...RobFlint.co.uk

Rob Flint is a Chartered Management Accountant with a broad range of experience and skills in both management and financial accountancy.

Being a full member of the Chartered Institute of Management Accountants and currently studying towards the Association of Taxation Technicians qualification, Rob has a wealth of experience in delivering business knowledge where it matters - in the numbers.

Particular areas of specialism include, but are not limited, to:

  • Cash flow forecasting
  • Management reports and accounts
  • Budgeting
  • Personal taxation
  • Business taxation
  • Accountancy practice administration
  • Business management/strategy
  • Risk and control


Why Financial Accounting Is Neither Simple Nor Precise

Financial accounting strives to answer two basic questions: how did the business do last year, and what did the business own and owe at the end of the year?  The answer to these questions are summarised in two basic statements, which are produced by entities on an annual basis, the income statement and the balance sheet.

If you even have a passing knowledge of the business environment, answering these questions may not seem that daunting.  In fact, determining an organisation's economic performance and condition is often very difficult.  Unfortunately, financial statements rarely are able to give a completely definitive and precise answers to what seems, at first glance,  to be simple economic questions.  Why is this so?

Accounting's measurement problems derive primarily from three factors.  First, it is difficult to pin down exact criteria for measuring economic performance and condition.  Second, accounting uses money as its measurement unit, and money's unit value is not stable over time.  Third, accounting rule makers have to allow for the fact that business managers often are motivated to distort reality rather than reflect it accurately.

What is economic performance and condition?

In terms of economic performance, our simplest criterion for doing well surely involves looking at cash flow.  A business does well if it brings in more cash than it spends and vice versa.  But for all but the very simplest of businesses such a measurement approach can be hugely problematic.  Negative cash flow is not necessarily equivalent to poor economic performance.  Because of this accountants have had to develop a more abstract concept of profitability, which creates its own problems.

Accounting encounters even more difficulty in trying to pin down a firm's economic condition.  To determine this we want to find out about an organisation's assets and their values.  But there is more than one standard of value!  Should accountants use the current market values for the assets owned or the original cost in bringing the asset to use?  Rarely are these values the same and there are advantages and disadvantages to both approaches.

There is also legitimate debate over what should be counted as an asset in the first instance.  For example, should the value of human capital or other intangible assets such as goodwill, patents and trademarks, be measured and included? If they are deemed appropriate for inclusion, how do we begin to measure them?

Money: accounting's unstable measurement unit.

As discussed above, the unit of measurement in the accounting world is money.  It is the medium of exchange between parties in the business world as it can be traded for goods and services.  But, as we all know, money changes value over time.  What one pound will buy today is almost never the same as to what it could purchase a year ago or in the future.  Remember when a chocolate bar was 5p?

If a company had a net income of say 100,000 last year, was the economic performance of the entity the same as five years ago when the net income was also 100,000?  Definitely not.  The result of the weakening purchasing power of the pound puts a very different slant on the performance of that company.

Questions about economic condition are also affected by the instability of money as a unit of measurement.  Consider two companies each with 500,000 of assets and 300,000 of liabilities.  In one of the cases the company must pay its liabilities within one year whilst the second organisation only has to repay the debt in ten years time.  Are the companies in the same position?  Decidedly not.  The purchasing power of the currency will change over the 'vesting' period.

Measurement error: management's motivation for mendacity.

Measurement error is unavoidable.  But would it not be nice if we could assume that everybody involved in the accounting measurement process was highly motivated to avoid errors?  Sadly, this is not the case because business managers often wish to avoid accurate measurement if it will lead to significant damage to their career and finances.  Facing such ruin, managers will be strongly tempted to avoid fair and accurate measurement.  Window dressing anyone?

There are two important ramifications for accounting stemming from this motivational bias.  Firstly, in order for financial reports to have any credibility at all, they must be verified by an independent auditor which is a hugely expensive, imperfect and complex operation.  The best part? The companies themselves pay the auditors!  Secondly, in formulating accounting rules, the rule makers have to carefully consider how any proposed measurement procedures might be subverted by managers intent on providing a skewed view of economic performance or condition.  The rules have thus, paradoxically, become so complex as to become too difficult to distort but even harder to understand.....


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