A return to basics

National Public Accountant, The, Dec, 1990 by Anthony L. Tocco, Christina L. Vierling

A Return to Basics

Realized vs. realizable, historical cost vs. replacement cost, LIFO vs. FIFO, straight-line depreciation vs. accelerated depreciation. This list, while not all inclusive, has led to some of the most hotly debated issues - accounting for income taxes and accounting for retiree health care benefits - currently facing contemporary accounting today.

While the determination and reporting of income is the primary concern of the financial accountant today, it also creates the most troublesome problems. The figures obtained by any two accountants, even under identical circumstances, will rarely ever be exactly the same. There are two basic reasons for this: 1. Accounting is primarily and

always will be an art and not

a science. It deals with and is

based on fair estimates and

sound judgment. 2. Despite the many regulations,

recommendations and opinions

issued by the various

regulatory bodies, there still

remain many gray areas for

the exercise of the accountant's

professional judgment.

An example might best illustrate the dilemma of contemporary accountants. Suppose two accountants compute net income for a firm. Accountant A employs straight-line depreciation and the FIFO method of inventory pricing and computes net income to be $500,000. Accountant B uses an accelerated depreciation method and the LIFO method of valuing inventories and determines net income to be $300,000. One might ask which accountant is right? According to contemporary accounting, both are right because both followed accepted methods of accounting.

Income Determination - A

Ritual

The important concept in the determination of income is not the bottom line but rather the ritual used in obtaining the bottom line. Both accountants in the above example followed the ritual of inventory accounting and depreciation accounting. But suppose the president of the firm makes an estimate of net income at $400,000. He bases his estimate on recent sales, cash receipts and disbursements, current inventories, etc. According to contemporary accounting procedures this figure is wrong. Even though it falls well within the range of the figures already presented, it is incorrect because the president didn't go through the ritual prescribed by accountants.

One might well ask, why is contemporary accounting so replete with ritual? The first reason is the way in which accounting has evolved from simple bookkeeping for simple firms to complex accounting for complex corporations. The second reason is the fiscal period hypothesis: because accounting has adopted an arbitrary time span, its reporting techniques must be based on a fiscal year rather than on business decisions.

Logic vs. Random Choice

The implication here is not that there should be one set of procedures to be followed in determining net income, but that there should be some logic for selecting the individual procedure followed in particular circumstances. To date, the contemporary accountant has only to choose an accepted method of depreciation or inventory valuation and apply it on a consistent basis, regardless the best choice among the alternatives available. It is questionable that the objective of accounting is being achieved through this random selection of alternatives.

Objective of Accounting

The primary objective of good accounting is that it be useful. As obvious as this may seem, the contemporary accountant has become so engrossed in the details and intricacies of his profession that he may not realize that the users of accounting data are paying less and less attention to his work.

This premise can be substantiated by selecting the annual report of most any firm and observing the number of footnotes and interpretive comments attached to the financial statements. While it is true that a word or two can often throw new light and meaning on a financial statement, one must question whether the statements fulfill their purpose when the number of words and figures in the footnotes exceeds those in the statements! If an artist drew a picture on the top half of his canvas and then had to explain nearly every detail on the bottom half of the canvas, surely he would begin anew. As accountants we must do the same.

Recommendation

If financial statements are not meeting their objectives, particularly in the art of income determination, it is due to something major and fundamental which approaches the very essence of the financial statements. It is not something related to the methods or techniques or even to the principles, but rather it is related to the conceptual framework of accounting.

For many years accounting has been accused of putting the cart before the horse; it is now time to rectify this position. Accountants should develop a conceptual framework upon which accounting principles and opinions can rest. Through the development of a framework, the accounting profession can develop a preventive approach - avoiding problems before they occur - rather than a remedial approach - attempting to correct problems after they have already surfaced.