{"id":20837,"date":"2025-01-10T06:52:36","date_gmt":"2025-01-10T06:52:36","guid":{"rendered":"https:\/\/peraltafinancing.com\/accounting\/financial-accounting-versus-financial-reporting-part-1\/"},"modified":"2025-01-10T06:52:36","modified_gmt":"2025-01-10T06:52:36","slug":"financial-accounting-versus-financial-reporting-part-1","status":"publish","type":"post","link":"https:\/\/fivemor.com\/?p=20837","title":{"rendered":"Financial Accounting versus Financial Reporting \u2013 Part 1"},"content":{"rendered":"


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An Honest Financial Accounting: Draft of Chapter 1 \u2013 Part I<\/strong><\/p>\n

Chapter Title: Financial Accounting versus Financial Reporting<\/p>\n

Draft Table of Contents<\/a><\/p>\n

In this chapter we consider where \u2013 within the broader activity of \u201cfinancial reporting\u201d \u2013\u201cfinancial accounting\u201d should begin and end.<\/p>\n

\u201cAccounting\u201d<\/strong><\/p>\n

A popular way to begin discussing the basic ideas of \u201caccounting\u201d is with a fictionalized case \u2013 actually, more of a fable than a business case \u2013 one variety of which was published in 1974.[1]<\/a> A feudal lord engaged two of his serfs to grow wheat on separate plots of his land for a season. \u00a0A key excerpt:<\/p>\n

\u201cIgor, who had been given 10 acres of land, 10 bushels of wheat and 10 pounds of fertilizer, spoke next. \u2018Here, my Lord, is a partially used-up ox, the plow for which I gave Feyador, the Plowmaker, three bushels of wheat from my harvest and 105 bushels of wheat. I, too, used all my seed and fertilizer last spring. Also, my Lord, you took 30 bushels of wheat several days ago for your own table. I believe the plow is good for two more seasons.\u201d<\/p>\n

Now, that\u2019s\u00a0accounting<\/em>! It isn\u2019t a very detailed accounting \u2014 but an accounting nonetheless \u2014 for which necessary steps are as follows:<\/p>\n

Step 1:<\/strong>\u00a0 State what the entity started with;<\/p>\n

Step 2: <\/strong>State what the entity ended up with; \u00a0<\/strong><\/p>\n

Step 3:\u00a0 <\/strong>State in reasonably sufficient detail the flows that took place during the period, i.e., why the amounts reported in Steps 1 and 2 are different.<\/p>\n

Unfortunately \u2013 for two no-good reasons \u2013 US GAAP doesn\u2019t match such a straightforward characterization of accounting: it often puts Step 3 before Step 2; and,often while doing so, it ends up presenting fiction as fact. \u00a0To illustrate, let\u2019s consider this brief addendum to the fable:<\/p>\n

\u201cI also hired Iliya, our village\u2019s master plowperson, to teach my daughter Ida how to plow. For that I paid him with two bushels of your wheat. \u00a0I did all the plowing myself this year. But Ida will be taking over next year as I am retiring to Miami, in the New World. \u00a0 My CPA\u2019s opinion is that US GAAP calls for presenting the two bushels I paid Iliya should be reported in compliance with U.S. GAAP as an asset on my balance sheet \u2013 to be captioned \u2018deferred training costs.\u2019 I do realize that my Lord won\u2019t ever be able to make his own bread from the bushels I paid Iliya, or to sell them. But my CPA explained to me that it also wouldn\u2019t be fair to count the cost of training Ida for next season against this year\u2019s income.\u201d<\/p>\n

The FASB actually did, in its early days, let the world know that Step 3 should<\/em> follow 1 and 2.\u00a0 \u00a0It wrote that assets and liabilities should be viewed as primary elements in accounting; and accordingly that presenting deferred costs per se<\/em> as assets would be a fiction.\u00a0 As even such a simple fable can show, \u201cnet income\u201d for a business enterprise is impossible to cleanly define \u2014 despite many attempts to do so \u2014except by its derivation from changes in assets and liabilities.[2]<\/a><\/p>\n

But the FASB\u2019s concept statements have never been official rules \u2013 like one requiring capitalizaiton of certain training costs. [citation omitted] \u00a0When it came to writing actual \u201cstandards,\u201d the principle that honest reporting of assets and liabilities should be given primacy over measuring net income was disregarded whenever it was inconvenient.\u00a0 Which was very often.<\/p>\n

Here are just a few of the significant examples from US GAAP that demonstrate how pervasive the problem of putting Step 3 before 1 and 2 has become:<\/p>\n