Monday, April 30, 2007

Two Views 

It is fascinating that the key communication to investors is financial accounting data but financial data is not and never will be precise. Now, there is a movement to standardize accounting principles worldwide -- something that should have happened long ago. But, standardization means accounting in the US will move away from "bright line" to principle-based approaches. A bright line rule states an accounting policy with a specific limit. If it has the following characteristics and equals X, then it is accounted for this way rather than that. A principle-based policy says that it if it has the following characteristics, it is accounted for in one way rather than another. Enron was able to game the accounting system through bending "bright-line" principles to fit a mold. On the other hand, accountants in the US demanded bright line principles to stave off lawsuits. The defense was that if an accounting principle met a specific rule, the accountant wasn't at fault, even if a client was committing fraud.

What is interesting in this discussion is that at the base of all the hard numbers is estimation. It is estimation within prescribed limits but judgment nonetheless. That is why it is baffling that institutional investors and analysts demand reams of numbers to fill out financial models, as if numbers were hard truths and the soft data of a company less so. However, in the end the truth of any company lies in the integrity of its leaders, something that can't be measured in a financial statement. Leaders who demand clean financials get them and those who game rules produce data built on fiction. Or, to put it another way, leaders who have proper regard for the investing public and want to build good relationships with them are the ones who insure that accounting is clean. Sound familiar?


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