Essay on "Accounting Profession Towards a More User Friendly"

Essay 10 pages (3151 words) Sources: 8 Style: Harvard

[EXCERPT] . . . .

Accounting Profession

Towards a More User Friendly Financial Statement

Anyone that has ever read a financial statement is familiar with the disclaimer that begins, "This statement contains forward-looking statements" However, when one begins to read the contents of the financial statement, one soon finds that there is very little that could be considered forward-looking at all. The financial statement provides a historical look at company performance, suggesting that the future of the company will be similar to the past. However, every investor knows that this is not necessarily true. What has happened in the past may have nothing to do with the future of the company. Shocks in the market happen and companies cannot always be prepared for what is to come. This research will explore the backward-looking and forward-looking aspects of the financial statement and will support the need for better forward-looking models.

The nature of the Forward-Looking Statement

Shareholders and investors often turn to the financial statement to learn how companies have performed in the past. However, the most popular section of the financial statement is often the forward-looking statement. In this section, the managers and executives present their expectations and predictions for the future of the company. There is no standard formula for making these predictions. Every manager has their own method and set of factors that they consider in making their predictions.

Some estimates are conservative, while others are optimistic. The forward-looking statement reflects that personality and experiences of the managerial staff. One of the key tenets of the forward-looking statement is that it is only a guess. However, many investors place much more faith in the statement than it would merit.

Sometimes, investors base their entire decision on the forward-looking statement. When something happens and they do not get the return expected, or lose their investment, it often led to lawsuits in the past. In Harris v. Ivax Corporation (1999), the U.S. Court of Appeals for the Eleventh Circuit held that a company's statements in press releases were protected from liability, as long as they included the proper cautionary statements. The company does not need to accurately predict every circumstance that could occur, but they do need to address any major risks that are identified.

The "Safe Harbor" rule of the Securities Act of 1933 protects companies from losses incurred due to forward-looking statements, as long as the company had a reasonable basis for making them (Cadwalader, Wickersham, & Tact LLP 1999). Companies may not engage in deception, but they are not required to foresee every situation that could occur in the future. This makes it a caveat emptor situation on the part of the shareholder. They must trust that the information contained in the financial statement is sufficient and accurate enough to be predictive, or at least reasonably so.

Ulterior Motives

Safe Harbor offers the company some protection against litigation due to shareholder losses as a result of statements contained in the forward-looking statement. Accounting statements must comply with all elements of the Generally Accepted Accounting Practices (GAAP). This assures at least some degree of uniformity and standardization of the information contained within. The purpose of the GAAP is to make certain that everyone can read and understand the statements made in the accounting statement. This offers shareholders at least some degree of certainty about what they are reading in the statement.

However, one must realize that the GAAP is more of a set of guidelines than a set of hard, fast rules. Within the GAAP, there is some room to adjust the accounting practices to suit the specific needs of the company. For instance, there is some room for deciding what to include for direct and indirect expenditures. Differences such as these can change one's perceptions about the information contained in the statement.

Shareholders are often not sophisticated enough in their accounting knowledge to understand what all of these changes mean for the value and predictive nature of the statement. Therefore, they rely on the interpretations of others for the information that they need to make their investment decisions. Shareholders expect brutal honesty from the accountant and from the managers responsible for making those familiar forward-looking statements.

Everyone expects honest answers, but the question is, "Do they get it?" The Enron and WorldCom scandals changed the way investors, shareholders, and employees view the financial statement and accountants, in general. After unsuspecting employees lost their pensions and everything that they had managed to save, the government enacted rules that require corporations to set aside a portion of their earnings to be used for future needs, such as retirement plans and pensions. However, doing this reduces profits and can make the company look less attractive to the investor in the present (Thompson 2007).

The manager has a motive to make their company appear to be a good investment for the future. However, so many times, shareholders only look at profits now, rather than what the company is stashing away for the future. Saving for the future means having less in the present. Managers must attract investors, therefore, there is a motive to make their company appear to be more profitable than it is in reality. They are not telling untruths, they are just rearranging the numbers so that they will appear to be more attractive to the present investor.

The GAAP gives them room to do this legally in many circumstances. This is where the experienced investor has an advantage over the inexperienced investor. There is a fine line between an illegally misleading statement and one that is simply attuned to the more experienced investor. Shareholders often rely too much on the forward-looking statement to make their financial decisions.

Historical Information

Past performance of a company is no guarantee of its performance in the future. GM and Chrysler investors twenty years ago, would never have imagined that this same company would be talking bankruptcy today (Stoll and Terlep 2009). These companies were once considered the most promising and stable of investments for a secure future. Now that future is not so secure. As stock prices fall, investors are realizing that forward-looking statements are not the best crystal ball for the future.

We have discussed the caveat of relying too much on the forward-looking statement and the problems associated with using historical trends to predict the future performance of a stock as well. Most financial statements are already outdated at the time they are published. Year-end statements may not be published until the new accounting year is well underway. They many contain information that has changed considerably since they were began. The world of finance is fast-paced and what was true yesterday, may not necessarily be true tomorrow.

As a result of these two factors, shareholders are basing their decisions on information that may no longer be relevant, or on statements that may or may not come true. Shareholders and other investors have a need for information that is up-to-date and that reflects and accurate representation of the company's current financial state or potential future state. The current accounting system does neither adequately enough for the average shareholder to interpret.

The Need for Relevancy

The average investor is not an accountant in many cases. They need relevant information that is presented in a "user friendly" format. In the past, the investor often relied on a stockbroker to interpret the accounting statement and make wise investments for them. Now, many investors are making their own investments and managing their own accounts. They are reading the financial statements for themselves and making their own decisions. Yet, a number of shareholders and investors are not aware of the nuances of reading these statements. This issue has raised the question of whether a more user-friendly accounting system is needed.

The accountant can be compared to a photographer, providing a snapshot of the company and their finances. This snapshot has many nuances that can provide clues as to the financial position of the company, both in the past, and in the future. The financial statement should tell give the reader an idea of what the business does and how it operates. It should reflect business cycles and expected shocks in the business. The financial statement should tell the reader what they can expect in the future, with a certain amount of reliability, Although, no one can predict the future, it is possible to predict the most common business cycles.

The relevancy of a financial statement can change over time. When the business is experiencing the normal business cycle, with its array of expected ups and downs, the financial statement holds a considerable amount of relevancy. For example, the retail industry has a highly predictable business cycle throughout the year. Normal ups and downs are expected. Investors can use these regular cycles to their advantage. In this case, the financial statement is highly relevant and timely information. It is a useful tool in the ability to predict business cycles.

As long as the business is in a state of regular growth or… READ MORE

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