| The Unresolved Flaws in Financial Accounting | | | | be disappointed to find out later that in trying to |
| The users of accounting information include | | | | collect on the accounts receivable only one-third |
| company owners, managers, investors, creditors, | | | | was actually obtained. This weakness was the |
| and government agencies. It is generally | | | | reason of the now defunct cash basis versus the |
| acknowledged that most financial reporting is | | | | current accrual basis. In the cash basis accounting, |
| “primarily externally oriented” and most of | | | | revenue or expenses were recorded when actual |
| the users are nonaccountants who get frustrated | | | | units of measurement (money) exchanged |
| trying to understand the statements. Since they | | | | hands. |
| are not part of the management team, they | | | | SUBJECTIVE vs. OBJECTIVE REPORTING: |
| more or less are looking from the outside in. | | | | A greater existing flaw in financial accounting is |
| Despite the many accounting associations from | | | | the subjective latitude given to accountants |
| the Accounting Principles Board to the American | | | | preparing financial statements to use their |
| Institute of Certified Public Accountants to the | | | | “professional” judgment. This flaw gives |
| Financial Accounting Association that established | | | | some accountants the latitude to manipulate |
| the Financial Accounting Standards Board, there | | | | reports as we witnessed in the Enron debacle of |
| continues to be alternative ways of reporting | | | | 2001. Business transactions between entities, |
| which adds to the confusion and limitations of | | | | people or business, are concrete events that are |
| financial reporting. | | | | recorded. In the Unites States for example, the |
| Recognizing and Reporting Methods: | | | | unit for measuring these events is the dollar. As a |
| FIFO vs. LIFO: | | | | result, there should be no basis subjective |
| FIFO and LIFO are two of the major methods of | | | | judgment when reporting an empirical event or |
| reporting transactions. Because these are | | | | transaction. It is odd that different accountants |
| alternative methods left to the discretion of the | | | | should reach different acceptable conclusions for |
| entities, two similar companies in the same | | | | the same event. This creates room for more |
| industry could report the same transactions for | | | | questions and further skepticism from the public. |
| similar goods and arrive at two separate | | | | As a quantifiable unit of measurement, a dollar |
| conclusions. The FIFO method assumes that | | | | amount should always be the same no matter |
| earliest goods purchased are the first to be sold. | | | | how it is reported. |
| The LIFO method assumes that the latest goods | | | | LESSONS FROM OTHER DISCIPLINES: |
| purchased are the first to be sold “as a result | | | | ECONOMICS |
| the first cost assigned to ending inventory are the | | | | The above mentioned flaws do not exhaust the |
| costs of the beginning inventory.” So goods | | | | list of limitations of financial statements which |
| purchased in September can be included in a prior | | | | among others include quantitative versus |
| month’s cost of goods sold. This method, | | | | qualitative values in reporting; the principle of cost |
| though acceptable alters final reporting for better | | | | which does not reflect current market value after |
| or for worse. | | | | an asset is purchased; and the inability to compare |
| ACCRUAL vs. CASH: | | | | firms in the same industry because of different |
| Under current generally accepted accounting | | | | reporting methods for example Coke and Pepsi. |
| principles, financial accounting is backward looking. | | | | Economists have their share of inconsistencies, |
| By reporting past transactions that rely on accrual | | | | most of them over the future effects of policy. |
| accounting to conform to the matching principle, | | | | Financial reporting however is backward looking. It |
| financial statements do not account for how | | | | reports events that already took place. But when |
| much of the outstanding debit accrued under | | | | it comes to measuring quantitative values, the |
| accounts receivable will actually be collected. This | | | | kind accountants handle in reporting, economists |
| could mislead non accountants into over | | | | have a more unified angle from which to measure |
| estimating assets in the immediate period after | | | | transactions. For example, in computing the price |
| the release of a report because the adjustments | | | | elasticity of demand which measures the |
| due to non collection are done much later. In this | | | | responsiveness of quantity demanded to a |
| scenario, a report released at the end of the year | | | | change in price, economists realized that the price |
| may project that a firm has $10,000.00 in | | | | elasticity going from point A to point B was not |
| accounts receivable. That projects $10,000.00 | | | | the same with going from point B to point A, a |
| more in the asset column of the firm. This may | | | | mathematical approach. So they developed the |
| give a more positive outlook when in actuality the | | | | midpoint method for measuring elasticity which |
| firm may end up recouping only $3,000.00 of its | | | | gives the same answer regardless of the direction |
| account receivable. An investor attracted to the | | | | of change. |
| company on the basis of its strong outlook may | | | | |