One of the big issues we face, as auditors, is an entity following an accounting standard for its financial statements. Which begs the question, what is an accounting standard?
The best way to look at it is that an accounting standard is the expectation of how transactions should be recorded and disclosed in financial statements. For generally accepted accounting principles, also called GAAP, this way of recording and reporting transactions is presented in the Accounting Standards Codification, or ASC’s.
Why should anyone care? That is the question we are struggling with this week. It seems that there are some, even in professional accounting, who are unsure why GAAP should be followed. I have shared with you some of our more interesting conversation with clients and their management but we have similar discussions within the profession.
The simplest answer is, eliminating confusion.
GAAP, with all its faults, is just what it says it is, generally accepted. This doesn’t mean universally accepted but it does mean that most of us agree that transactions should be recorded and reported a particular way. By agreeing, up front, on how transactions should be completed, we get rid of the guesswork and the uncertainty of everyone deciding on their own.
Yes, this is all wonderfully theoretical but the vast majority of small businesses, non-profits and HOA’s don’t care about GAAP, is the argument we hear. No doubt. But the people who put their money into it should.
On a simple level, you are approach by a friend, a contractor lets say. He wants you to be a guarantor on a project. It seems he can’t get bonding. You agree but only if you look at his financial statements so you know what you might be getting into.
He hands you a single piece of paper. On it it says,
Cash $500,000
A/R $2,500,000
Profits $3,000,000
Are you ready to sign on the dotted line to guarantee this upcoming project? If so, please write me immediately because I have an investment idea for you!
Of course you are not going to accept it. Not because you question the numbers, per se, but because you don’t understand how they came into being. In short, this is confusing isn’t it?
What would you like to know? How about how he decides to recognize his income? Perhaps how he elects to record expenses? Does he have any debts that are not on the books?
You are interested in his accounting principles. Now, if you happen to know how most (not all) contractors do accounting, you could ask something like,
Other contractors I know record revenues based on how much of the work is completed, is that how you record it? I have read several other financial statements from contractors and they all have some amount of construction costs, how do you record costs?
If everyone could pick and choose the policy they want to follow we don’t have standards. You would not have an ability to compare one company against another in the exact same industry – you would not even be able to follow a single company from year-to-year. Accounting standards enable you to do this.
Look, we know GAAP can be complex. But in all fairness, your entity is complex. If you are a retailer of candy bars and you sell for cash only, you have very simple accounting. If you take money today for work that will be done over the next three years, you created complexity. And if you do work today and allow people to pay you over the next three years but only in relationship to how effective your work is, you created a nightmare.
As a reader, you should want to know how an entity records and reports transactions. You should want to feel comfortable that a lot of other similar entities are doing the same thing. In short, you want to feel good that the financial statements you are looking at are, in fact, generally accepted.
If you don’t like GAAP, then don’t play with other people’s money. Don’t ask lenders, don’t ask investors, don’t ask me. If you are the only person who relies upon how you do the accounting do it any damn way you please. I mean, lets be honest, you won’t even look at a financial statement. You will log into your bank to see how much cash you have and make all your decisions based on that.
But if you expect others to put their faith in you, then embrace GAAP. Ensure you prepare financial statements for them to read that comply with the standards the accounting profession has provided. The standards don’t exist to make your life miserable, they exist to help you get the funding you need. Overwhelm your reader with good, actionable information and they will return the love. They may not give you money, but they will likely do what they can to help you succeed.
Because honesty and integrity are still rewarded in this world, even if it often doesn’t seem like it.
Have a great weekend. And if you are looking for an auditor or CPA firm to review your financial statements, or just help you make sure your financial statements are useful to your readers, feel free to get more information and contact us through our website. We are here to help you rely upon your management, even if that is you.
Accounting Clarity 