The Unresolved Flaws in Financial Accounting

The users of accounting information include company owners, managers, investors, creditors, and government agencies. It is generally acknowledged that most financial reporting is "primarily externally oriented" and most of the users are non accountants who get frustrated trying to understand the statements. Since they are not part of the management team, they more or less are looking from the outside in.

Despite the many accounting associations from the Accounting Principles Board to the American Institute of Certified Public Accountants to the Financial Accounting Association that established the Financial Accounting Standards Board, there continues to be alternative ways of reporting which adds to the confusion and limitations of financial reporting.

Recognizing and Reporting Methods:

FIFO vs. LIFO:

FIFO and LIFO are two of the major methods of reporting transactions. Because these are alternative methods left to the discretion of the entities, two similar companies in the same industry could report the same transactions for similar goods and arrive at two separate conclusions. The FIFO method assumes that earliest goods purchased are the first to be sold. The LIFO method assumes that the latest goods purchased are the first to be sold "as a result the first cost assigned to ending inventory are the costs of the beginning inventory." So goods purchased in September can be included in a prior month's cost of goods sold. This method, though acceptable alters final reporting for better or for worse.

ACCRUAL vs. CASH:

Under current generally accepted accounting principles, financial accounting is backward looking. By reporting past transactions that rely on accrual accounting to conform to the matching principle, financial statements do not account for how much of the outstanding debit accrued under accounts receivable will actually be collected. This could mislead non accountants into over estimating assets in the immediate period after the release of a report because the adjustments due to non collection are done much later. In this scenario, a report released at the end of the year may project that a firm has $10,000.00 in accounts receivable. That projects $10,000.00 more in the asset column of the firm. This may give a more positive outlook when in actuality the firm may end up recouping only $3,000.00 of its account receivable. An investor attracted to the company on the basis of its strong outlook may be disappointed to find out later that in trying to collect on the accounts receivable only one-third was actually obtained. This weakness was the reason of the now defunct cash basis versus the current accrual basis. In the cash basis accounting, revenue or expenses were recorded when actual units of measurement (money) exchanged hands.

SUBJECTIVE vs. OBJECTIVE REPORTING:

A greater existing flaw in financial accounting is the subjective latitude given to accountants preparing financial statements to use their "professional" judgment. This flaw gives some accountants the latitude to manipulate reports as we witnessed in the Enron debacle of 2001. Business transactions between entities, people or business, are concrete events that are recorded. In the Unites States for example, the unit for measuring these events is the dollar. As a result, there should be no basis subjective judgment when reporting an empirical event or transaction. It is odd that different accountants should reach different acceptable conclusions for the same event. This creates room for more questions and further skepticism from the public. As a quantifiable unit of measurement, a dollar amount should always be the same no matter how it is reported.