Critical Reviews on Concepts in Accounting - Assignment Example

Critical Reviews on Concepts in Accounting An Empirical Evaluation of Accounting Income Numbers The main introductory argument of the paper is that accounting practices are useless until these are reconciled with macro-level analyses and assessments based on more complicated methodologies. It is the contention of the authors (Professors Ray Ball and Philip Brown) that accounting theorists themselves are in agreement with that belief. To support the opinion, Canning was quoted as stating that measures of net income are purportedly without factual basis and that it is only the figure which resulted after the accountant has completed the procedures which were used to arrive at the number. It is as if the paper advances the theory that the net income shown in the financial statements of a corporation is not its actual earnings. Some other factors and variables which have any relation or bearing on the corporation and its operations have to be considered. For instance, a company is in the business of selling bell-bottom jeans. On January 31, 2010, it has reported in its financial statements for the year that ended on December 31, 2009 a net income of $210,000. In the first week of December, 2009, sales dropped by 80%. It was discovered that the erstwhile trendy bell-bottom pairs quickly became out of fad. If the suggestion of Ball and Brown is to be followed, the final net income of $210,000 is not the ultimate determinant of the earning capabilities of X Company. Curiously, however, the authors admit though that it is not safe to presume that the income figure is without use just because it has no meaning in substance, adding that the data and information contained therein and the timeliness of making those items available are important for evaluation. The paper actually tries to convey the idea that the data produced by accounting records and summarized by the accountant in the financial statements are not the sole gauge to measure whether the company really makes profits. While the work of the distinguished professors is impressive, it goes beyond the role of accounting as its founders or creators possibly intended it to be and to function as such and as the general principles behind it unequivocally manifest. The process records, classifies and summarizes transactions and events significantly in money terms. Simply put, it deals with things of the past and the recording pertains to those circumstances which are financial in character. Whatever the recording, classifying and summarizing activities produce are then interpreted and presented in the financial statements. (Horn, Frederick [internet]). Within the ambit of its general precepts, accounting always presumes the entity to be a going concern in that it exists and will continue to exist.(going-concern-principle. BusinessDictionary.com. [internet]). Financial statements will not tell the readers about how the corporation will survive owing to the downtrend in sales. As a matter of course though, and as the full disclosure requirement dictates, information of possible material losses has to be mentioned in the notes to financial statements. (Accounting Concepts. QuickMBA. [internet]). Hence, huge receivables which appear to have apparently no chance of collection must be explained as probable bad debts in the ensuing year. In the same manner, corporate trade liabilities subject of litigation must be so disclosed. It is confessed that prospective investors or stockholders, among other factors, look at the income figures of the company where they desire to invest. There is no logic putting one’s money in a venture that is losing. Still, there appears no preparedness yet to evolve accounting into economics, particularly that which involves forecasting. It is true that the field of accountancy has in relatively recent developments embarked on the field of management accounting. Nonetheless, the latter is not an exact science. (Management Accounting is a science but not an exact science. June 19, 2006.[internet]). While accountants may have the rare opportunity to more or less predict financial conditions and situations based on historical data, it has to be taken into serious consideration that analytical projections are no guaranty to determine what happens next. So many of the supposed financial and economic wizards foresaw otherwise when James Chanos believed Enron would crash.(Barboza, David. January 7, 2010.[internet]). It did. The experts were wrong. One man was correct. There is truth to the notion that stock prices react as changes in income reports take place. Along this line, the paper of Ball and Brown proposes models by which market expectations of corporate incomes might be known. It is opined that this cannot be consistently so. An illustration may be necessary. Let it be assumed that American sugar traders are making a heyday due to sudden shortages in the merchandise brought about by a drought in Cuba equating to less supply and higher prices. The market will possibly expect the next year to be the same as weather and climate circumstances protract for, say, three to four years. That does not connote that the huge profits will continue to be constant and that the investors do not realize this. The point is that there can be no exact model in forecasting market behaviour. A pattern can be made but there is no absolute certainty that it will remain as is. Anent observations over the timeliness and contents of the income statements, the suggestions in the book might no longer apply nowadays. The advent of quick information brought about by advancements in computer technology has erased those drawbacks. If years ago financial statements were done in one month time, those reports can now be out on a daily basis. The reading and comprehension of the contents no longer pose as predicaments because of modern communication systems. The more important concerns lie in the attitude and moral values of the makers of these financial statements and the effectiveness of good corporate governance in the firm. Do firms manage earnings to meet dividend thresholds? Stockholders are the true owners of the corporation. Legally and technically speaking, their powers are more paramount and sovereign than those of the company directors who are mere managers of the firm. The collective and concerted efforts of the stockholders have serious influence and implications in the organization, including the ouster or removal of a director. There is wisdom for the salaried executives to make happy the stockholders, their bosses and the proprietors of the corporation. The interests of the stockholder are all packed in his shareholdings. Any fruits that the stocks deliver to the company member will make him happy. As a matter of fact, it is possibly the only thing that hooks him in attention to the affairs of the corporation. These fruits or shares in the company profits are in the form of dividends. Incidentally, the right to dividends is not absolute. There are restrictions. It is like saying that it is yours but you cannot have it, that is, in certain instances. The limitations on dividends declaration and payments are not what to be tackled here. Instead, the drive of this critique is focused on how these dividends are declared and paid well and on time. The discussion on dividend restrictions comes first. However, these pertain to constraints on dividends for private debt contracts. That means that debt contracts will have preference in payment over dividends. There seems to be no need to discuss this matter in length. This is so because whether the stockholder likes it or not, if creditor insisted to stipulate the restriction and the authorized agents of the corporation agree, the stockholder can have no other option. However, as implied earlier, it is but natural and normal for corporate officers to exhibit a semblance of protection for the interests of the stockholders in the management decision-making and policy-formulation processes. In short, the company executives are expected to do all they can to avoid any encumbrance on the settlement of declared dividends. The stockholders are entitled anyway to the earnings due their shares if the company is in good times. However, the perception that companies manage earnings in order to accommodate the payment of dividends is easier said than done. This cannot simply be especially if the adjustments will be material and significant like big manoeuvres in accruals. Besides, the financial statements will necessarily be distorted. The kind of framework being envisioned here is only fine if the deficiencies in funds and earnings to cover the settlement of the dividends are not huge. What if these can be readily noticed by the stockholders themselves, the auditors or the state regulators? This idea is misplaced and the data and information appear not to have been substantiated. The insinuations have surely not been well researched and studied. The whole viewpoint encourages wrong accounting practice. Furthermore, managing earnings in order to accommodate dividends payment may be conveniently done for a year or two. To do it constantly and continuously will bring the company to a situation and time when things will be out of hand and will no longer be manageable. That way, the corporation will be creating its own monster. The best option for the corporate officers to adopt is to be straightforward and to be honest to the stockholders. As a matter of fact, this has to be extended to all stakeholders. (Perry, David L. [internet]). If there are no liquid or current funds available for the payment of the dividends, then it has to be made known to all and sundry. Let the general members later on resolve the issue within their lawful authority as enshrined in the applicable laws. It is time that high moral ethics and desirable attitude are propagated in the corporate halls. Companies need to be governed well and sound and upright behaviours need to flourish in order that business wins back the trust and confidence of the public and the investors. It has to be importantly noted that the effort to avoid the limitations will not apply to restrictions imposed by the government as are provided for by law like in the case of investment companies for gains realized from the sale of securities. (United States Code [internet]). The same exception has to be made on the related literature presented by the authors. It is the same animal. Yes, it is true that managers have wide latitudes of discretion in the reporting and presentation of financial statements. Such a discretion is very much susceptible to abuse. The deviation may be minimal at the first instance. It will possibly double in the next and treble in the after next. Besides, any whimsical exercise can create complication in the future. An illustration may be necessary. Let it be presumed that X Corporation initially reported no income and no loss, that is, incomes and expenses are even. In order to accommodate dividend declaration and payment, depreciation expenses are adjusted and are thus deferred for, say, $500,000. This means that depreciation for the current year is understated by $500,000 while income is overstated by the same amount. By force of that temporary solution, the depreciation in the ensuing year will have to be overstated by $500,000. This is a clear case of window dressing which cannot be maintained for a considerable period of time.(Window Dressing. [internet]>. By the next fiscal period, the officers of the corporation will have a lot of explaining to do in the subsequent general membership meeting. While it may be admitted that there is veracity in the innuendoes that these things happen in the corporate world, such a scheme does not totally bring resolution to concerns over dividends. References (All sources are from the Web / Internet.) Accounting Concepts. QuickMBA. Knowledge to Power Your Business. [internet] Accessed January 10, 2010. Available at: Barboza, David. Contrarian Investor Sees Economic Crash in China. January 7, 2010. The New York Times. [internet] Accessed January 10, 2010. Available at: going-concern-principle. BusinessDictionary.com. [internet] Accessed January 10, 2010. Available at: Horn, Frederick E. MANAGERIAL EMPHASIS IN ELEMENTARY ACCOUNTING. JSTOR Trusted archives for scholarship. [internet]. Accessed January 10, 2010. Available at: Management Accounting is a science but not an exact science. June 19, 2006. AcademicDB. [internet] Accessed January 10, 2010. Available at: Perry, David L. Classroom Materials for "Starting with Ethics". SANTA CLARA UNIVERSITY. [internet] Accessed January 10, 2010. Available at: < http://www.scu.edu/ethics/publications/iie/v12n1/questions.html> United States Code. TITLE 15 - COMMERCE AND TRADE. CHAPTER 2D - INVESTMENT COMPANIES AND ADVISERS. SUBCHAPTER I - INVESTMENT COMPANIES. Section 80a-19, Payments or distributions. [internet]. Accessed January 10, 2010. Available at: ). Window Dressing. INVESTOPEDIA. A Forbes Digital Company. [internet] Accessed January 10, 2010. Available at: Read More