accounting standards

Sadly I am not allowed to say too much about today’s meeting as the board was in executive session but the gist of the other accountant’s opinion is that economic reality doesn’t matter only the legal form of a transaction.

Really?

When pressed about how that could possibly be the case since contractors obviously have earned a certain amount of revenue based upon an economic theory, the reply was, “Well you can’t confuse for profit with non-profit.”

Really?

When asked how, when a contract shows the total amount due or, if you elect you can pay a sum each month over XXX number of months and it includes interest at Y%, this someone does not create a sum certain for accounting purposes, there is not somehow some understanding that the sum certain is a receivable, the replay was, “The contract says it is revenue only upon the payment of the monthly amount.”

Really?

The board naturally is confused. Rightly so. Two professionals, two different opinions, one type of transaction.

Except that one professional has a position backed up by research on the application of GAAP and how the Accounting Standards Codifications call for the transactions to be recorded. The other is an opinion based upon his 30+ years of experience so he doesn’t need to know GAAP.

Honestly, if I were the board I would fire us both. Me for yelling at a dumbass accountant who thinks that if he appeases his fired client he will continue to reap referrals and the other accountant for being a dumbass and trying to provide accounting 101 lessons.

I was wrong to lose my temper. At the end of the day the treatment we selected is appropriate and consistent with GAAP. But there was almost $2,500 of billing listening to a lecture of how debits are on the left and credits are on the right. I was infuriated not for myself but the fact that these board members have owned and run businesses, sat on boards and really do understand the basics of accounting theory. They paid $2,500 to listen to a self-proclaimed expert prattle on how form matters over substance.

Each person in the room understands that Enron happened. That WorldCom cost them and their friends dearly. When no matter how you cut it, you can’t incur an expense without the expectation that there exists a pool of resources to pay the attendant liability. And one expects their financial statements to reflect the reality of that situation.

GAAP exists for a reason. GAAP doesn’t reflect – or rather should not reflect – the mere form of a transaction. GAAP reflects economic reality. And it does matter. Because the next time you go to buy a home and you look at the books and it shows zero receivable from the owners and a bank liability of any amount, please understand, you are likely facing a special assessment only no one wants you to know. And, had those books been properly kept on GAAP, you would have known the problem exists. You probably still would have bought but at least you won’t be able to say (with a straight face) that you weren’t warned. Which is the whole point of a financial statement anyways – to help you make better investing decisions.

So, GAAP is GAAP. If you are bothered by the fact that your accounting is complex, look to the reality of your transaction as it is likely complex. The further you get from doing work and billing for it, the more complex you make accounting in addressing your transactions. Don’t blame the accountants… We are simply the messengers.

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.

Tag: accounting standards

Why GAAP matters