A Topdown View of Financial Reporting

To some respected people, especially fellow Accountants, the following extract might offend, but I make no apologies. I fully justify my views instead.

Given that Accounting can be extremely complex, even mind bending at times. Certain areas, like taxation planning can be a minefield. Indeed, only the skillful accountant can guide you through. I will not mention taxation, finance or other issues out there that are all the trend. The ever changing man made tax laws for each and every different country may mean a good team is vital. I will talk about all this another day.

Financial Reporting then. This is essential how we must officially report our end of year company results to the wider interested public, including the Tax man. He is more interested in abiding by rules, workings and paying on time.

I had to do some teaching once, and asked the students to imagine a simple mill on a river. We assume a basic money system with no inflation.  The mill turns and it produces bread. It sells the bread, perhaps on credit or cash, it buys wheat bushels on credit to grind, has employees running around, incurs expenditure on repairing the mill, and has a host of other expenses. In short we have a business.

If you step back far enough, any business, JP Morgan, Procter & Gamble or Tesco all look the same. (Stepping back used to be a major problem for me, but I have learnt it to be a vital Life skill)

Company investors want to produce a document that reflects “the state of affairs”. Problems are inherent from the outset. If the bread is sold on credit, should we show the bread as being sold even though we do not have the money as yet. We have bought some bushels of wheat, but they are substandard and we want our money back. The supplier says it’s too late. How do we show this? The business owes money for repairing the mill stone, but has not paid as yet. To show this now or when the business can afford to pay in maybe a year? Herbert an old disgruntled employee wants a bigger cut of the profits because he used to work harder than the rest. He is going to take back is cart and horse that he lent the business if not compensated. Should we somehow show this too?  The old barn needs a lot of repair work otherwise the business will have to stop soon. The people downstream complain that we should pay for the pollution we cause, since the fishes have left and they find it hard to survive. All these questions require a solution on paper.

How exactly should we show all this is the subject of Financial Reporting. The variation of subjective opinion give rise to different Accounting conventions and standards, that have seen some movement over time. Every country has seen it slightly differently. In the UK, we used to have SSAP, (Statement of Standard Accounting Practice), which were superseded with FRS’s, Financial Reporting Standards. Now a lot of countries have adopted IFRS’s, International Financial Reporting Standards, some have not.

All are ways in dealing with fundamental issues. They attempt to codify a solution to the predictable and the unpredictable scenario. Rules that govern how we should show the manifest and the un-manifest.

As accountants, we must subscribe to these conventions that are generally accepted after some debate, so that we can compare companies historically with themselves, and with the results of other companies.

One can get lost in it’s complexity once more, but the moral of the story is to step back and keep doing so until you see the mechanics clearly.

Vishal – VNAccounting.Com

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