What is Hit On and Missed By Traditional Accounting
Traditional accounting's emphasis on balance sheet, income statement, and statement of cash flows, comes down to an emphasis on the diference between: things owned including current cash and future agreements based differences based income & costs/expenses,and things owed.
Without cash on hand a business is in danger of collapse or requiring expensive loans, no matter how much is owed by customers for services rendered or goods sold and no matter how little is owed by the business to others. The big controversy ad focus of interest appears to be whether certain aspects should be accounted on the cash or on the accrual basis.
This traditonal common modern kind of accounting provides artificial incentives based on illusions, that incorrectly encourage business managers to sell off assets that have appreciated and have been valued at cost when purchased and will be valued at the new cost of sale when sold. Because the appreciated asset has been undervalued, its sale will make the company look good by traditional accounting standards. Though the right thing to do might be to hold on to the asset, the temptation is to sell it because the traditional accounting report will make a D grade performance next year look like an A due to the sale of the asset. In real terms the asset may not have appreciated much since it was bought, but the combination of real price if it is sold combined with the exaggeratedly low last historical cost when bought, makes the asset seem as if it has suddenly via the manager's green thumb evinced in selling it, appreciated more than it has. Wise business judgement decrees releasing an asset when it has appreciated to a certain level--the traditional accounting distorts the perception re when this level of appreciation has been reached.
Likewise this kind of accounting creates artificial illusory pressures which could result in the procrastination of the sale of a depreciating asset. A piece of land that was bought 10 years ago for $100k but is now worth only $20K on the market but has in the accounts been valued at cost meaning $100k should perhaps be sold, the loss eaten lest things get worse. But the manager will be tempted to hold on to the depreciating asset, because if he does, things will LOOK $80K better than they will look if he sells the asset.
Traditional accounting being guilty of creating illusion re sale of owned assets, when a thing is bought held on to and then sold by the accounted for company, you can count on it being guilty with regards to the charge of foolishly ignoring the changes in value of things sold by the accounted for company to others that the accounted for company later needs to buy. A company could sell something off, be surprised to watch it gain in value, and then have to buy at a high price that same thing it sold, when it could have saved money if it had never sold the thing in the first place. A wise guy could sell some company property off, then watch it plummet in value to a worth much less than the money obtained from its sale, and smirk about his good business sense. Clever as he may indeed have been the wiseguy's wisdom will not show up in the books.
Nobody bothers with tracing how things that have been sold by the accounted for company have changed in value do they? But they care alot about how things that have been bought have changed in value.
Similarly with liabilities such as loans, for example if a company borrowed a bar of gold 20 years ago, and agreed to return the bar of gold, and has some latitude re when to return it, and the bar of gold has increased or decreased in value, it is possible to imagine how the traditional accounting based mind could make a wrong decision.
It is hard to imagine traditional accounting or the managerial mind as influenced by traditional accounting being reasonable re something like the borrowed bar of gold, still, then again if traditional accounting chose to value the returned bar of gold at what it was worth when first borrowed, at the time when it was returned, and the bar of gold had appreciated or depreciated in value, traditional accounting might tempt some to stray.
I can see how traditional accounting, could pressure managers to get things looking good by the books, by indulging in all kinds of untimely and unnecessary sales and purchases of assets: an appreciated asset that has been valued at $20k historical cost for 20 years is sold for $40k, the $40k is used to replace the asset that was sold; the books show it as a clever chess move when actually time and energy was spent merely selling something and then replacing it with something that is the same thing as the thing sold and worth the same amount.
All this has nothing to do with whether things are looked at through the accrual (income statement) or cash (statement of cash flows) lense.
The manner in which assets and liabilities effect net income, which is at the heart of the combo that is the balance sheet, income statement, and statement of cash flows, also generally has relatively little to do with the accrual or cash approach.
Thus you can count on the traditional accounting based mind failing to fully map the connections between assets and liabilities held historically on the one hand and net income on the other.
@2006 David Virgil Hobbs
Without cash on hand a business is in danger of collapse or requiring expensive loans, no matter how much is owed by customers for services rendered or goods sold and no matter how little is owed by the business to others. The big controversy ad focus of interest appears to be whether certain aspects should be accounted on the cash or on the accrual basis.
This traditonal common modern kind of accounting provides artificial incentives based on illusions, that incorrectly encourage business managers to sell off assets that have appreciated and have been valued at cost when purchased and will be valued at the new cost of sale when sold. Because the appreciated asset has been undervalued, its sale will make the company look good by traditional accounting standards. Though the right thing to do might be to hold on to the asset, the temptation is to sell it because the traditional accounting report will make a D grade performance next year look like an A due to the sale of the asset. In real terms the asset may not have appreciated much since it was bought, but the combination of real price if it is sold combined with the exaggeratedly low last historical cost when bought, makes the asset seem as if it has suddenly via the manager's green thumb evinced in selling it, appreciated more than it has. Wise business judgement decrees releasing an asset when it has appreciated to a certain level--the traditional accounting distorts the perception re when this level of appreciation has been reached.
Likewise this kind of accounting creates artificial illusory pressures which could result in the procrastination of the sale of a depreciating asset. A piece of land that was bought 10 years ago for $100k but is now worth only $20K on the market but has in the accounts been valued at cost meaning $100k should perhaps be sold, the loss eaten lest things get worse. But the manager will be tempted to hold on to the depreciating asset, because if he does, things will LOOK $80K better than they will look if he sells the asset.
Traditional accounting being guilty of creating illusion re sale of owned assets, when a thing is bought held on to and then sold by the accounted for company, you can count on it being guilty with regards to the charge of foolishly ignoring the changes in value of things sold by the accounted for company to others that the accounted for company later needs to buy. A company could sell something off, be surprised to watch it gain in value, and then have to buy at a high price that same thing it sold, when it could have saved money if it had never sold the thing in the first place. A wise guy could sell some company property off, then watch it plummet in value to a worth much less than the money obtained from its sale, and smirk about his good business sense. Clever as he may indeed have been the wiseguy's wisdom will not show up in the books.
Nobody bothers with tracing how things that have been sold by the accounted for company have changed in value do they? But they care alot about how things that have been bought have changed in value.
Similarly with liabilities such as loans, for example if a company borrowed a bar of gold 20 years ago, and agreed to return the bar of gold, and has some latitude re when to return it, and the bar of gold has increased or decreased in value, it is possible to imagine how the traditional accounting based mind could make a wrong decision.
It is hard to imagine traditional accounting or the managerial mind as influenced by traditional accounting being reasonable re something like the borrowed bar of gold, still, then again if traditional accounting chose to value the returned bar of gold at what it was worth when first borrowed, at the time when it was returned, and the bar of gold had appreciated or depreciated in value, traditional accounting might tempt some to stray.
I can see how traditional accounting, could pressure managers to get things looking good by the books, by indulging in all kinds of untimely and unnecessary sales and purchases of assets: an appreciated asset that has been valued at $20k historical cost for 20 years is sold for $40k, the $40k is used to replace the asset that was sold; the books show it as a clever chess move when actually time and energy was spent merely selling something and then replacing it with something that is the same thing as the thing sold and worth the same amount.
All this has nothing to do with whether things are looked at through the accrual (income statement) or cash (statement of cash flows) lense.
The manner in which assets and liabilities effect net income, which is at the heart of the combo that is the balance sheet, income statement, and statement of cash flows, also generally has relatively little to do with the accrual or cash approach.
Thus you can count on the traditional accounting based mind failing to fully map the connections between assets and liabilities held historically on the one hand and net income on the other.
@2006 David Virgil Hobbs
posted by David Virgil at 3:38 AM
0 Comments:
Post a Comment
<< Home