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Accounting has historically not defined income as change in wealth, or change in net worth or value. It has defined it by thousands and thousands of conventions that measure allocations of historical costs.

Â…if accounting prompts strange behavior solely because of the accounting, that's not a good answer.

This is the crux of the fair-value debate: each side agrees both qualities are important, but fair-value advocates emphasize relevance, while historical-cost advocates place greater weight on reliability.

What amount of value creation can be assigned to the efforts of management for a particular time period? That is the essence of accounting. Otherwise, it's simply an appraisal process.

Eventually everything shows up in earnings and cash flow, but it shows up late.

Activities consume resources - people, materials and equipment - and this consumption can be measured. Activities are triggered by events, which can be counted, or decisions, which can be reviewed. Activities produce outputs - products and services, which can be counted and measured. Activities can be undertaken by different methods, which will vary the unit cost. Activities are linked together to form business processes. Understanding what activities are, what they cost, what drives them, what they produce, how they are done and how they are linked together is useful.

We have understood manufacturing activities in this way for years. We measure the consumption of direct labour and materials in making products. On average, however, direct labour, materials and components account for around two thirds of total costs in manufacturing businesses. The other, unmeasured, third is overhead activities and costs. In service industries, the ratio is the other way round - the unmeasured 'overhead' accounts for two-thirds or more of costs.

Overhead costs are the black hole in conventional management information systems. Activity Based Management (ABM) shines light into the hole. Knowledge of a business at the level of activities is the basic building block upon which new understanding can be built of where profits are being made and where they are being eroded.

Return on capital measures the productivity of capital investments. How useful is this measure for businesses in which capital investments tend to be small and returns of more than 50 percent are common? For people-intensive businesses, it is more important to know about employee productivity than capital productivity.

We often find that improper costing of fixed costs and capital, such as the cost of capacity, creates misleading signals of performance and value in a business's portfolio. First, traditional costing systems today ignore the cost of capital. Second, the treatment of excess capacity is often incorrectly treated as a unit cost, instead of the period expense that it truly is.

Indirect overhead costs are often capitalized and recorded as inventory, rather than expensed as period costs. The capitalization of overhead costs where there is no cost for capital actually makes these costs "free," and creates a great short-term incentive to overproduce to inventory rather than make to demand. This characteristically leads to month-, quarter- and year-end production spurts, production-planning problems, excess inventory, trade loading, and stale, discounted product pushed onto the customer.

If you have only one product and sell to only one or two large customers, you don't need much of a cost system to learn where you are making and losing money. But companies typically have hundreds of different products or product variations and hundreds or thousands of customers. In this situation, traditional cost systems will not accurately trace a company's expense base to each product and customer, leading to a highly distorted view of the company's economic model. Even a simple time-driven ABC model will fundamentally change the way the company manages its process improvements, its product variety, and its individual customer relationships.

There is nothing wrong with accountancy training — for accountants. But accountants are taught to give priority to the visible financial costs and assets, not to the less quantifiable human assets, which they regard as costs. They focus on the past rather than the future, because that alone can be accurately measured and audited. Their training regards risk, uncertainty, and the unknown as undesirable.

After 40 years of preaching, we have convinced everybody that cash flow is more important than profit. (Everybody except Wall Street, and Wall Street will never learn that lesson. There are no slower learners than securities analysts. I can testify to that; I was one. So they and the companies they promote still run into credit crunches, which kill about four of every 10 new businesses and cripple most of the rest.)