{"id":71626,"date":"2025-02-06T14:27:30","date_gmt":"2025-02-06T14:27:30","guid":{"rendered":"https:\/\/peraltafinancing.com\/accounting\/ungarbling-financial-accounting-accounting-onion\/"},"modified":"2025-02-06T14:27:30","modified_gmt":"2025-02-06T14:27:30","slug":"ungarbling-financial-accounting-accounting-onion","status":"publish","type":"post","link":"https:\/\/fivemor.com\/?p=71626","title":{"rendered":"Ungarbling Financial Accounting | Accounting Onion"},"content":{"rendered":"


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Alas, I have not posted very much of late. \u00a0But, it\u2019s only because I am trying to find as much time as possible to write my book<\/a>\u00a0describing a simple, comprehensive and robust basis of accounting that any public company could use; and that would produce more relevant information for investors than U.S. GAAP or IFRS. \u00a0Progress has been slower than I had hoped, but to-date I have drafted the chapter explaining the objectives of my \u201cShareholder-Oriented Financial Accounting\u201d (S-OFA), and am now drafting what I call the foundational constraints of S-OFA.<\/p>\n

I decided to take time away from book writing for this post for two reasons. \u00a0First, I thought that it could help me to organize my thoughts about one particular foundational constraint that I have not heretofore written about: \u00a0the \u201cgarblings\u201d (i.e., distortions and confusions) of numbers and\u00a0<\/em>terms\u00a0that are ubiquitous in U.S. GAAP and IFRS.<\/p>\n

Second, I continue to struggle to find a title for the book. \u00a0The latest working title is\u00a0Shareholder-Oriented Financial Accounting: Liberation from the Politics of Capital Markets Regulation. \u00a0<\/em>It doesn\u2019t feel to me that the part after the colon hits the sweet spot. All suggestions \u2013 serious, funny, or otherwise \u2014 are welcome. \u00a0Respond either by commenting on this post, or email me<\/a>.<\/p>\n

Ungarbling the Garbling in GAAP<\/strong><\/p>\n

Garbling occurs to some degree in practically all media, but in financial accounting it\u2019s both intentional and very intense. \u00a0Let me explain.<\/p>\n

The U.S. GAAP\/IFRS approach to measuring assets (and liabilities) is frequently and far too simplistically described as a \u201cmixed attribute\u201d system. \u00a0Historic cost may be mistakenly considered to be an attribute, but that is a digression. (Historic cost is merely an attribute of a past transaction, as opposed to the asset itself.) \u00a0A legitimate reportable \u201cattribute\u201d is generally understood to be either: a measure of value if sold (e.g., \u201cfair value\u201d); cost to replace; or present value of future benefits.<\/p>\n

But, IMHO, too few understand that some (the majority of?; an increasing number of?) assets\u00a0are \u201cmeasured\u201d with algorithms, which cannot possibly produce a \u201cfaithful representation\u201d of any of the aforementioned financial attributes. \u00a0That is because there is only one way to describe the numbers generated with these algorithms: \u00a0by nothing more than the algorithms themselves. \u00a0I will refer to the numbers produced by these algorithms as \u201cgarblings.\u201d<\/p>\n

One of my favorite examples of a garbling \u2014 one that I have used in many posts (see here<\/a> for the latest, and here<\/a> for the collection \u2014 is the \u201ctranslation\u201d of land that is held by a foreign subsidiary. \u00a0(I\u2019ll explain why I put \u201ctranslation\u201d in quotes later.) According to U.S. GAAP (and IFRS), the algorithm that produces the number reported on the consolidated balance sheet would be historic cost in the foreign currency multiplied by the current<\/em> exchange rate. \u00a0SFAS 52 even states that this process of \u201ctranslating\u201d the land into the reporting currency is nothing more than a mechanical process (therefore, leading to a translation \u201cadjustment\u201d as opposed to a gain or loss).<\/p>\n

Other examples abound, with leases<\/a> and loans<\/a> being two recent examples. \u00a0Together, they reveal that GAAP is not even a \u201cmixed attribute\u201d information system that, at its very best, adds together the historic cost of some assets (non-attributes) with the fair value of an interest rate swap; and presents the apples\/oranges summation as \u201ctotal assets.\u201d \u00a0It is even less than that. \u00a0U.S. GAAP and IFRS are largely collections of garblings.<\/p>\n

It seems to me that this is unique among what I might call language-based reporting systems, e.g., newspapers, radiological reports. \u00a0Statements from these systems could require specialized knowledge to be accurately understood, but it is clear that within these systems intentional garbling is seen as an act of bad faith. \u00a0The defenders of garbling in financial accounting argue that garbled numbers are informative nevertheless, because they approximate, or are correlated, with attributes. \u00a0Moreover, garbling could be excused because the cost of estimating an attribute is too high, and\/or its reliability is too low. To these arguments, I have the following responses:<\/p>\n