Who Cares About Lease Accounting?

Blake talks with Issac Heller about the new lease accounting standards, whether or not investors really care, what accountants need to know either way, how accountants can create transparency for auditors to make audits better for all, and more.

[00:00:00] Thank You to Our Sponsor, Trullion.

Blake Oliver: This episode is brought to you by Trullion. Trullion is AI-powered accounting software that is modernizing accounting. Trullion helps CFOs, controllers, and auditors collaborate in a unified platform. Stay tuned to hear more from our sponsor, Trullion, later in the episode.

[00:00:16] Preview.

Isaac: It's a big question because I'm not an investor. I'll have to speak best on behalf. There's a Seeking Alpha article. Seeking Alpha kit is a syndicated application. But one of the popular writers wrote, "The only purpose of the new lease accounting standard is to create more works for accountants.''

[00:00:39] Earn Free CPE.

Blake: If you'd like to earn CPE credit for listening to this episode, visit earmarkcpe.com. Download the app, take a short quiz, and get your CPE certificate. Continuing education has never been so easy. And now, onto the episode.

Hello everyone, and welcome to another episode of the Earmark Accounting Podcast. I am your host, Blake Oliver CPA, lifelong learner, and my guest today is Isaac Heller, Co-founder and CEO at Trullion. Isaac, great to have you on the show.

Isaac: Great to be here, Blake. Good to see you, and I love what you're doing in the podcasting world.

[00:01:22] What is Trullion and Isaac’s background?

Blake: Well, thank you so much, and thank you for sponsoring this episode. I'm really eager to learn about your background. I'm eager to learn about Trullion. I understand you guys are doing some really interesting stuff with artificial intelligence, new accounting standards, lease accounting. Give me the backstory or the elevator pitch, maybe, for Trullion. What is it to the uninitiated?

Isaac: Sure. I mean, Trullion is financial accounting technology just by way of background. I have a business in finance background, and I'll admit at the beginning, I'm not a full CPA. I started my career in early-stage companies, moved to a pre- IPO technology company in Dallas, Texas. I was moonlighting with MBA degree at night at the University of Texas in Dallas. And I got really into GAAP and IFRS through my courses and some amazing teachers. My real-world application was that pre-IPO company and going through what's called revenue recognition, which at the time was a new GAAP ASC 606 standard. That was interesting.

At that company, I also ended up doing product management for a revenue accounting product in the airline industry. So, if you ever want to nerd out around co-chairs and interlines game. And then, serendipitously, I had moved to New York and started working for a real estate technology company, having nothing to do with accounting, but it was in the crosshairs of the lease accounting standard, which was another on balance sheet activity, like revenue recognition.

So, within a few years, my love of GAAP and IFRS from a textbook turned into a real-life hair-pulling PDF and Excel scavenger hunt, let's call it. Living in New York with my wife, kid at the time, and we decided to start Trullion, which would essentially do cool things like read PDFs and Excel and unstructured data inherently, and then help with the accounting workflow, including journal entries and disclosures. And Trullion is what it is today, but that's how it all started.

[00:03:35] Trullion just raised $15 million in a Series A.

Blake: And you just raised Series A in February. Is that right? $15 million.

Isaac: Yeah, 15 million Series A. We're super excited about it. And we're also very excited about the investors who led it. So, one is Michael Eisenberg, general partner at Aleph who is a very, very well-known early-stage investors, famously for companies like Lemonade and Melio, which is a big accounting company these days, infamously for WeWork. But he's a fantastic investor. Also co-led by Third Point Ventures, which Rob Schwartz leads that and also Dan Loeb, who's a famous name in the financial reporting world. So, we've got some amazing people behind us that are suddenly interested in accounting.

Blake: So that's a funny way to get to accounting standards is you were an MBA; you were working in different companies that were dealing with these different accounting standards. They're first revenue recognition, then lease accounting. So, you got a firsthand experience of just how difficult it can be to comply with many of these standards. And I myself got into that when I was working at a Flowcast as a product marketer, we were selling to corporate controllers, and this was five years ago. And it was all revenue recognition, lease accounting. Lease accounting kept getting delayed, right? We're finally getting... The actual standard is happening now, right?

Isaac: Oh, it is happening. It is happening.

Blake: Okay. So, it was like every controller or CFO was just like thing in the back of their mind, just knowing at the back of their head. Not what they want to be focusing on.

[00:05:18] How difficult is it to have to deal with accounting standard changes?

Blake: For those of us who are in the small business world and don't have to deal with these accounting standards changes, can you describe how difficult it is? What was it like having to adopt the new revenue recognition standard? Or what was it like having to deal with the lease accounting? What is entailed in that?

Isaac: Yeah. First of all, small, medium-sized businesses, technically, if they want to be GAAP-compliant or IFRS-compliant, do have to comply with these standards. So, if you have one lease, it may not be difficult, but you still need to represent that on the balance sheet. And if you have a handful of customers, but you have performance obligations, meaning you have to actually deliver the product or service that they're paying you for, technically, you can only recognize your revenue once that deliverable is performed.

So, at scale, when you're working at a company like where I work, Sabre, that has hundreds of airlines and thousands of projects ongoing, you need to be moving from what I call the transactional view of accounting, which is, hey, you paid me a dollar, so I just got a dollar. To the theoretical view of accounting, which is you paid me a dollar, but I'm only 50% complete with the project, and I can only recognize 50% of the revenue.

So that's like the theoretical side. Same with lease accounting. I used to just pay a thousand bucks a month for my lease. And now I need to go look at the term of that lease contract and the options or clauses that I could theoretically exercise, and I need to come up with a useful life, and then I need to come up with an incremental borrowing rate and convert that into a right of use asset and liability. It's almost like I have to treat it like debt.

Which might make sense to some people. Because you did sign a contract. And so, it's not like you're on the hook for a thousand dollars because it's that much. No, you're on the hook for $12,000-

Blake: Full amount.

Isaac: ...times five years, or whatever it is. So that's revenue recognition, that's lease accounting standard. I go back to my days in the MBA, and it starts like this. I believe in this stuff. I'm from Texas, so I was in the Enron World and SOX, and I lived through this. And I believe in the effort of moving towards more transparent and accurate financial reporting. It actually does make sense to put more on the balance sheet. It actually does make sense to force a SaaS company to admit that there might be a cancellation clause in the first year of that contract.

So, you can't really a hundred percent be ensured that three years of that revenue will be collected. So that's the first thing, is like, I believe in this stuff, I believe it's leading towards a more transparent world, and I got enthusiastic about that. So then once you go into the, let's call it the corporate world or the business world, and you go back to your Flowcast experience, where you have controllers that are banging their heads or CFOs that are rolling their eyes because they don't look at it as a value proposition. And then you have like ERP and systems that actually don't do this accounting, so you have to do it outside, that's when you start to relate to the pain. So small medium-sized businesses, they can find the radar for now.

Blake: So, you actually think that these accounting standards improve financial reporting? Because, well, let me just explain a situation from my experience in software with the new revenue recognition standard. When we were at Flowcast, we like to mock it because one of the things that we did as part of our company was, we had a setup team, a team that would, for a fee, come in and set up Flowcast. And under the new revenue recognition standard, well, previous to the revenue recognition standard ASC 606, we would expense all of our salaries in that team, and we would recognize the revenue for that service in like the month or two months in which we performed the service to set up the software.

But under ASC 606, we now had to estimate the life of that customer and defer the software implementation service fee over the life of that customer. And to us, it didn't make sense because here we are, all of our costs are in August and September, for instance, when we did the setup, but now we're having to defer the revenue across months or even years. And the weird thing that happened was if a customer churned, we would then accelerate the recognition of all of that revenue in the month that they churn, which actually created a strange increase in revenue. So, losing a customer actually led to an improvement in financial results on a GAAP basis. And I never understood how the people who make up these standards could come up with something that mismatches income and expense. Isn't the entire point to match income and expense in the same period? Like that's why we do accounting.

Isaac: Yeah. No. You're absolutely right. And that's a situation that we've run into as well. We haven't had a churn customer, but in a previous life, we absolutely did. Look, I would think of it... I would visualize one of those graphs with the X and the Y-axis and it just looks like a stair-step that goes up, and accounting is trying to get that stair-step aligned on a curve where there's a little bit right and a little bit wrong, but for the most part, things are right. It's never going to be a beautiful, smooth curve where you're hitting all t the bumps, the ups and downs. But overall, yes, I think that your sales costs, that's an acquisition cost to get a contract.

And if you start to play with that, right, and you get into reseller engagements or rebates, you can really manipulate the cost of acquiring a contract in a substantial way. So, there are some little residual issues along the way. And by the way, we could spend another podcast about talking how GAAP's imperfect, my solution or the way I described is like this, GAAP and IFRS as far as BISB make a best effort to look at issues that are happening and sort of correct them in the future. I mean, if you think about lease accounting, probably maybe started with two guys sitting on a plane and said, wait a minute, this plane isn't on the books. These guys are leasing the plane, but the Southwest Airlines has $100 liability, that just doesn't make sense.

So, it started in some really good theoretical place. And then, of course, regulations and standards take a little while to iron out the kinks and make a lot of people happy. And so, my big play and probably what Flowcast would say in a lot of these other companies that are popping up is technology becomes the great equalizer. So, if you can have technology that can manage that data effectively, then you can be compliant with a revenue recognition standard, which is important because you've got everyone to agree. That's a big deal. We're in America in 2022. People still follow and believe in GAAP. So that's a big deal, we have to respect that.

But if you do have the data clean, then to a point, you could run scenario analyses on the different ways that life could end. Or you could have a probability score around churn that makes that revenue a little bit more accurate. But it all comes down to like technology is filling that gap.

Blake: So, it sounds like the revenue recognition standard, at least that that one change was predicated by or caused by companies manipulating their revenue under the old standard. It was considered to be too much discretion that people had, so FASB comes up with hundreds and hundreds of pages of rules. But I feel like accountants are pretty smart, and they're always going to figure out ways to get around the rules if they want to. And that's what we have with GAAP these days, is we have rules and rules and rules and rules, more rules than ever, but people still manage to manipulate earnings. That's just my feeling. I'm curious too about like- I want to hear your thoughts, but also with lease accounting. I mean, because that's what you focus on.

[00:13:49] Do investors truly care about lease accounting?

Blake: Trullion focuses on lease counting. And that's the big thing everyone's worried about right now. Does it actually make... Are investors asking for this? Do they care whether or not the lease is around the balance sheet or not? I know we have to do it; we have to comply. This is the law as handed down by FASB and it's the rules according to GAAP. But does anyone care other than the people who make the rules?

Isaac: It's a big question. Because I'm not an investor, I'll have to speak my best on behalf. There's a Seeking Alpha article. Now, Seeking Alpha kit is a syndicated publication, but one of the popular writers wrote, the only purpose of the new lease accounting standard is to create more works for accountants. It was a cynical title, but he had some truth to it. And he walked through the public balance sheets and basically showed how the whole thing was cosmetic. Meaning everyone was shifting their leases onto the balance sheet, but effectively, the stock price didn't change mainly because, like you said, investors are smart, and they know that if Southwest Airlines doesn't have any planes on the books, that doesn't mean they don't have any planes. So, there's a footnote or a disclosure around their liability.

Blake: And it was always previously in the footnotes. All these leases were in the footnote somewhere in the financial statements. Now it's just they're on the balance sheet. I guess it changes the balance sheet in that now there's this asset and this liability, but those net out. So, the net effect is nil. I mean like-

Isaac: Yeah.

Blake: And what if they have provisions to get out of these leases? Does that not count? They still have to put it on the balance sheet even if they've got like a cancellation clause or something? I don't know. It just seems...

Isaac: No. This is a good question. It's like, okay, so to be clear, before there was a five-year maturity analysis that was required and really just showed your kind of forecasted cashflows for lease payments over the next five years. If you have a lease that renewed every year, I'm sure you could choose to put in the second year's cash and third and fourth, or not. There wasn't that much rules around it.

So now you're taking the lifetime of the lease, which could be seven years or nine years or two years, you're considering cancellation and renewal options, and then you're doing what's called a reasonable certainty exercise around whether you do or do not think you're going to exercise those options. Now, can I tell you the difference in an investor's perspective between what it was in the previous standards where you just have this five-year cash flow versus the new standard. I can't. I can tell you there's a difference, I can tell you there's a significant difference, I can surmise that in the public markets, because there's more scrutiny and a little bit more data available, there's very few public investors that will be caught by surprise. They know what they're dealing with. And a retailer in an airline, they have an idea of what the lease obligation is. And like a good old corporate or tech company, they might not have really cared what the expense size... what that side was.

In the private markets, it's interesting. Because then you get really into the theory of, do people really care about GAAP. Because now you've got these private companies where it actually could make a difference. Maybe they have a private equity owner or a bank holder, and then EBITDA looks different, or the debt and liabilities look different. And it's like, wait a minute, now I have a different cost of capital or access to financing or whatever it is. So, then it could get interesting. We'll see.

[00:17:27] Thank you to our sponsor, Trullion.

Blake Oliver: Thank you to Trullion for sponsoring this episode. By leveraging the power of AI, accounting teams can get more done quicker. By seamlessly ensuring compliance with relevant accounting standards and automating tasks that used to take hundreds of hours, accountants are freed up to add value and make an impact. Trullion uses modern technology to extract data from source documents and connect it to the audit trail all the way down to the entries. Trullion helps accounting leaders keep up with the pace of business while maintaining the highest accuracy standards. To learn more and to see Trullion in action, visit www.trullion.com, that's T-R-U-L-L-I-O-N.com.

[00:18:14] Trullion's mission statement and use of AI.

Blake: There's a lot of complexity in adapting to the lease accounting standard. And this is where Trullion comes in, the value proposition, I take it, is that my option without software is to go through all these contracts, pull out the information that I need to then do this formula that I've been given by the new standard. And they get that under the balance sheet with journal entries, et cetera. Trullion uses, let me get the exact phrase here-

Isaac: Two letters.

Blake: ... AI. So, here's the mission statement from your website? "We are creating business transparency by using AI and machine learning to power real-time visibility into company financials and form a single source of truth. So, I don't know if you have listened to my podcasts in recent years, but I'm a noted critic of artificial intelligence in many software companies because it seems to be, in many cases, a lot of vapourware and a lot of people behind the scenes are actually doing the work. They call it artificial intelligence, but there's not really much going on. Although with lease accounting, I can actually see how this could work. So, walk me through it. I scan my PDFs, or I scan my contracts into your system as PDFs. And then how do you help me automate that? How do you automate everything else after that?

Isaac: Okay. So, let's talk about two value propositions. And believe it or not, Blake, I would probably agree with you on most of the AI in the accounting industry and other industries. So, let's talk about two value propositions. To your initial question, it's like Dropbox. You upload a document... You can upload Excel. So, if you have a list of 10 assets, you could upload that as well. And the AI and more specifically NLP and what's called entity recognition will help identify key financial data within the document. In many cases, it will actually extract and suggest what's the start date and the end date and the lease payment.

And then in other cases, it's simply tagging what it believes are the important terms for you to look at. And then you can tag, and when I say tag, you get to have this fun exercise where you click on the PDF and it just sticks it in your accounting workflow, and then it kicks off the workflow itself, which you could think of as a nice form that asks a few questions about the new standard and then moves you through to create journal entries and disclosures. So that's Trullion in a nutshell. That's the lease accounting workflow.

Now, as a side note, we also have a revenue recognition workflow. So, we have two workflows and we actually have more. For example, we have an IT agreement workflow for government and GASB customers, where you can extract SaaS agreements and IT agreements and move those into a workflow. But we'll zoom in on the lease accounting workflow. So, there's two interesting value propositions. Number one, let's call it the AI, which saves a little bit of time, maybe an hour, two hours of document. But let's be real. If you're a company, even if you've got 15 leases, you're a pretty big-sized company and you don't listen to podcasts and buy software to save 30 hours.

[00:21:36] Trullion creates real transparency for auditors

You want something really substantial. So, the second value proposition I think is really, really interesting. So, in our mission statement, we talk about transparency. And if you use AI just to use the OCR layer, meaning just to connect the actual PDF with whatever you're doing, then guess what? Your auditor can have fun too. So, if I'm a controller and I'm connected-

Blake: Wait, auditors get to have fun? Auditors get to have fun?

Isaac: Yes.

Blake: This is revolutionary here.

Isaac: No. We like. Another topic, but going back into it and Oracle, these are like some of the most innovative revolutionary software companies in the world. And the use case was accounting and GL and stuff like that. Okay. Let's get to 2.0. So, accountants and auditors love data. They're very good. They're actually very tech-forward contrary to popular belief. And with Trullion, if you can embed a PDF into your financial workflow and then think about it like Spider-Man, like the spider web just kind of releases onto the document and tags those different touchpoints on the document, then now when it's time to go for audit, your auditor can swim, like parachute into your work.

So, they can see the workflow. And so, the audit trail in Trullion is not Blake logged in today and then he logged out later and he changed two things. The audit trail is like, this is where the contract was. There's a chat feature which says Blake asked his auditor a question around the incremental borrowing rate. They gave them this guidance plus X, Y from the yield curve or whatever it was. And then they added that, and they added that produce the journal entries. And then Blake signed off at the end of the day. So that's the second and bigger value proposition is you're creating transparency. And the word around real-time, like lets you think about a world where auditors aren't just pulling all nighters and what are we, March, April. Yeah, it's a good time to talk about it.

Blake: It is. Yeah.

Isaac: It's a time where you can be a real-time extension of your clients.

[00:23:49] What is OCR and NLP?

Blake: So, you used two acronyms I want to define for our audience. The first was OCR. What is OCR?

Isaac: Optical Character Recognition. It's basically image recognition. It can be anything like how your car beautifully detects whether there's a lane to the left or right these days, or if there's someone behind you, they're using some level of image recognition, and then applied to documents, they're taking a document and converting it from an image to a text-based readable quarriable item.

Blake: So, the OCR takes that image of the scan and turns that into text. And then NLP, what is NLP do?

Isaac: So, I've heard neuro-linguistic or natural language processing, but basically, it's taking... Now you're in text format because it did the OCR, and the NLP is helping identify what is a date and what is a financial. And then the more sophisticated your NLP is, it can say what's a start date and what's an end date and what's the lease payment and what's the tenant improvement, and what's the ARR versus the MRR and all those types of things.

Blake: So that's finding all the data points that I need for this workflow that then you kick off and I can select... It sounds like I can select data points that it didn't identify, add those in, go through the workflow to create this entry. And I assume a schedule that accompanies it for all the following months. But one thing you said was really interesting, I hadn't heard this before is the idea that now my auditor can go back and drill down into the original document from the journal entry in the software, they can actually go... Like you've linked the document now, the contract to that lease accounting entry.

[00:25:43] Early Trullion customer story

Isaac: I'll tell you a story. One of our first customers was actually a European customer. They found us on LinkedIn. They had about 30 leases actually in different countries. It's kind of a cool client. And all of a sudden one day... let's say they were an SAP customer. Okay. It was a little bit of a bigger client. And then one day we got an alert that someone logged in to their database that wasn't from their company, they're actually from PWC. And we were like, "Guys, someone non-authorized logged into your database. And they said, no, that's our auditor.

And so instead of pushing their journal entries to their ERP, such as SAP, they had... because we have the journal entries and the disclosures, they had the auditor go directly into our system. Now, at the time, we had a lot of audit firms requesting access to our software, not the PWCs of the world who tend to do things in turn, but basically the other 396 of the top 400 firms, from CBIZ MHM to your regional Oregon accountant. And those firms have since actually procured our software to distribute it to their clients. So, there's like mid-market clients on Sage and Microsoft Dynamics and even QuickBooks as well, to do this nice little dance with their clients where their clients can upload the data to Trullion, and they can audit it directly out of Trullion.

[00:27:09] How did Trullion develop this AI technology?

Blake: So, did you make this NLP algorithm? Did you build this AI yourself or do you license it? I imagine there aren't that many people who can create this sort of thing, they must be in high demand, the engineers who build it. How did you get that talent on your team?

Isaac: Well, I've got a partner, Amir Boldo, our CTO co-founder. We're a US company. I grew up founded in New York, but, we've got a great team in Tel Aviv, actually. So, we said from the beginning, we would build a global company that could service both GAAP and IFRS customers. So, we sit both in the US and in Tel Aviv. And then Amir has got a team of engineers, including a couple machine learning leaders. You can read our blog on Trullion. We talk about some of our methodologies. They're in high demand. Again, Blake it's interesting. If you would have asked me at the beginning, I would have said, yeah, AI is everything, and this is going to be an AI company, but AI has just become a component of what we do.

It's not like this magic wand that extracts everything and makes it perfect for you, it's kind of just become this embedded component where, okay, it gets you 70 or 80% of the key terms and you have this nice little workflow where you can pick which ones you want to tag into it. And so, all that does is it gives you an extra tool. But at the end of the day, an accounting workflow is an accounting workflow. It will look and feel the same as anything else. It'll just have some nice extensions to the unstructured data and some of the conversations that happen between accountants and auditors.

Blake: So, AI isn't everything, a lot of it is the workflow. I discovered that I'm an outsider. I started my career as a bookkeeper, Working my way up from the bottom. I guess this is where my scepticism about AI comes from because that's where a lot of the promise of AI has been put in the last few years is, we're going to automate bookkeeping and nobody's going to have to enter transactions into the GL anymore. And, of course, you can automate maybe 80 or 90% of it. But then there's always the exceptions, and that's what requires the human intervention. So, you might not need an army of bookkeepers, but you might need some really skilled systems people watching all the transactions go through, cleaning them up when they don't work.

[00:29:22] Where do you think AI will take the accounting and finance professions?

Blake: So, speaking more broadly, where do you think artificial intelligence is taking us as an accounting and finance profession? Where are we going to end up? I mean, a lot has happened in the last 10 years.

Isaac: Oh, wow. It's a big question. Let's do some numbers. That's more fun. Let's us look at it as macro equation. First of all, we talk about the three pillars of financial reporting, which the first pillar is the tens of billions that CFOs spend every year on their controllers and reporting leaders and basically the people who are putting everything together, rev rec like in focus. The second pillar is those ERPs, the systems of record. I'd say they're spending tens of billions a year on everything from QuickBooks to Oracle. And then the third pillar is the money that you pay for audit and consulting. So over 200 billion, a lot of it is in the Big Four.

So, question is, how does that dynamic change? Let's take the Big Four for the auditor, for example. So, you've got 200 billion a year that's spent there. That is not going to like go to robots in the next 10 years, but let's say there's 20% of that's automatable. Now, if you can just give the software tomorrow that automates everything, that's not powerful enough because there needs to be a more compelling value proposition because believe it or not, auditors do a great job. That's why they are where they are and they've dominated for decades, especially within the Big Four.

So, you need to have a 2 or 3X value proposition. And that's where AI can't come in, because right now you're sampling. You're taking one or three of a thousand transactions and recreating the work that's done. And you've got on the other end fraud, whether it's a Wirecard or Clariant a couple months ago. So, we all know, in theory, if you can move from sampling to full coverage, that you could create a more compelling value proposition. So, I believe that AI becomes part of the equalizer, obviously just good old workflow software is very important. But what AI can do in our case is it just connects the unstructured data. It just connects you to documents and invoices. I, as a founder, Still get audited from our investors. And like they're asking me for the emails and the balance confirmations, and unlike trying to run a company and they're asking me for like... They're giving me a Word document; I'm filling it out. And there's a Big Four auditor.

So, if you can start to connect some of that unstructured data, the AI is okay, the AI gets you 70, 80, 90%, but it connects it within the workflows. So then going back to our equation, the $200 billion a year that we spend, 10 to 20% of it, let's say shifts into technology. There was a hope that the audit firms could lead that revolution. I'll let you and the listeners decide how that's going, but it's starting to look more and more like the audit firms are getting comfortable partnering with leading providers like Flowcasts, like Trullion, and that percentage shifts into software. AI is a dominant component of it. And then we get much more accuracy and transparency and efficiency as a result. So that's kind of the macro way we look at it.

[00:32:39] What about other changes in standards, specifically ESG.

Blake: What about all these other changes in standards? Everyone's talking about ESG, or at least I hear that all the time from the thought leaders in our profession, there seems to be a lot of interest in it, actual interest from the public in accounting standards for once with, what does it stand for, Environmental Sustainability Governance. And the SEC just came out with some draft ideas about change disclosures that companies may have to add in. And this sounds like a huge opportunity for Trullion, given there's all this unstructured data in documents, places about environmental stuff. Is that where you're headed next? Am I going to be dumping in all of my climate change documentation with Trullion and then you guys will help find all that information about our carbon footprint and whatnot?

Isaac: Oh, man. This is a loaded topic. Look, I had a sister who worked at Google, and she got an offer from a drone company this is 5, 10 years ago. She left for that drone company because drone was going to be the next best thing. But drones didn't become a big thing. So ESG is, is regulated. So, it's definitely here to stay. The question is, is do you make a big capital expenditure on software to try to address as a sort of a standard or movement that isn't really crystallized? So, standards and lease accounting and revenue recognition, it's going into effect in 2021, and it's going into effect in 2023. And here's the white paper that says how, and here's all the position papers. And like, this is pretty much out there.

ESG is a beast. You have these tidal waves sort of corporate responsibility combined with climate change that are really coming on strong. And we all know that we should do something, but I don't know if ESG is... Number one is it clearly defined, and number two, does the public agree that there's sort of this cost-benefit analysis agreed upon for ESG? Does that make sense?

Blake: So, you're saying it's very undefined at the moment and the public isn't clear on what it actually wants.

Isaac: Also, CFOs.

Blake: Yeah. CFO. Yeah.

Isaac: So, I'll give you an example. Well, first of all, let's go back to the unstructured data. It is a very, very difficult equation to collect all of the data from around a company and try to understand whether they're in compliance with ESG. Think about another big regulation like GDPR. Well, you can actually do big data dumps and discovery analysis across different documents because there's some well-defined areas of what does it mean to be in violation of data privacy. Like ESG, okay, you can talk about a supply chain company. I'll give you an example. I forgot the analysis, but they did like an ESG score and there was a cohort of companies that had the top ESG score. Actually, Francine McKenna, if you know, did a good analysis on this.

And weirdly, they were also all doing business in Russia. They had it on their Russia footprint. So, it's like, what is ESG? Is it being environmentally sustainable, is it not being friends with Putin? There's a wide range of things that outcomes that can come. And then also the fact that if you start to push harder on energy companies, which are going to be presumably some of the biggest violators of ESG, that's the A. How does that really impact the world? How does it really impact the world in countries where commodity prices impact the majority of the population? It could create more or less or more instability. It sounds great where we're sitting in America, but those are kind of my general thoughts. It'll happen anyway.

Blake: Well, it may take a while. I mean, these previous standards took how long to develop? Revenue recognition was in the works for, it feels like a decade?

Isaac: Oh yeah, oh yeah.

Blake: FASBI, IFRS, it all moves very slow.

Isaac: But those are so much more clear, Blake. To your point, like can Trullion get to the unstructured data. Well, hey, we're dealing with documents, and we're just trying to pull out a dozen terms that are pretty well-defined start date, end date amortization. And guess what? Yeah. You have to figure out the incremental borrowing rate. But it's got one digit and a percentage next to it. ESG, it's like a huge black box compared to that. Think about all the different analyses that you have to do across the business from internal to international relations, to supply chain, to date history-

Blake: I guess-

Isaac: ... everything.

Blake: The thing that's not clear in my mind is like, let's say you just want to come up with one metric, like carbon footprint, how do you even define across companies a score for carbon footprint? There's a lot of data you have to collect to figure that out and a lot of different ways that people estimate it. What is your personal carbon footprint, Isaac? How would you even calculate that? Is it based on like how many miles you travel in a car and how many flights you take and how many products you consume and then you have to trace back the carbon footprint of all those different products be made? I don't know.

Isaac: Yeah, totally. Totally. I'm giving money to organizations that offset that and am I ordering food delivery which someone has to drive to me or am I driving to go... like all these types of things, I think it's impossible. Blake, here's what concerns me about ESG and going back to my Texas days and Enron. Enron ended up turning into a good thing for business. It was good for business for the accounting world. We got SOX out of it. You've got another company, not too far from Flowcast in audit board, which has built a fantastic software company around internal audit and compliance.

And these regulations created a lot more work for the industry. But we're sitting here more than 20 years later with similar issues around fraud. We're talking about Wirecard in 2022 and many of these other situations, or there could be more lurking. So, my hope is that whether it's the SEC or it ends up being FASB, Big Four, whatever it is, I hope they don't overextend themselves too much. Because there's a lot of fatigue here. There's a lot of fatigue with these standards. There's a lot of fatigue with Corona. There's evolving business models where stepping out of a bull market into a potentially scary time. And this could really start to rattle people, ruin some of the trusts that you get out of accounting in the Big Four.

[00:39:34] Does the public trust auditors?

Blake: Yeah. Well, you say trust. I'm not sure that the public has much trust in auditors these days. You brought up those cases, the Wirecard in Germany and Karelian in the UK is another example of... I mean, these are big companies. And you feel like if the auditors had really been looking out for the public, they would have found this, they would have seen it happening. I mean, in the case of Wirecard, I think it was Ewire. Ewire didn't even do confirmations of bank balances. That's like basic audit 101. What were they doing if they weren't auditing the bank balances of Wirecard billions and billions of dollars?

So, I sit here as a, a non-Big Four accountant. The biggest firm I ever worked for was a thousand people. A hundred partners, thousand staff, which is still a pretty big firm, top 25, but not serving global fortune 500 companies, that sort of thing. And so, I just sit here as a CPA, and I look at accounting standards and I think... I look at the auditors and I think, what are they doing? It's a $200 billion industry. How does it protect the public if it can't stop this kind of stuff? And then the slap on the hands that they get from the regulators is just... A couple million dollars to KPMG is nothing. So, I don't know.

Isaac: Oh man. Let me throw out a few potentially exciting, but scary, but still theoretical ideas of where things go. So first of all, Wirecard was a $2 billion cash asset that was fraudulent. And my friend's grandmother had that in her pension, and she didn't even know it that was one of the main stocks. So, it just wiped out. So, it really does impact from the top to the average person. So, it's a big deal. All of my friends... A lot of my friends work at the Big Four have worked at the Big Four and everyone in Earnest once a more transparent and trustworthy ecosystem and is doing their best job. But in that case, the gap between what's needed to be done and what the methodologies are of audit are just too wide. And so, there's no equalizer. It's almost like you can't get out of your own way.

So back to trust, I think we're at a very, very low trust point. I think it's going to get worse. Unfortunately, you and I know about Wirecard and a lot of our friends, but I don't think it hits mainstream the way it should. It's a big deal. And so when trust erodes, and you've got this world where like accounting is seen as a reactive sort of post through everything, reconciliation exercise to check the box, and then you've got like private markets where there's a lot of money in venture capital and private companies and you see big companies going private and then being taken private, you're essentially, like with these companies, how do I say it, the stakeholders can become the private investors? And if the private investors don't think there's trust, they need trust, and they have a lot at stake. And if the people aren't confident in the rules, then that's going to give other people opportunity to create the rules. Think of it that way.

[00:42:53] Why would a tech company want to go public these days?

Blake: So, to me, this trend of companies staying private of avoiding going public, it's not just because they want to avoid the red tape of an IPO or being a public company, it's that they also don't see the value in being a public company. Because there's all this red tape, but there's not a lot of value. For technology companies, I would argue there's not a lot of value in GAAP financial statements. And the reason is that we're dicking around putting all these leases on the balance sheet, but 90% of S&P 500 market value is intangible. And GAAP hasn't adapted to handle intangible assets in a hundred years.

It's essentially the same. GAAP is essentially the same as it was a hundred years ago when General Motors was running the economy. And we are no longer in industrial economy. And so, I wonder who are these people who make these rules and how, I don't know, blind are they to the fact that most of the value... I mean, think about this. It kind of blows my mind. Most of the value, 90% of the value in the S&P 500, it's the 500 biggest companies in our economy, it's not on the balance sheet. So why would we value audit when what they're auditing is only 10% of what we care about. And that's, to me, why audit fees have stagnated over the years, why auditors, aren't making more money, why first-year staff salaries have stagnated because if you can't raise the fees because there's not value, then you can't raise salaries and maintain partner compensation the way it was. I don't know, I'd love to hear your thoughts on this.

Isaac: Well, it's a perfect storm. It's a little scary. Because we spent the first part of the discussion talking about new standards. We talked a little bit about evolving business models and some of the complexities. And if we're all in agreement that you can't pay more to your auditor, meaning we're not seeing the value, then you're stuck. So going back to the lease accounting equation, that's why we like Trullion because we're working with these private audit firms and they're like, hey, we're good people and we want to follow the rules, but we just can't keep up. Oh, and by the way, we can't hire, oh, by the way, the number of people taking the CPA exam is down. And we can't keep up.

So, in some way, we're maintaining accuracy at least for one standard and one moment at a time. But I don't know what happens. Again, I think people, rule makers and auditors are all in earnest, but these things, they're big macro equations. And usually when the gap is so wide between what is expected and what's available in a dominant area of the market, that's when technology becomes an equalizer. I mean, it's not a stretch to think of an Uber analogy with accounting, where if you have technology platforms that just start moving faster and faster and become better and more trusted, and then you have private investors who are confident in those platforms kind of like, I think of Carta, which is a company that helped with GAAP table management and then moved into giving people confidence in 498 evaluations.

That's the way it can go. And it is really scary because then once rules... Like we're talking about rules here and trust. So, if all the private investors to your software point don't care about GAAP and they only care about ARR and LTV and Bessemer as a whole paper about the 42 metrics they care about and none of them is revenue recognition.

Blake: None of them is part of GAAP. Yeah.

Isaac: Then there's...

Blake: That was talking to me. When I joined a technology company as a CPA, I go from public accounting into tech, spent four years working for different technology companies, not once did we ever talk about the financials. It was irrelevant to our business.

Isaac: Yeah, totally. Well, I think that's a commentary also on the venture world and like just the idea of top-line or nothing. I hope profitability comes back in fashion, but...

Blake: Well, yeah. So, a technology company... This is what I've learned over the last few years. To put it very simply, most subscription businesses, what you are building is an annuity, your customer base. You have a cost to acquire customers, you try to keep that low enough, you acquire the customers and then they pay you every month, every year, as long as you deliver the service. That is the intangible asset of a subscription business. That's the primary asset of a subscription business is the subscribers. And that is nowhere on the balance sheet. And so, you get this mismatch. Even though you have revenue recognition, you get this mismatch of income and expense because all my sales and marketing expense is expensed in the period in which it is incurred. But it's to build this intangible asset.

So, that's why software companies look terrible on a GAAP basis, because they're spending all the money upfront for a deferred stream of revenue downstream. And GAAP could adapt to figure this out. And we have done this. That's why we focus on metrics like cost to acquire customer, lifetime value, cost per lead, all these SaaS metrics that we pay attention to because they allow us to understand what's happening in a way that accrual basis GAAP financials do not. And the accounting standard setters must be completely oblivious to all this. I mean, I was, as a CPA before.

Isaac: Yeah. It's weird. It's like denial probably. That's probably when it's like. You want to tackle it first. And maybe revenue recognition was a first step towards tackling that, especially in larger enterprise software arrangements, but then it gets to a point where it just moving faster than you and so you're just kind of waving from behind like, hey, good luck with that.

Blake: Yeah. I mean, I guess it doesn't matter if we're recognizing the revenue more consistently when all of our expenses are upfront because we're not matching income and expense. if you think about it, the job of an accountant is the balance sheet. That is why we exist. Otherwise, we will only need bookkeepers. Anyone can do a P&L. But it's deciding what gets deferred and what gets put on the balance sheet, what gets capitalized, when it gets expensed, that's how we get to profit.

And that's our job as accountants is to come up with a profit number that makes sense. And this is what we failed at doing for the last few decades. Amazon looked terrible until recently because GAAP didn't understand how Amazon's business worked. GAAP's great for a business that makes widgets or sells inventory, but not for a business that sells some sort of intangible asset like Facebook.

Isaac: No, totally. Look, I think there's a lot of things in play. I mean, first of all, if you look at multiples in software and technology, it's a little crazy if we... and I'm not even talking about the private markets which is just crazy. It's a little nerdy. If you think about it. It used to be that things would trade at 3-, 4-, or 5-times revenue multiple. And that was the discussion. And then all of a sudden, it's like 20X, one day and 40X the other day. So, volatility is scary to me. That's something where there's some red flag in what's going on. It may be a bigger macro factor. Look, there's still a lot of private investors that hold stock in the SaaS companies that go public.

Look, whatever investors is third point third. Their point's a hedge fund. And now they're co-leading a Series A. And you look at Tiger Global. And Insight Partners, Providence, these late-stage private equity firms and hedge funds that are going into a public-private arbitrage. So, I'm not putting this all in GAAP, I'm just saying these people feel pretty confident in the metrics and the data. And if they're sitting on the board of a Series D company that's going to be IPO in a couple of years, they know the economics of monday.com better than any investor because they have, marketing acquisition data or whatever the hell it is.

Blake: Right. There's all this data that is inside the company that does not get disclosed to public investors because it's not required by GAAP. And-

Isaac: Which is a big issue. It's a-

Blake: Yeah. It gives the insiders way more of an advantage. I mean, the whole point of public accounting standards is to give public investors the information they need to decisions

Isaac: Yeah, totally. Look, I think one of the themes, so I talked a lot about this with Artie Minson. Artie was an EY auditor for many years. He became CFO, vice chair at AOL Time Warner. And then he was basically CFO and then President WeWork which had their own story about Community Adjusted EBITDA and sort of financial reporting.

Blake: Best on GAAP metric of all time. Community Adjusted EBITDA.

Isaac: Yeah. Artie, he won't let me in on that. But what he has told me is someone who started his career as a CPA and became this high-powered CFO is that it used to be like the CPAs and the accountants were the coolest, smart guys in the room, like when he started. And now it's seen as a tax on the business. And so, if you're a CFO now, you're building this legion around FP&A and finance and then you're also building this accounting team. It's like one gives you the data that you need and what is called strategic. How many times have you seen a title of someone like strategic finance? We have someone in our company, Trullion, he is the strategic financier. You've never seen strategic accounting manager.

Blake: That's true.

Isaac: Right. And so now you're paying twice. You're paying for the data you want that's "strategic" quote-unquote. And then you're paying for the accounting, which you have to do. And it's really unfortunate because if the fundamental data i.e., the system of record based around the accounting, meaning you could just kind of get compliant on the way to getting the data you want, that would be so much more efficient. But now you're managing everything in external systems. The CPA at the end of the day, they're not going anywhere.

Blake: Well, the problem we have is that we have all of these standards. They don't actually increase value to the market, but they still have to be dealt with. So, it's basically just creating more work without enabling us to sell more. So, we have to become more efficient. And this is where solutions like Trullion make a lot of sense because if I'm an accounting firm and I have clients where I'm internal and I need to get this work done, it doesn't make sense to hire bodies to do it anymore. There's no-

Isaac: Dead-end.

[00:53:47] The great resignation.

Blake: So, this brings us to the great resignation. I mean, this is why I'm very bullish. Even though I'm critical of GAAP, I'm very bullish on all the solutions that help us deal with GAAP because we just don't have the bodies to deal with it anymore. Everyone I talked to; they've lost in public accounting anyway. They're losing people in busy season, which never used to happen before. People used to wait until the end of busy season to give their notice. Now, they're just, "Sorry guys, I'm out. Have a good March."

Isaac: It is jumping off the ship. Yeah, it's like a [CROSSTALK]-

Blake: And giant salary increases to go to other places, it's tough.

Isaac: It's tough. And you do see the publicity around the Big Four, KPMG, for example, publicizing those salary increases and bonuses and things like that. And that's not going to fundamentally change how accounting is done. In fact, if anything, that might create a culture of certain types of people who are happy to get a bonus to stick around. And so, the real warriors in accounting are the people that believe in the profession and believe in transparency. I don't want to use the policemen analogy, but people that want to kind of do good and protect what's there.

It'll be interesting with the great resignation. I think that people in their firms, they have to be champions. And an audit firm, even a small or like a bookkeeper might look at a SaaS expense and feel like more than I do today. Or maybe that's only a 20% reduction, or maybe that's not even a reduction, but it's pretty close. And you almost have to be a warrior and be like, this is the right thing to do. My next client is going to care that I send him to a nice portal or that I can give him a report cleanly. if I want to scale, if I want to be modern, I need to associate myself with this. And maybe there's a risk to me, but in the long run, this is going to be part of my job, and I'm just going to be a better accountant because of this. So that's where we're going.

Blake: You nailed it there with the better portal. The client experience is becoming more and more important because it's possible to deliver a really good experience over the internet now. Like you and I, we're recording this podcast. Are you in Texas or New York? I don't even know right now.

Isaac: So, right now, I'm in Tel Aviv. I mean, I'm in my Tel Aviv office.

Blake: You're in Tel Aviv. That's incredible.

Isaac: By the way, is this voice only? Because I'm looking at Blake right now, this is cool, you got your office. I mean, it says "Think Big" in the background. Can they see?

Blake: It depends. If you're on YouTube, yes. If you're listening to the podcast on Apple Podcasts or Spotify, no. But yeah, you've got a big sign behind you, "Think Big." I love that. Yeah, I think like what you're saying, if I understand it, is that we, as accountants, need to think bigger when it comes to how we use software or why we put it in place because it used to be just an ROI calculation.

I'm going to save X hours by purchasing this application. But the better reason to do it is because I'm creating a better experience for my staff which will keep them around, they're not going to leave and for my customers. The ROI is important on the hours, but not as important as it used to be. And I guess I say that because like, I would never go work for a company where I have to do everything manually in Excel. And I think most people wouldn't want to do that anymore. Most accountants, they would... I'd even rather sacrifice salary to work at a place where I don't have to do that manual soul-crushing type of data entry.

Isaac: It is really cool.

Blake: It really is. I mean, look, like I said, I came from the very bottom as a bookkeeper doing data entry into desktop accounting software. And I've personally experienced the change from what that was like to automating 80% of my own job and building a business around it. And so, it just shocks me when I still see people working in accounting departments where it's... I mean, we were getting paper ledgers five years ago when I was in public accounting still. In Los Angeles, we'd get the mail to us. It only happened once or twice, but still, just that even as out there indicates that there's a big segment of the accounting profession that's still doing things with 10 keys and paper ledgers. And so, a lot of opportunity.

[00:58:15] Change doesn't have to be scary, the jobs will still be there.

Isaac: Yeah, a lot of opportunity. And Blake. it's not as scary as I think people worry or make it out to be. If there's still people out there that are sceptics, the world has established that there is a lot of incentive and interest of a financial reporting ecosystem. Hundreds of billions are spent every year in a combination of external accountants, and then also systems. And that money will still be invested. Some of the economics will be shifted, but nobody's going away. And in fact, I know this. If you have fraud, if have ineffiencies, that means there's something to be gained. That means that people might even spend a little bit more to eliminate that fraud or whatever it is.

So that means that you can actually make the market bigger. Go look at other examples. I mean, you're in podcasting. Go look at examples of media publishers and music, how things move to Spotify and actually it ended up being more revenue the labels and stuff like that. There's a lot of data here. People care about this a lot. Let's have a party. Let's make this market bigger with technology.

Blake: I like your analogy about Spotify, but as somebody who came from the music world, I was a musician before I got into accounting, I will tell you there was at least a 10-year period where nobody was making any money except Spotify.

Isaac: Good. Good. The glory days. The glory days.

Blake: Well, Isaac, thanks so much for joining me today.

Isaac: Thank you.

Blake: If our listeners want to learn about you and what you're up to, where's the best place for them to go?

Isaac: Trullion. www.trullion.com T-R-U-L-L-I-O-N.com. Trullion is truth and millions. It means something to us.

Blake: I like that.

Isaac: It's a piece of technology, but it's also a mission. We're good at saying a million or a billion or a unicorn if that's not backed up by real credible financial data. I'm out there on LinkedIn. We've got a great team. Look us up, hit us up, we're always happy to chat.

Blake: Thanks, Isaac. Great talking to you.

Isaac: Okay. Thanks, Blake.

[01:00:23] Thanks for listening, visit earmarkcpe.com to earn free CPE from this podcast.

Blake: Thanks for listening. I hope you enjoyed this episode and that you learned something new. And if you did, wouldn't it be nice to get some CPE credit for it? Well, I've got great news. My new app, Earmark CPE offers free NASBA-approved CPE credits for listening to podcasts, including this one. Visit earmarkcpe.com to download the app, take a short quiz, and get your CPE certificate. That's earmarkcpe.com.

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