Modern methods of doing business are complicated. In the corporate world, the investors, executives, as well as board members, rely on numbers to make estimates of the timing, magnitude, and uncertainty related to cash flows. Such estimates help them to make wise decisions pertaining to investments in a company, acquiring a company or business. Such estimates also help in promoting appropriate capital allocation.
However, in the real world, the picture is totally different. The first corporate financial statements depend on proper estimates and they depend on honest judgment calls. The Second-standard financial-metrics help to do comparisons between companies but they may not be accurate in judging the value of a particular company. There may be instances when executives and managers deliberately inject errors into different financial statements.
Over a period of time there occurred many reforms in corporate accounting, however, it is still murky. In recent times a number of online platforms have emerged and they have dramatically changed the business competitive environment. In recent years, financial reporting is mostly guided by new rules governing revenue recognition, continuous expansion of unofficial performance measures.
Financial reporting in companies is often not accurate. There exist practices of manipulating the operating decisions that create financial reporting. In the accounting profession, finding ways and means to reduce such behavior is a challenge.
Problems in Financial Accounting
Following discusses in detail the various problems in financial accounting:-
Adoption of Universal Standards
A single set of international accounting standards was created many years ago with the objective of uniting the U.S Generally Accepted Accounting Principles or GAAP and the International Financial Reporting Standards or IFRS practiced by European nations. However, the adoption of universal standards has some challenges and they include comprehending the actual value of a firm, comparing various company accounts across countries.
However, in this context, it is important to say that the implementation of IFRS regulations varies from one country to another. Observations reveal that each country has its own set of IFRS regulations. In many countries the compliance, as well as enforcement, is weak. The independence and quality of the accounting profession are often not up to the mark.
Revenue recognition is important and tricky in the corporate world. When certain products are sold in the market then it may be difficult to determine the profits that are generated from the product sale.
Under the new GAAP rules, if there exists no objective way to calculate product costs in advance, a business is not permitted to do recording revenue from sales until the different upgrade requirements are delivered and the cost of the upgrades are known. Observation reveals that determining the costs of the upgrades can take a few years. Many are of the opinion that such type of a system can result in accounting rules influencing the way business is done. However, there are several shortcomings of the revenue-recognition system and the shortcomings obliged companies to use unofficial practices to report financial performance. Businesses and companies are trying to incorporate new and effective revenue recognition standards under the GAAP and IFRS.
Unofficial Earnings Measures
All types of businesses are using non-GAAP and non-IFRS measures of earnings for a long period of time. One of the popular ways is the EBITDA which is a favorite among the private investors as it is known to be quite useful in the corporate world.
However, in this regard, it is to acknowledge that the alternative measures are usually idiosyncratic. Investors, accountants in U.K and analysts require exercising caution in interpreting unofficial earnings measures and they should look closely at different corporate explanations that may depend on managerial judgments.
Fair Value Accounting
Investors, accountants in U.K and executives rely on two measures to determine a firm’s asset values. First one is the original price that is paid and that can be the acquisition cost. Secondly, a fair value which is the amount the assets bring if they are sold today. During the financial crisis that occurred a few years back, the objective was to guide the auditors on the methods of determining the fair value. However, in those days, the result was quite confusing. The measurement process was quite controversial and was difficult.
Over-provisioning and Under-provisioning
Analysts, accountants in U.K, investors often focus on the manner in which the costs are accrued in a company’s reports. The managers often overstate expenses deliberately and that they do to fulfill certain objectives. They often choose to under-provision of an expense or a loss. Recent alterations with GAAP and IFRS rules have made overprovisioning and under-provisioning activities less egregious. Many believe that recent changes in regulations have weakened companies’ ability to manipulate various financial reports. Nowadays, managers try to alter numbers by manipulating the operations instead of the reports.
New Analytical Tools Helps
Nowadays, investors, accountants in U.K and company board members are more responsible as they comprehend well that manipulating operating decisions to report higher earnings in the short-term can compromise the company’s long-term competitiveness. With the changes in accounting regulations, accounting fraud is a story of the past. Nowadays, since fudging in accounting reports is very rare, the focus is on to ensure that the investors, directors are more transparent on the various operating decisions that can adversely affect accounting reports. The various new techniques are being used by the investors and the analysts.
Yet another tool for detecting unscrupulous accounting practices is the verbal cues. There are many words as well as practices that are used to detect unscrupulous practices.
Observations reveal that the financial result manipulation is prevalent in the early part of a CEO’s tenure in the office and it diminishes with time. Early years of a CEO’s tenure are periods of great uncertainty about the ability of the CEO. Sometimes, if the CEO’s engage in corrupt practices then they may distort earnings with the objective to keep their jobs. In any business, the board members, as well as the investors, require to be extremely vigilant regarding a company’s accounting practices whenever a new CEO assumes office.
In recent times, observations suggest that more and more auditing firms across the world are failing to execute their duties. Firms like Carillion and House of Fraser are not up to the mark as far as financial reporting is concerned. They often fall short of the standard quality and because of which they are quite ill famous and unpopular. Online contents on these two firms speak volumes of their inefficiency and shortfalls. Many raise doubts on the smooth functioning of the firms because every now and then these firms give a picture that they are shutting down. For additional detail regarding financial reporting and why it falls short often, visit relevant resources available online.