- Greg Trompeter – Director, Kenneth G. Dixon School of Accounting
- Melanie Fernandez – Partner, BDO
- Paul Gregg – Assistant Chair, Finance Executive in Residence, Dept. of Finance; CFO, Rini Technologies, Inc.
- Jim Adamczyk – Senior Executive VP / CLO, FAIRWINDS Credit Union
- Mike Johnson – Dean, UCF College of Sciences
Paul Jarley: This is a story of a man who was ahead of his time. Some say that he had the most important idea of the last 500 years. He may very well have helped to invent the future. He most certainly understood the role trust plays in our modern economy. And he was of all things, a mild mannered accounting professor.
Paul Jarley: This show is all about separating hype from fundamental change. I’m Paul Jarley, Dean of the College of Business here at UCF. I’ve got lots of questions. To get answers, I’m talking to people with interesting insights into the future of business. Have you ever wondered, “Is this really a thing?”. On to our show. [music]`
Paul Jarley: A few months ago, I received an email from Mike Johnson. Mike is Dean of the College of Sciences and more importantly, my drinking buddy. The subject line read, Innovations in Accounting. Who knew? I opened the email and clicked on the link to an article entitled, “Why Everyone Missed the Most Important Invention of the Last 500 Years”. I was skimming the article when Greg Trompeter walked into my office. Greg is the director of the Dixon School of Accounting, and so I turned to him and said, “Hey Greg, have you ever heard of triple entry bookkeeping?”
Greg Trompeter: (laughs). Triple entry bookkeeping.
Paul Jarley: Indeed he had.
Greg Trompeter: It’s an idea that came up, maybe in the mid to late 1970s. There was a professor at Carnegie Mellon. His name is Yuji Ijiri and he came up with a notion that for four or five hundred years people had been using double entry bookkeeping as if it were perfection itself. He said, “Well, maybe you could make it better”.
Paul Jarley: Okay, let’s stop right there. I realize a podcast in accounting theory is a bold move. But Dr. Ijiri was quite the dude. His obituary notes he was interested in things like the relationship between accounting, quantum physics, and quantum computing. How many people do you think are trying to connect those dots? He didn’t strike me as the kind of guy who would waste his time on frivolous pursuits.
Yuji Ijiri: Bookkeeping evolved from single entry, which just recorded what happened, to a double entry, where what happened has to be explained by reasoning.
Paul Jarley: Dr. Ijiri might be dead, but in the miracle of today’s modern technology, he left behind a YouTube video explaining his ideas around triple entry bookkeeping.
Yuji Ijiri: I get attracted by three. Everything three is very interesting and much more complex than two. And what the triple entry might look like.
Paul Jarley: He challenged a group of Ph.D. students to figure this out. 10 years lapsed, when he realized…
Yuji Ijiri: Nobody is doing anything about it. (laughs).
Paul Jarley: So he decided to take matters into his own hands. Yuji wrote two books on the subject. The second of which…
Yuji Ijiri: bases on the calculus of taking a type of derivative of existing accounting and come up with a new dimension and then create the double entry at that level. I think it has a lot of applications…
Paul Jarley: I know that seems esoteric, but Dr. Ijiri’s ideas might just rock your world. As Greg explains, changes in accounting facilitated changes in markets and significantly impacted the geographic scope of trade.
Paul Jarley: A brief history lesson…
Greg Trompeter: The Sumerians, I believe, invented single entry bookkeeping. So describe single entry bookkeeping for me.
Paul Jarley: Basically keeping track of my cash. It was really simple. At the end of the day, you sort of balanced out your cash.
Greg Trompeter: That would have been single entry bookkeeping. And it had a problem with…there could be errors that wouldn’t be caught. And there was less accountability. It was really difficult to check on any assets or any liabilities you have other than cash.
Paul Jarley: So your single entry accountant, was probably a relative.
Greg Trompeter: Yeah. And the ventures you were involved in were probably very local.
Paul Jarley: It wasn’t just the that boundaries of trade were expanding. Owners started hiring managers to run the business on their behalf.
Greg Trompeter: Somebody other than the manager is the owner. So you had this agency problem where the owners have to have the ability to trust the managers and so trust becomes a bigger issue, enterprises get larger, it’s easier to screw up the books. So double entry bookkeeping did a couple of things. At the simplest level, double entry bookkeeping made it so that debits had to equal credits, assets had to equal liabilities plus owners’ equity. So at the end of the day, there was an internal check on the accuracy of the records.
Greg Trompeter: But perhaps more importantly, it gave you better controls.
Paul Jarley: [music] The first book on double entry bookkeeping was published in 1494. A lot has happened since then. Publicly held companies came along, auditors followed. Their job is to make sure what is being reported actually happened. And that investors aren’t being duped. Government regulations followed, lots of them. 500 years later, double entry bookkeeping still rules. It’s been a remarkable run that’s facilitated trust in our financial network. But it’s an inherently backwards system.
M. Fernandez: Everything is looked at historically.
Paul Jarley: Listen to Melanie Fernandez, a partner at BDO and a College of Business Hall of Fame member.
M. Fernandez: That’s probably the biggest complaint that I get as an auditor, is, can’t you have more real time information that is reliable and has been certified.
Paul Jarley: Dr. Ijiri thought he could help by introducing calculus notions into accounting, what he calls, momentum accounting.
Greg Trompeter: He argued that assets and liabilities is where we are today, owners’ equity is the accumulation of where the company has come from in the past. And the third entry force, he called it, would be tied to how we were doing in the future. So if you think about his financial statements that would come out from the triple entry, you would have a balance sheet, which is at a point in time: this is assets, liabilities and owners’ equity. Then you have the income statement, which sort of explains using cool accounting, how we get from one balance sheet to the next balance sheet. So the income statement is sort of like the first difference.
Paul Jarley: Right.
Greg Trompeter: Then his notion of momentum, forced acceleration, taking us more into the world of calculus and physics, was sort of why last year’s income was different from this year’s income. Much the same way the income statement explains why last year’s balance sheet was different from this year’s balance sheet.
Paul Jarley: Which might be of more interest to a financial investor.
Greg Trompeter: Absolutely. One of Ijiri’s points was that investors … if in fact the statement just showed that the momentum was this year’s income is $30 bigger than last year’s income, you can do that easily enough. But if the bookkeeping system actually tracked why it was different, and we could see sales were up in part because it was an increase in prices, partly because it was an increase in volume. That would actually be useful information to an investor, to see why are profits up? And to highlight that on the face of the financial statement.
Paul Jarley: Sorry for the accounting lesson. It will pay off later when our story takes a sharp turn. Stay with me people. My next stop is Paul Gregg.
Paul Jarley: So Paul, would momentum accounting help investors, or can they get that information by other means.
Paul Gregg: They know some of it.
Paul Jarley: Paul is an executive in residence in our finance department. He has a wealth of experience and currently serves as CFO of Rini Technologies.
Paul Gregg: So let’s take Apple. Apple discloses in their 10K the unit sales of things like iPhones and iPods. And so one could track those, but the question is, what are they going to be in the future? And then one could say, well let’s take Microsoft as an example of where we were all buying our first pc and they had an extremely high growth rate. That ultimately leveled off. That’s typically what happens to big corporations that they may go through periods of extreme growth, and then they level off. And when you’re trying to figure out what those future sales and earnings and cash flows will be, the question is how long will they grow at hyper growth and at what point will they level off. That’s where, using calculus and other regression tools could help one in saying, well what would be the case for the iPhone compared to the case for Microsoft and what would that predict by way of when Apple’s growth will start leveling off because we had a similar anomaly when Microsoft was starting off.
Paul Jarley: When I was listening to Gregg, I couldn’t help but think about our Bloomberg terminals. Would you be able to do those kinds of analyses using the data that Bloomberg provides today?
Paul Gregg: Absolutely.
Paul Jarley: I can’t help but think that Dr. Ijiri might have invented economy information systems. If computers had been just a little more advanced when he started his work. The timeline is important. Yuji’s second book on triple entry accounting came out just two years after the first version of Microsoft Excel for Windows. We’ve come a long way since then. Back to Paul.
Paul Gregg: Systems that we use from Oracle to PeopleSoft
Paul Jarley: Yeah, yeah.
Paul Gregg: [inaudible 00:09:28] They’re all providing the type of management information systems. But corporations that spend millions of dollars for these systems are integrating the fine-tuned reporting data that they need.
Paul Jarley: That Dr Ijiri would’ve asked for.
Paul Gregg: It’s not just debits and credits.
Paul Jarley: That’s not to say there aren’t weaknesses in today’s financial reporting system. Judgment still plays a large role. Managers sometimes manipulate earnings. And people lie for personal gain.
Paul Gregg: But many of my clients push the edge, and frankly I think it’s a problem where the auditors either didn’t do enough work or turned the other way in order to keep the client. From management standpoint, the pressure to hit earnings is immense, from a performance goals and compensation, and maintaining the stock price. The pressure is there. A lot of it is in the revenue recognition area where companies have some ability to manipulate revenues, and recognizing revenues. A very complex area of accounting. Some of it’s just outright fraud, like Worldcom where they were basically capitalizing expenses and calling it a capital budget item instead of a pure expense which is what it was. And it materially distorted the cash flow statement and income statement.
Paul Jarley: Ah, now this is where our story takes a sharp turn. I’m sure trust was on Dr. Ijiri’s mind when he was developing his triple entry system, but hardly anybody was listening. 16 years after Yuji’s second book, a financial cryptographer named Ian Grigg, published a working paper entitled, “Triple entry accounting.”
Ian Grigg: [Music] Triple entry takes us from this inside the corporate trusted scenario and extends it to other customers, to outside the company border into other companies.
Paul Jarley: Listen to Ian explain his key ideas.
Ian Grigg: What we can now do is cryptographically sign an entry, Alice assigns her payment to Bob. It goes out to some intermediary, which could be the blockchain, it could be a server, …
Paul Jarley: No, did you just hear that?
Ian Grigg: Which gets signed again and then goes across to Bob. And now we’ve got three entries which are sitting there. We’ve got Alice and Bob sitting with their primary copies and if they have any dispute, Ivan or the blockchain is sitting in the middle, which guarantees that we’ve all got the same thing.
Paul Jarley: Welcome to blockchain. Bitcoin is released less than four years after Ian’s paper. Now, the article Dr. Johnson sent me speculated that someone read Professor Ijiri’s work as well as Ian’s paper, and produced Bitcoin. Ah, maybe. But I can tell you that Grigg’s paper doesn’t even reference Ijiri, and as Gregg and I discussed…
Ian Grigg: It happens all the time in our world, where people from very different fields are working on very similar ideas and don’t even know it.[crosstalk 00:12:25]
Paul Jarley: And don’t even know it.[crosstalk 00:12:25] Sorry Yuji. Ian seems to have come up with his ideas independently, and I can’t sew where understanding your triple entry accounting system was necessary to create Bitcoin. If you’re an academic like me, you can’t help but feel sorry for Dr. Ijiri. What happened to him seriously sucked. But none of this means that blockchain won’t have a major impact on the accounting profession and the future of trade. In some ways, you could think of today’s podcast as the second part of our podcast on bitcoin. In that podcast, we mentioned that blockchain had the potential to severely limit the company’s ability to cook the books. Paul Gregg agrees.
Paul Gregg: It will make verification easier.
Paul Jarley: Much easier.
Paul Gregg: Because today.. before we had blockchain the transactions are documented except that I had my bank and my bank records and you have –
Paul Jarley: Exactly.
Paul Gregg: Your bank and your bank records.
Paul Jarley: I’ll put mine as my business.
Paul Gregg: So we know from each other’s side. But there are plenty of instances – AIG comes to mind – where there was a transaction that Warren Buffet’s insurance companies booked conservatively, and AIG took an aggressive stance which was not in accordance with GAAP in order to book the earnings immediately.
Paul Jarley: Okay. If two companies entries on a transaction are simultaneously verified in real time, what is there left for auditors to do. Trust seems to be built right into the blockchain. When I asked Jim Adamczyk, vice president of Fairwinds Credit Union this question, as part of my interviews on bitcoin, he took the fifth.
Jim Adamczyk: I’m not answering that question [laughter] – no. It could make their job more efficient and more transparent.
Paul Jarley: Greg is a bit more forthcoming,
Greg Trompeter: If in fact blockchain takes off as some people say it will. You’ll need auditors to redouble their efforts on control testing. If once something goes into the system it can’t be changed, you want to make sure that what goes into the system is right, so internal controls are going to become even more important than they have been in this post Sarbanes Oxley era.
Paul Jarley: It’s also worth noting that blockchain isn’t the only high tech way to reduce fraud. Accounting firms are also investing in big data. Back to Melanie.
M. Fernandez: Initially we’ll be using it to bring in the data and look at it in different ways that will highlight unusual trends, anomalies things that we might not have looked at just from a person trying to analyze data using the human mind to really uncover whether there’s fraud. I mean that’s really kind of the whole purpose of getting the money and all this training and everything is to really be able to make it easier to identify situations where there’s higher risk or just outright fraud that may have occurred. I think there’s some jobs for people out there that really enjoy that stuff and understand that stuff.
Paul Jarley: Greg agrees.
Greg Trompeter: I also think though you’re going to find accountants are going to be needing a lot more background in inferential statistics and analytical modeling. That’s going to become much more important for auditors.
Paul Jarley: Time to get to the bottom line. Is Yuji’s triple entry bookkeeping system a thing? From Greg Trumpeter.
Greg Trompeter: I’m guessing his thing is not a thing. But I also know it took over a hundred years before double entry bookkeeping caught on.
Paul Jarley: From Melanie Fernandez
M. Fernandez: I’ve never heard of it. I’ve never heard of triple entry bookkeeping.
Paul Jarley: From Paul Gregg.
Paul Gregg: No, I think what will happen is we’re continuing to have more sophisticated reporting and disclosures that allow analysts to better forecast the result to the company.
Paul Jarley: It’s my podcast so I get to go last. If only Ian had footnoted Yuji I would be singing his praises as the inspiration for blockchain. But he didn’t. And ERP systems ran past any notions of momentum accounting. There was only one thing left for me to do.
Paul Jarley: [background noise] Do you remember that email you sent me a while back about innovations in accounting?
Paul Jarley: When we completed this podcast, I went straight to the bar with Mike Johnson.
Mike Johnson: You’re talking about triple entry bookkeeping …
Paul Jarley: I am indeed.
Mike Johnson: The most important invention in human history.
Paul Jarley: You owe me a bourbon over sending me down a rabbit hole.
Mike Johnson: I’m happy to pay you the bourbon.
Paul Jarley: It’s Woodford Reserve by the way.
Paul Jarley: So what’s your take? Check us out online and share your thoughts at business.ucf.edu/podcast. You can also find extended interviews with our guests and notes from the show.
Paul Jarley: Special thanks to my producer, Josh Miranda, and the whole team at the office of outreach and engagement here at the UCF College of Business.
Paul Jarley: And thank you for listening. Until next time, charge on. [music]