When we speak about the so called “truth” in nowadays accounting pratices, we might be referring to as this is the best assumption made based on what’s known. If you lost tons of money because you relied only on the flattering numbers in a company’s quarter or year end financial statement and made the investment for its “solid” business performances, you might find yourself be completely on your own for this one.
The company in which you invested in might just tell you that they did their best they could to come up with those numbers. But were those numbers telling the entire truth? Probably not. What they might not be telling you was that in order to boost up their acquisition offering for next quarter, the management needed to create “better-looking” financial statements with higher profits for this quarter, meaning they might have a substantial liability that would not be booked till after the acquisition.
Long ago, the word “accrual accounting” was born to replace the simple tallying of cash in and out. With that and other current general accounting principles, helped created goal-driven but not truth-driven accounting pratices. It allows managers to manipulate the assets and liabilities based on what they want to achieve. The author had clearly stated in his article that more disciplined accounting principles or guidances should be taken in place to better regulates and monitor how accurately decision makers are when revealing financial information. For example, he suggested that consistent discrepancies should be tracked to make sure managements are not making the some mistakes over and over again knowingly.
The article also urged the investors to scrutinise the numbers harder. Never judge a book by its cover. Knowing that even accounting numbers can be subjective, one needs to take a more closer and deeper look into the company and its managers history as well as information provided by a reliable third party before making any intuitive decision.
Although Accrual Based Accounting methods bring with them great benefits like allowing the management to exercise better management of assets, gives a fair description of the financial position of a company at any given point of time and more importantly in today’s times of complex business transactions allows them to be recognized fairly. It had allowed managers the ability to present to shareholders a much better picture of how the company is doing over a long period of time.
The author touches upon how the introduction of “estimates” complicated and increased the problems the industry already faced. Since Lanxin and Anelisa have already touched upon the points pertaining to how estimation can be sometimes misused by corporations to manipulate and misreport earnings and how its is necessary for the investors to be careful and conduct their own research before making any investing decisions.
I would like to elaborate and talk about a topic that the author briefly mentions about “Fair Value Accounting.” I would like to elaborate about this form of accounting and how it has over the last few years been come to blame for one of the biggest economic crises we have seen in our lifetimes.There are proponents who blame fair value accounting for our current economic crisis since it valued a lot of the assets that financial institutions held to pittances. Detractors of this form of accounting suggested that it led to many banking institutions failing and which further led to fall in the value of assets.
However not marking to market would also mean that institutions and corporations were in essence trying to shy away from the problem at hand until it got manageable/ or probably worse and is not often the best approach. The solution to this issue could be a middle way out and an accounting practice that would segregate how assets are valued and carried on books based on their purpose.They could also be categorized based on the possibly predetermined length of investment and purpose of investment. But panning either method of accounting is not a solution to the problem on our hands and the FASB in collaboration with governments and corporations should work towards coming up with the most effective and transparent accounting practices.
I believe Accrual Based Accounting is an inevitable accounting practice in today’s times of complex business arrangements. But addition of Footnotes and specific directions on Assumptions made by management of corporations and increased investor awareness will make the reporting system foolproof and the markets more efficient.
I agree with Lancy’s comment that a reliable third party is crucial when researching a company to invest in. As the article stated FASB has attempted to force companies to clarify on the legitimacy of their calculations on financial statements. However it appears that even to this day, FASB is still only considered a “guideline” and not a rule. It took Congress to pass the Sarbanes Oxley Act in 2002 to enforce these guidelines and hold companies accountable for their financial reporting. This is only after large corporations ruined the lives of many Americans who lost their life savings by investing in them. Large companies are too big to manage and the complexity allows room for manipulating and error. As an investor, one must have a keen eye on reading financial statements, or trust a third party to interpret what all the numbers mean. And even then, until these corporations start to be “honest” when documenting their transactions there will still be room to doubt the legitimacy of their numbers.