University at Buffalo - The State University of New York

Published: April 17, 2008

By KEVIN FRYLING
Reporter Staff Writer

In the grand scheme of things, William Kross says injuring his back right out of college might have been the best thing to ever happen to his career.

William Kross says the Enron scandal is an instance where a corporation used accounting accruals to "cook the books" and inflate stock prices by making it appear significant cash flow existed when, in fact, there was only an expectation of future wealth.
PHOTO: NANCY J. PARISI

An enthusiastic intramural baseball player, Kross, who joined the UB faculty last fall as a professor in the Department of Accounting and Law, School of Management, says it was not long after his graduation in the late 1960s that he was sidelined from his first job by the flare-up of a serious sports injury.

“While I was in the hospital, I decided I really wanted to go to graduate school,” says Kross, who took a month off from his job as an accountant at AT&T to undergo back surgery. “I don’t know that I would have left that quickly had I not had that time to reflect. Maybe I would still be working at AT&T if I hadn’t had that problem with my back.”

The ensuing 30 years in academia have provided him the freedom to take a long, hard look into some of the tough questions facing the field of accountancy, he says, including trying to figure out the reason accounting numbers are no longer as strong an indicator of corporate stock prices as they were 20 or 30 years ago. He says that for him, this has meant turning a critical eye toward accruals accounting, in which the calculation of a corporation’s annual cash flow includes funds from earnings on credit—in which cash doesn’t arrive until years in the future—or cash advances—in which earnings are contingent upon living up to financial obligations that come due at a later date.

Is it appropriate to consider cash that’s not yet in hand when summing up a business’ financial situation for that particular year? Or, essentially, should corporations count their chickens before they’re hatched?

“The cash might occur beforehand or the cash might occur afterward, but the year in which the service is provided is the year in which the profession decides how much better off you are,” he explains. “Even though for 400 years the accounting profession has assumed that earnings, including accruals, are the best indicator of future cash flow, there’s still some conjecture about whether it would be easier to strip away the accruals and just look at the cash flows themselves.”

One of the most troublesome facets of the current system is the fact that corporations can use accruals accounting to “cook the books” and inflate stock prices by making it appear significant cash flow exists when there is actually only an expectation of future wealth, he says, adding that the most infamous example of this probably is the Enron scandal.

“Their cash flows were really quite low but their accruals were really quite high,” Kross explains. “Enron was a situation in which accountants—or at least some of their accountants—obfuscated, rather than facilitated, an understanding of what was really going on.”

He also notes that even honest attempts to calculate earnings using information from accruals, especially concerning future cash flows, are inherently tricky and risky. “Just because someone owes you money doesn’t mean they’ll pay it,” he says.

Speculation about the growing gap in the statistical relationship between earnings numbers and stock prices often settles on an assumption that accountants are simply not as skillful at calculating future earnings as they were in the past, he says. But Kross points out that his own research, including a paper published in the Journal of Accounting Research in 2005, fails to confirm this conclusion. In fact, based on a comprehensive examination of economic data from numerous companies between 1973 and 2002, he says evidence exists that modern accounting techniques are growing stronger, rather than weaker, at predicting future cash flows based on earnings.

“We’re really not yet sure why it is that accounting earnings don’t map into stock prices as well as they did 30 years ago,” says Kross, noting the importance of further research on the subject. “Maybe the market is looking more to other things, not accounting earnings, to map stock prices.”

The recipient of a doctorate in accounting from the University of Iowa and bachelor’s and master’s degrees in accounting from Western Illinois University, Kross was a faculty member at Purdue University for 29 years before joining the UB faculty. The prospect of joining a department with a rich accounting-research tradition was a powerful magnet in terms of bringing him to the university, he says.

“There were some retirements of established people and they wanted to get an established researcher here,” he says. “It’s certainly later in my career, but trying to help the faculty here rebuild a strong research group—given the tradition of excellence that they’ve had historically—was very attractive.”

Director of UB’s doctoral program in accounting—a position he also held at his former institution—Kross says graduate students with whom he worked at Purdue have gone on to faculty positions at such institutions as the University of Wisconsin and Hong Kong University of Science and Technology. He frequently works with many of his former students on research collaborations, he adds, including a current project with Myung-Sun Kim, who is not only a former student, but also an assistant professor of accounting and law at UB.

The father of four adult children, Kross says he also felt the time was right for a move to Buffalo from Lafayette, Indiana, because his youngest son, Nathan, recently had left home to study music and mathematics at DePaul University.

A native of Chicago, Kross resides in Williamsville with his wife, Therese, a preschool and kindergarten teacher who’s completing a doctorate in education from Purdue via long-distance independent study. The couple’s three other children—Darcy, Douglas and Matthew—live in Chicago or Lafayette.