Let's Keep Accounting Simple

The other reason why this profession is respected highly is due to some of the inherent quality of the subject-matter itself, namely accountancy. It’s one of the few subjects of human creation that has served society so well for many centuries. Accounting at its barest form is basic arithmetic or a system of counting. Being an offshoot of mathematics which itself is an offshoot of sciences, accounting came to be understood as an exact science.

Colloquially, many still perceive a chartered accountant as someone who is exact in his statements and numbers. This is justified in many ways because society understands the role of chartered accountants as custodians of wealth. And money, profit, wealth etc.. are all subject to being accounted for with precision. The respect the accountancy profession commands over other professions such as lawyers or doctors is because the latter are not precise to the point, in their processes and outcomes. They hedge their bets at every stage adding uncertainty in users’ decisions.

But this very reason for which our profession is so highly valued is continually under attack.  Our pursuit to create complex financial statements by using complex accounting standards is in my opinion doing more harm than good to the core character of our profession. Take for instance the standard on recognising deferred taxes on the income statement. Like most accountants, I share their understanding of deferred taxes; which is– the need to align effective tax rate to tax payable as per income tax laws – atleast as far as temporary differences are concerned. However by introducing this standard we have set the bar of ‘understand-ability’ of financial statements so high, that all other intellectual barriers appear like kindergarten games to the accountant.

Understand-ability I believe is the mother of all reasons behind preparation and presentation of financial statements.  We have conveniently extended the logic of ‘ignorance of law is no excuse’ to accountancy, which I think is totally wrong.  

Therefore now, not understanding deferred tax, CGU- impairment, MTM, cash-flow hedge etc. has become no reason for not being able to understand and interpret financial statements. The above caveat with respect to ignorance of law cannot apply in the same way to accountancy.

We have employed ‘gifted’ professionals to work to produce these complicated standards. In-turn another set of sharp individuals master those standards and disseminate them to an above-average collection of individuals (including the author). While this is intellectually stimulating and entertaining at times the damage in the long run is not evident to us. 

I wouldn’t blame entirely the accountants for the disorder. The shrill cries to make financial statements more relevant came in first from the economists. The economists were looking for reasons to justify their poor record of predicting events. And the convenient scapegoat for them is the data they relied on. After all, data can be twisted and refined a zillion times.

When you look back, some of the positive changes in accountancy were in fact made from the outside. Depreciation accounting was one such useful contribution by economists. Allocating proportionate cost of a long term assets to the current period’s performance was a brilliant idea indeed.

However, lately, much of what the economists have been saying is only damaging. The accounting profession took these suggestions far too seriously. See what we have done with respect to the idea of fair value accounting.   Economists needed to justify why they missed 6 out of the last 5 recessions. And all they did was find ways of ‘improving’ input data.

By complicating financial statements we are alienating its users. The more complicated financial statements become the more selective its application tends to turns into.

There was a good old time when as a user of financial statements I would look at PAT (profit after tax) of an income statement to understand performance. I had a high degree of assurance about my understanding of what that line item meant.  Now with complicated standards, I have jumped a few lines ‘up’ to PBT. Now since PBT has also become complicated (with exceptions and extraordinary items – conveniently interchangeable items to many accountants) I have jumped a few notches higher to EBIT.  Okay, but now I realise that there are few fancy items such as depreciation on revaluation and amortizations on goodwill resulting from acquisitions, whose treatments vary. So I moved a few notches up to EBITDA (Earnings before Interest Depreciation and Amortization). EBITDA is operating profit also loosely understood as operating cash flow.  As an investor or a promoter, operating profit suits me well. But off-late I have seen many users go a few notches higher. That is right to the topmost item- Sales or Turnover.

Users are so tired of synthetic accounting adjustments even in the operating expense line items that all they care about now is Sales. Many put a value on a company merely based on sales, called as sales – multiple. If more investors (who comprise the bulk of users) care only about sales in the income statement whatever we present below that is just waste of paper-ink.

We really need to slow things down a bit. Today we are in a race to participate in as many accounting standard sessions as possible. Shouldn’t we discuss the larger implications that these changes will bring to the profession vis-a-vis the society. If our students are measured on the basis of knowing more and more complex accounting standards and pronouncements what will be the future of this profession.  Let’s dumb-down things a bit. What Lincoln said of democracy – can now be said of accounting profession today – Financial Statements are ‘Of the Accountants, By the Accountants, For the Accountants’. Except that the latter means we are doing more harm to ourselves.