"
system and is always an attempt to gain a useful tool for
management decisions in practise!
There is no method, which can help us to predict future exactly
but the dynamic accounting model helps us to predict the firms
future liquidity more precisely than the traditional accounting
method does.
It is usual that there are more possibilities for prediction
errors to occur when we try to predict for longer periods than
for shorter periods.
4.4.7 Size of the Company
One of the drawbacks of the system could be since it is costly to
implement and it requires training programs, the benefits
compared to costs are not big enough for smaller companies. There
could be another argument that smaller companies just don't need
this system because they have an overall control over the company
´s liquidity matters. While it is good for larger companies
because their operation are more complex.
4.4.8 Valuing Fixed Assets
The way you value fixed assets in the current accounting system
is to use certain book values and use historical cost price as
described earlier in our project. According to Mr. Henning
Kirkegaard, information like this should not be included in a
dynamic accounting system because "this type of information
is not the same as a prediction of payments".
Mr. John Eskebaek includes this information in the LogiCase
system by arguing that the uncertainty of future cash flows can
be reduced because fixed assets (for example: machinery) is
valued in terms of expectations. For example, if you buy a new
machine, it will increase your production capacity and can
therefore reduce the uncertainty about the possibility that a
certain project can be realised. This reduction of uncertainty
can lead to a possible gain because the budgeting will be
therefore more exact and the production capacity can be almost
fully used. Certainly, a situation (an asset) like this can have
an effect on future cash flows of the company and has to be
included.
4.4.9 Discounting of Cash Flows?
Obviously, no discounting of cash flows is needed because present
values are unnecessary in this model - only cash flows in future
points of time are relevant. You don't have to calculate the cost
of capital to determine the present values, which can be a hard
task and a source for errors.
4.4.10 Possible Danger
A last thing to mention about the dynamic accounting system is a
very general one. Let's imagine, someone decides to take an
action with financial consequences because he analysed a possible
liquidity problem. Unfortunately, this action can result in a
relatively small loss - compared to a state resulting of not
doing anything. For example, let's imagine a credit was taken to
overcome a temporary illiquidity. It can possibly turn out that
this credit will not have to be used which will result in a net
loss
still better that having to face the full consequences of a
sudden illiquidity => "hedging" within company ->
short-term prediction (3-4 months) reliable
5. Conclusion and Future Perspective
In order to give a solution to the problems of current accounting
practices we have tried to give a tentative solution which is the
dynamic accounting model, a tool that describes the payments made
and received in an organisation using four points of measurement:
expected, agreed, realised and paid. New dynamic accounting
theory presented by Mr. Henning Kirkegaard does not discard the
double entry bookkeeping system, instead the new model is based
on Double Entry Bookkeeping that is why Kirkegaard calls this an
evolution into accounting instead of revolution. Thereby every
transaction of an organisation is classified into a certain state
in a logical chain of events from expected to paid according to
it's "maturity". The expectations and agreements about
future payments are included in the information system. This is a
major difference from the traditional accounting registration
that is limited to only registering historical transactions.
All transactions with financial consequences - even uncertain
transactions like agreed or expected - are included already at a
stage when they are first known. Combined with the information
technology and data processing techniques possibilities of today
it is possible to generate an up-to-date picture of a company's
financial position.
Even though we have to accept a situation where prediction errors
will occur between the different measurement points it is still
better to have information available that a manager can act upon
than facing unpleasant surprises in form of liquidity problems,
or even an unexpected bankruptcy because of not having the
information needed to do something about the situation.
Before ending our discussion we would like to conclude that there
is a difference of approach concerning assets and liabilities
between the traditional accounting model and the dynamic one. In
the traditional model the assets and liabilities are used to
determine profits while the assets and liabilities defined in the
dynamic system are used for liquidity purposes at least for now.
The other difference we could see is that traditional definitions
are past oriented while in the dynamic model the focus is on
future perspectives. Tangible assets e.g. property, plant and
equipment are not recognised as assets in the dynamic model
because once these assets are purchased they are treated as an
expense and afterwards there is no depreciation allowed on
tangible assets in dynamic accounting. Depreciating the value of
an asset does not increase the liquidity but of course it can
decrease the profitable income of a company. But in the dynamic
accounting the focus is not decreasing the taxable income instead
giving a true and fair picture of the company's the accounts and
of course the liquidity. . While in the equity part there are not
much differences between two models.
We will end up our discussion with the following points which are
still need to be answered and future research is needed to
explain the future more precisely and decreasing the prediction
errors.
· There is no method, which can help us to predict future
exactly but the dynamic accounting model helps us to predict the
firms future liquidity more precisely than the traditional
accounting method does.
· It is usual that there are more possibilities for prediction
errors to occur when we try to predict for longer periods than
for shorter periods.
We would like to repeat the example of Rubin's Vase, where it was
argued that only one part of the picture can be seen at one time,
we would say that it is a matter of choice now which part of the
picture we want to focus on.
List of References
1. Henning Kirkegaard: Improving Accounting Reliablility, Quorom
Books, London1997.
2. FASB: Statement of Finacial Accounting Concepts,John Wiley
& Sons Inc
1998/99.
3. Robert N. Anthony: Accounting Text and Cases, McGraw Hill,
1999.
4. Peter Walton: International Accounting, International Thomson
Business Press, 1998.
5. Material from the interview with John Eskebaek and Søren Ølund,
SEFF Systems A/S, Farum