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Alex J. Pollock of the American Enterprise Institute has published an excellent paper, From Making Judgments to Following Rules: The Evolution of U. S. Accounting (July 2005).
He notes that accounting is becoming increasingly farcical:
The phrase “generally accepted accounting principles” (GAAP) has come in time to mean the opposite of its original and apparent meaning. When introduced in the 1930s, the term actually meant what it seems to mean: those principles which are subscribed to and used by the majority of knowledgeable, reputable practitioners. It was bottom-up and descriptive in the common law mold. Now GAAP means those rules that are mandated by the FASB, whether or not they are generally accepted and even if they are generally opposed. This is top-down and prescriptive in the manner of statute law. The original meaning has disappeared, as the rules-based approach has become dominant. The government, which of course mandated this rapidly-growing mess by its detailed regulations and criminalization of every decision that might be questionable or merely unlucky in the light of 20/20 hindsight, now blames the companies and their auditors for excessive caution. ("I'm sorry I killed my parents, but it's not my fault -- I'm an orphan!")
Pollock concludes:
Companies will continue to prepare their GAAP financial statements. They should also explain to investors, creditors, and counterparties how they actually conceptualize and manage the business. This could involve producing additional financial statements reflecting the non-GAAP perspectives needed to create accounting representations approximating the economic truth as they believe it to be. This implies multiple statements, multiple perspectives, and “true and fair views (plural).” Truth is likely to be more closely approximated in this fashion than it would be using a single, official perspective requiring ever more elaborate rules. However, this project also requires integrity, knowledge of the business, and informed judgments about truth and fairness.
In short, companies should erect a system parallel to GAAP that tells investors what is really going on.
The deficiencies of accounting regulation have also been addressed at the Cato Institution -- see Accounting at Energy Firms after Enron: Is the “Cure” Worse Than the “Disease”?(Feb. 12, 2003)
The problems are particularly acute in the tech sector; GAAP-based nitpicking may be bad for other industries, but it is absolutely disastrous for companies that rely heavily on the value of intangible assets.
posted by James DeLong @ 11:27 AM | Accounting
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