Looking at Companies Through the Traditional Principled Accounting Lense
TPA=Traditional 'Principled' Accounting
There are principles, rules adhered to by accountants; conventions, norms, that are supposed to increase the utility of accounting statements ( http://www.accountingcoach.com/online-accounting-course/09Xpg01.html ). Important basic principles are:
ACCOUNTING REPORTS SHOULD ERR ON THE SIDE OF PESSIMIST VERIFIABILITY, VALUING ASSETS AT HISTORICAL COST
Recorded amounts ignore inflation this is historical cost method; asset amounts are historical cost not current value; potential losses from lawsuits accounted potential gains from lawsuits not accounted; inventory can be written down to below cost but not accounted as at above original cost; stocks traded on stock exchange shown at current value optionally; because the current value amount (of for example a land asset) is less RELIABLE, less VERIFIABLE, and less OBJECTIVE than the original cost, the original cost is used; accountants must choose the method that produces the more pessimistic results when two methods are applicable.
ACCOUNTING REPORTS SHOULD BE USEABLE UNDERSTANDABLE AND COMPLETE
Accounting policies and relevant info must be disclosed; when a change in methodology is introduced making a current report different from past reports reader should be notified; reports should be comparable to reports of other companies using similar methodologies; if the accountant believes the company will not fail he must say so.
TRANSACTIONS REPORTED WHEN PERFORMED NOT WHEN PAID FOR
Expenses and revenues are reported when sale is made or work is done not when sale is paid for and workers are paid; advertising expenses charged to period when ad is run;
ESTIMATES USED TO PROVIDE TIME INTERVAL ECONOMIC HISTORIES
Records use estimates to show business economic interval for short time intervals of down to a month.
COMPANY'S CONTINUED EXISTENCE ASSUMED TO ALLOW FOR COST DEFERRALS
It is assumed company will exist long enough that it can defer some expenses to future accounting periods.
TO ERR IS HUMAN
Little details can be skipped and results can be rounded off.
SEPARATION OF BUSINESS AND OWNER
Separation of owner personal finances from owner business finances.
Traditional 'Principled' Accounting (TPA) thus is like a lense whose functioning is effected by these principles, a lense through which companies are viewed. This lense in certain ways distorts matters.
Traditional Principled Accounting and Income Statements
The strictures of modern TPA, do not effect the practical utility of the Income statements showing the Net Income, and the Retained Earnings shown on the Balance sheet, except for the simple matter of adding the net income to the retained earnings. Thus the TPA lense does not distort this aspect.
Traditional Principled Accounting as a Lense to View Times Series Balance Sheets
The idea of TPA appears to be that there is something prudent and responsible, about an accounting system that tends to exaggerate the number of companies that are typical, average, balanced companies, by pumping out these balance sheets that portray lots of companies as all being in some kind of balance, with assets equalling liabilities plus stockholders equity.
With the TPA lense, asset values are marked down as depreciating but never marked up as appreciating, the most they can be marked up to is their historical cost. This results when time series balance sheets are analyzed through the TPA lense, in companies that are actually worse than the accounting reports make them seem to be, not being noticed as actually being worse, and even more than this, companies that are actually better than they seem to be looking like average companies.
The idea of the TPA lense seems to be to focus like a laser on certain aspects of a company regarding which there is a relatively high degree of confidence that what is judged about the company is true. Thus the companies that emerge to look especially good when when observed through the TPA lense, are companies regarding which one can have a high degree of confidence that the company is in good shape. The TPA lense however misses details because bad companies look good and good companies look bad, but nevertheless the TPA lense shines the light on companies regarding which one can say with a high degree of confidence that they are healthy companies.
Because the TPAlense tosses out changes in asset values based on events having nothing to do with the performance of the business in question; because it tosses out changes in stockholder equity value that are based on human supposition regarding future performance; because it tends towards the pessimistic take on a company it looks at, the TPA lense focuses like a laser on qualities that with a high degree of certainty reflect excellence in the company. When you see a company whose time series balance sheets as observed through a TPA lense over a period of years show steady improvement, you can be relatively certain that it is a strong company.
Yet even in attempting to do what it attempts to do, the TPA lense, is imperfect. Example: "gain on sale of land", land being sold for more than its historical cost, is included in the equation that produces net income--which is something the TPAlense should not do if it really wants to do what it is made for, well.
Traditional Principled Accounting as Exaggerator of Net Income & Retained Earnings vs Assets/Liabilities Ratio
One of my estimates re how the numbers produced by the TPA lense should be used to measure company performance is as follows: (NI+RE)/(L + A) where NI=Net Income; RE=Retained Earnings; A= non-cash assets; L=liabilities. The bigger the number produced the better the company is doing in the present sense in terms of its ability to turn what assets it has, into income. The bigger the company's liabilities, the lower this number will be. Sound counter-intuitive because the opposites assets and liabilities are treated the same way but there you have it. When this formula is used with numbers produced by the TPA lense, the result will be an exaggeration of the extent to which the company produces income relative to its assets and liabilities, because the TPA lense undervalues assets.
@2006 David Virgil Hobbs
There are principles, rules adhered to by accountants; conventions, norms, that are supposed to increase the utility of accounting statements ( http://www.accountingcoach.com/online-accounting-course/09Xpg01.html ). Important basic principles are:
ACCOUNTING REPORTS SHOULD ERR ON THE SIDE OF PESSIMIST VERIFIABILITY, VALUING ASSETS AT HISTORICAL COST
Recorded amounts ignore inflation this is historical cost method; asset amounts are historical cost not current value; potential losses from lawsuits accounted potential gains from lawsuits not accounted; inventory can be written down to below cost but not accounted as at above original cost; stocks traded on stock exchange shown at current value optionally; because the current value amount (of for example a land asset) is less RELIABLE, less VERIFIABLE, and less OBJECTIVE than the original cost, the original cost is used; accountants must choose the method that produces the more pessimistic results when two methods are applicable.
ACCOUNTING REPORTS SHOULD BE USEABLE UNDERSTANDABLE AND COMPLETE
Accounting policies and relevant info must be disclosed; when a change in methodology is introduced making a current report different from past reports reader should be notified; reports should be comparable to reports of other companies using similar methodologies; if the accountant believes the company will not fail he must say so.
TRANSACTIONS REPORTED WHEN PERFORMED NOT WHEN PAID FOR
Expenses and revenues are reported when sale is made or work is done not when sale is paid for and workers are paid; advertising expenses charged to period when ad is run;
ESTIMATES USED TO PROVIDE TIME INTERVAL ECONOMIC HISTORIES
Records use estimates to show business economic interval for short time intervals of down to a month.
COMPANY'S CONTINUED EXISTENCE ASSUMED TO ALLOW FOR COST DEFERRALS
It is assumed company will exist long enough that it can defer some expenses to future accounting periods.
TO ERR IS HUMAN
Little details can be skipped and results can be rounded off.
SEPARATION OF BUSINESS AND OWNER
Separation of owner personal finances from owner business finances.
Traditional 'Principled' Accounting (TPA) thus is like a lense whose functioning is effected by these principles, a lense through which companies are viewed. This lense in certain ways distorts matters.
Traditional Principled Accounting and Income Statements
The strictures of modern TPA, do not effect the practical utility of the Income statements showing the Net Income, and the Retained Earnings shown on the Balance sheet, except for the simple matter of adding the net income to the retained earnings. Thus the TPA lense does not distort this aspect.
Traditional Principled Accounting as a Lense to View Times Series Balance Sheets
The idea of TPA appears to be that there is something prudent and responsible, about an accounting system that tends to exaggerate the number of companies that are typical, average, balanced companies, by pumping out these balance sheets that portray lots of companies as all being in some kind of balance, with assets equalling liabilities plus stockholders equity.
With the TPA lense, asset values are marked down as depreciating but never marked up as appreciating, the most they can be marked up to is their historical cost. This results when time series balance sheets are analyzed through the TPA lense, in companies that are actually worse than the accounting reports make them seem to be, not being noticed as actually being worse, and even more than this, companies that are actually better than they seem to be looking like average companies.
The idea of the TPA lense seems to be to focus like a laser on certain aspects of a company regarding which there is a relatively high degree of confidence that what is judged about the company is true. Thus the companies that emerge to look especially good when when observed through the TPA lense, are companies regarding which one can have a high degree of confidence that the company is in good shape. The TPA lense however misses details because bad companies look good and good companies look bad, but nevertheless the TPA lense shines the light on companies regarding which one can say with a high degree of confidence that they are healthy companies.
Because the TPAlense tosses out changes in asset values based on events having nothing to do with the performance of the business in question; because it tosses out changes in stockholder equity value that are based on human supposition regarding future performance; because it tends towards the pessimistic take on a company it looks at, the TPA lense focuses like a laser on qualities that with a high degree of certainty reflect excellence in the company. When you see a company whose time series balance sheets as observed through a TPA lense over a period of years show steady improvement, you can be relatively certain that it is a strong company.
Yet even in attempting to do what it attempts to do, the TPA lense, is imperfect. Example: "gain on sale of land", land being sold for more than its historical cost, is included in the equation that produces net income--which is something the TPAlense should not do if it really wants to do what it is made for, well.
Traditional Principled Accounting as Exaggerator of Net Income & Retained Earnings vs Assets/Liabilities Ratio
One of my estimates re how the numbers produced by the TPA lense should be used to measure company performance is as follows: (NI+RE)/(L + A) where NI=Net Income; RE=Retained Earnings; A= non-cash assets; L=liabilities. The bigger the number produced the better the company is doing in the present sense in terms of its ability to turn what assets it has, into income. The bigger the company's liabilities, the lower this number will be. Sound counter-intuitive because the opposites assets and liabilities are treated the same way but there you have it. When this formula is used with numbers produced by the TPA lense, the result will be an exaggeration of the extent to which the company produces income relative to its assets and liabilities, because the TPA lense undervalues assets.
@2006 David Virgil Hobbs
posted by David Virgil at 9:04 AM
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