Chapter 14, Problem 4TIF

The fundamental concept behind strategic performance measurement systems is that an organization’s strategy can be represented by a set of performance measures. This basic concept of representing a complex idea (like strategy) with something more tangible (like a measure) goes back hundreds, even thousands of years. Plato’s Allegory of the Cave provides perhaps the first evidence of this concept. In the allegory, Plato describes a hypothetical scenario in which a group of prisoners is chained to a wall inside a cave, locked in a position facing away from the cave opening. Plato explains that the prisoners have been in this condition their entire lives so their knowledge of the outside world is limited to what they are able to perceive in their current state staring only at the cave wall. Plato then describes how sunlight from the outside casts shadows of anything that passes by the cave opening into the cave. These shadows appear on the wall that the prisoners are facing, and sounds from the outside echo off the shadowed wall. Plato explains that, to the prisoners, reality is not outside the cave but the shadows are reality. To them, sounds don’t come from the outside but rather from the shadows on the wall before them. Plato then goes on to discuss the status of a prisoner freed from this bondage and his initial reaction to exposure to a different reality. Plato says, “Will he not fancy that the shadows which he formerly saw are truer than the objects which are now shown to him?”

This allegory illustrates that reality can really only be indirectly perceived via imperfect representations of reality. That is what accounting is all about. Accounting measures are imperfect representations of economic ideas that cannot be seen directly—just like Plato’s shadows in the cave. Accounting measures are merely reflections of more interesting and important concepts.

Consider financial statements and answer the following: Why do people care about what is on a firm’s balance sheet or income statement? Are they really interested in the financial statements in and of themselves, or do they use the financial statements to learn something about the issues they really care about? What are some of those issues?