ACCOUNTING NOISE 5: Cooking the Books
Any company that is not conservative in the reporting of its revenues and expenses is engaging in “accounting noise.”
Proper financial statements should be able to provide the following information about the business:
Feedback. The information from the Financial Statements should be able to explain past events, confirm or adjust expectations / predictions, show the results of past decisions and form a rational basis for decisions for the future.
Predictive value. The Financial Statements should be able to show where the business is headed or where personal finances are going. We will go into the nitty-gritty of how to read and appreciate this attribute in Financial Statements later when we have laid down enough of a background and vocabulary.
Timely. The Financial Statements should be available as early as possible to be able to influence decisions and provide directions when and where appropriate business or personal action is required. The “as of x x x” caption of the Balance Sheet and the “for the period ended x x x” of the Income and Cash Flow Statements should be noted carefully.
Unbiased. The Financial Statements should not lean towards any favorable result or behavior; e.g., only payments that have a reasonable chance of actually being received are recorded / reported, or –given alternative valuations of an item—the more conservative figure should be used (the alternative used must not tend to overstate the value of an asset or income resulting in unfounded optimism).
It should be kept in the back of one’s mind that Financial Statements can be used (and have often been used) as a form of public relations ploy (showing all the upside and glossing over the downside), as a smokescreen (using accounting jargon to mask or bury misjudgments), and as enticements for financial institutions to lend, investors to put in funds, and suppliers to extend credit.
Image from Microsoft Clipart
