Accounting for Innovation

Publikuar më: 30/03/2014
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Since Luca Paciolo wrote his 27 page treatise, or even earlier during ancient times, not much has changed from bookkeeping fundaments. Change in accounting is like change in religion or religious institutions, it comes the hard way, takes time, and even when it happens doesn’t change much, because usually it is an arbitrary rule that comes as a response to an industry issue.

During the late subprime crisis, or banking crisis, or financial crisis, or public debt crisis accounting rules took a substantial part of the blame.  To a certain extent it is true that the morphing crisis since 2007 cut angels in every step thanks to accounting rules. Starting with the subprime crisis; securities that ambiguously were registered as safe and liquid. Then when the crisis hit and the stock market went down, the rapid fire declining   prices of bank assets could not be valued, hence nobody knew what was hidden in banks’ balance sheets. And lately, the public debt crisis, accounting rules gave ways to ambiguous debt declaring policies. Some countries even cooked their public books and thanks to derivatives they lowered their public debt account.

During the last 6 or 7 years the debate on accounting rules has been extensive. Book keeping is still in action, heavy and important institutions such as ECB, Fed, IMF, BIS etc. and field experts are still debating how to cope with the issues that came into light during the crisis.

Nevertheless, the interest of this writing is not e mere history of recent facts and accounting issues per se, but the connection of a notion such as accounting with another notion of personal interest of mine: Innovation.

Before going straight to a definition of accounting or innovation let’s make it clear where the two different processes should converge with each other in order to improve at least  one of them, Innovation.

For a long time, innovation has been thought as a linear process (Godin, 2006), however the modern concept in the knowledge economy has changed, not that the knowledge economy affects the new point of view on innovation.

The liner model has three steps: Invention, Innovation and Diffusion. This view emphasizes the early stages of the process, pressing on systematic technological research, and understating the later phases. Based on the new paradigm of innovation it understates diffusion, or implementation and market components of innovation and new product development.

The linearity does not usually account for relations among different elements of innovation and treats them separately as they were operational processes. Since from the early stages of the theory there were two different aspects of seeing innovation: the market pull and technology push. Both concepts together cover the two sided sources of innovation, however what happens next is the question.

Seeing innovation not any more as a linear process but more as an iterative one (Eugene Fitzgerald, 2010)the nexus with accounting would be to turn the linear work flow into a an easy and useful recording of events alias accounting, which will help later analyze and verify the chaotic iteration. The iteration includes balancing innovation elements and factors against each other while a synthesis of the process toward a goal is being reached.

Nevertheless, the idea is not to throw away the linearity and dive into chaos in order to wait for the innovative sparkle. On the contrary, taking the linear process and make it auxiliary to the new concept of innovation. And one way to do this is to account for innovation.

First let’s treat accounting as a mere "recording and summarizing of business transactions", if going further we could say analyzing, verifying and reporting results also would be its functions. These functions according to the definition of accounting that Merriam-Webster dictionary gives, and pretty much the same definition appears widely in literature. So, the accounting function would be limited to simply writing a historical line of many events in order to be analyzed and probably verified later on.

Another important aspect of accounting is measurement. (Harry I. Wolk, 2004) It includes direct and indirect measuring. Direct measurement which would be assigning a number to a process or an object, and indirect measurement that has to be made by roundabout means. (Harry I. Wolk, 2004)

Keeping in consideration the up stated aspects of accounting, let’s put some perspective from the innovation side. As previously noted innovation was seen as a linear process that can be described as follows: Discovery -> Invention -> Development -> Product -> Market -> Profit. (Eugene Fitzgerald, 2010)

In reality, what happens during an innovation process is more chaotic than just a specific set of steps that seems more like a good willed plan or a simple historical writing of events than the real collision of different elements stimulated toward a final objective.

The whole idea is that innovation is not a straight line. Not every discovery or invention gets to be developed into a marketable product. Many researchers know that there are plenty of inventions that never saw sun light. (Eugene Fitzgerald, 2010) Even if the invention makes it through the market it is not a guarantee for profit and sustained growth.

The innovator bounces back and forth during this process, and its elements dynamically change simultaneously. Hence, the iteration of the process becomes more difficult and risk increases if not observed carefully.

If we assume that innovation has three main components such as: market, technology, and implementation, then the innovator has to consider the elements of market, technology and implementation simultaneously. During the iterative process these elements change as their variables do too. The innovator tries to reach a cohesive environment toward a previously specified objective, which is the innovative idea.

As any other process, innovation has a learning curve until we reach a saturation point. However it does not mean that the learning process ends. With innovation it gets transformed into abstraction. Iterating through innovation means continuously learning and abstracting, even if we get the final product we don’t stop, but continue to improve in order to meet market expectations or create new ones.

There is no need to put some perspective on accounting theory. However, A.I.C.P.A. (America Institute of Certified Public Accountants) defies accounting as: “The art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events, which are in part, at least of financial character, and interpreting the results thereof”

For the purpose of this topic let’s take from the definition the first part, which is: the recording, classifying and summarizing in a significant manner. In classic accounting the system would simply report a moment of the process, or a picture of company situation. In our case, accounting would be a chronology of events, transactions, decisions and effects, which in other words would be a chronology of iteration.

First, accounting for the innovation process would help the innovator to better manage the cycle. Accounting the learning curve would be a good documentation for decision making purposes. Iteration includes repeating a process in order to make it better, and documenting it would help to bring down the chaotic beginning of the innovation process. We document learning through innovation accounting and go further. This then would be a good basis for abstraction.

For example, if the innovator has done some iteration related with market elements of the product, documenting the process would be good source of decision-making and analysis for further changes of market variables. It will also be helpful for the innovator when market elements will be considered in comparison with implementation and technology elements of innovation. In other words, documenting 999 ways of a failed innovation means crossing out 999 ways of not doing it and still looking for the right way. The record keeping function of accounting in innovation becomes more than that.

Second, documenting an innovative process means also protecting an innovation. The term protecting here takes a double meaning. On one hand it protects the whole process from defunct analysis and worthless repetition, and on the other hand it helps with the intellectual property, or the IP strategy. For example, SpaceX Company trying to build a specific product such as reusable space shuttles, did not file for patents due to the specificity of the product. Since the only competitor for that product is a government agency, revealing its secret innovation to a government agency would put the product in jeopardy. The company decided not to file for patents because the risk of disclosure was high. Therefore, the whole product innovation process has to be documented in another way.

The product of accounting is information. (Scott, 2011). Taking this in consideration, makes accounting, as a principle, strategic for every application. However, in innovation management it is crucial, because information is not only a highly priced commodity but also a fundamental part of the process. When the model is linear, a past piece of information is considered past, and not necessarily relevant for further development phases. On the other hand, in the iterative model every piece of information is critical to dynamic decision-making and changing market realia. This because invention, innovation, and diffusion are carried out simultaneously at the same time, adding also technology implementation and market information to the cocktail.

In conclusion, accounting for innovation would mean transforming the linearity of the process into a useful tool helping the complexity of the new paradigm of innovation, therefore better managing continuously changing innovation variables. The difference between invention and innovation is the whole context that the second has, but going safely and with less risk from the first to the second one needs to record, summarize, analyze and measure.

Lastly, the arguments made here are in their early stages. Further development needs to be considered for the notion, also evidence and data to give shape to a more debatable idea.

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