Category Archives: Accrual Accounting

Every one of us is familiar with the adage honesty is the best policy. In business honest behavior can be profitable in the long run. The only question that remains is how to quantify honesty and ethics. Till not so long ago, investors used the financial statements and the history to measure a firm’s future performance. However, as stated in the article investors lost billions of dollars by using this measure because the numbers on the financial statements were easy to play with. Accrual accounting was adopted so that the financial implications of a transaction were reflected on the statements as soon as the transaction took place. However, I believe it is the fair value accounting (FVA) that made comparisons and future estimations more reasonable.

The article sights that the reason people do not advocate FVA is because they believe it will add to accounting inaccuracies. May be FVA predicts future performance inaccurately but is estimation the only thing for which FVA is useful. I don’t think so. For example, as an investor I would prefer to have a current value of all the assets and liabilities for the firm I choose to invest and FVA definitely serves my purpose. FVA also helps the managers to divert a firm’s working capital appropriately according to current market conditions which in turn would reduce operational risks. Irrespective of what the antagonists say, I would consider myself as a proponent of FVA. Fair value accounting is the best method to determine future performance of a firm if the subjective factors associated with it are taken care off. Subjective factors include but are not limited to analyzing risk characteristics and return on investments. There are many cases in which the managers used FVA as a tool to inflate financial statements but it’s due to lack of internal controls. This could be avoided with proper auditing.

I think FASB‘s decision to devise a hierarchy for FVA is crucial. David Bianco’s concern could be alleviated if firms explicitly add footnotes stating their assumptions while calculating the fair value for instruments of lower hierarchy. Finally I consider accounting to be highly subjective but this should never be a reason for not using FVA. On the other hand, objective factors such as production costs, inventories should be strictly monitored to get closer to actual estimates.



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.