Small is Beautiful – an accounting take

I recently got round to reading E. F. Schumacher’s 1973 book Small is Beautiful: a Study of Economics as if People Mattered, inspired by a post on Maria Popova’s Brain Pickings blog.

Popova says: “Sharing an ideological kinship with such influential minds as Tolstoy and Gandhi, Schumacher’s is a masterwork of intelligent counterculture, applying history’s deepest, most timeless wisdom to the most pressing issues of modern life in an effort to educate, elevate and enlighten.” The general thrust can be guessed from the title – that economics emphasizes the wrong things, to counterproductive and probably even catastrophic ends. Much of the interest now, inevitably, comes from charting the extent to which Schumacher’s opinions and observations do or don’t seem dated, but overall it scores well on that front; if anything, even more so when trying to anticipate the post-pandemic landscape. He approvingly cites a then-recent commentary on “the fundamental questioning of conventional values by young people (as a) symptom of the widespread unease with which our industrial civilization is increasingly regarded.” At a time when large chunks of that industrial civilization (airlines would be a prominent example) seem likely to be a shadow of their former selves for the foreseeable future, and when unease of various kinds is at the highest levels in living memory, any informed input into constructive questioning certainly remains relevant.

For an accountant, the book has a couple of quirky points. Schumacher acknowledges that large-scale organizations are here to stay, while emphasizing the “dangers to the integrity of the individual when he feels as nothing more than a small cog in a vast machine” – he posits that the “fundamental task is to achieve smallness within large organizations” and sets out five principles to this end. One of these, labeled “the principle of identification” states:

  • Each subsidiary unit or quasi-firm must have both a profit and loss account and a balance sheet. From the point of view of orderliness a profit and loss statement is quite sufficient, since from this one can know whether or not the unit is contributing financially to the organization. But for the entrepreneur, a balance sheet is essential, even if it is used only for internal purposes…
  • A unit’s success should lead to greater freedom and financial scope for the unit, while failure – in the form of losses – should lead to restriction and disability…The balance sheet describes the economic substance as augmented or diminished by current results. This enables all concerned to follow the effect of operations on substance. Profits and losses are carried forward and not wiped out. Therefore, every quasi-firm should have its separate balance sheet, in which profits can appear as loans to the centre and losses as loans from the centre. This is a matter of great psychological importance.

Of course, this doesn’t really work from an accountant’s perspective – there’s no reliable way of generating a reliable profit and loss statement which doesn’t involve constructing a balance sheet at the start and end of the period (maybe Schumacher was thinking of financial reporting largely as something to be conducted on a cash basis, but of course this could rapidly lead users astray). But the emphasis on the balance sheet as a mechanism of accountability is exactly right, and the interest in how financial reporting works as a psychological matter still seems far rarer than it should. I’ve sometimes cited here (for example in the context of non-GAAP measures) how commentators concoct an entirely implausible notion of investor behaviour for purposes of pointing out the supposed harm of some practice or another. Now more than ever, if financial reporting isn’t telling real and comprehensible stories about capacities and weaknesses, then it’s inherently crippled.

At the very end of the book, Schumacher emphasizes the virtue of prudence. Of course, this concept is regularly evoked in discussions about accounting – often for the purpose of beating the current standards over the head. There are many who believe the conceptual framework should place greater emphasis on prudence or conservatism, even if this might constitute a form of bias. But Schumacher uses the word in a very different way, quoting from another source that: “the pre-eminence of prudence means that realization of the good presupposes knowledge of reality. He alone can do good who knows what things are like and what their situation is.” He adds in his own words that “prudence cannot be perfected except by an attitude of ‘silent contemplation’ of reality, during which the egocentric interests of man are at least temporarily silenced.” It’s hardly practical, no doubt, to think that debates about accounting might be conducted with such a mindset (and for sure, Schumacher is drawing on explicitly Christian concepts here – elsewhere in the book he draws heavily on Buddhism). No doubt, the best of us might differ on whether (say) a preference for fair value over historical cost reflects a triumph over or rather a submission to the egocentric interests of man. Hopefully though we can at least strive to consider – yes, even when practising accountancy! – how our actions and positions conform to a considered, informed notion of “doing good.”

The opinions expressed are solely those of the author.

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