Question

How would you respond to this post?

Investors typically seem to prefer businesses with a stable earn track. If true, that would encourage companies to increase their earnings. Under GAAP, there are many choices for how the company releases its financial statements. Although not the reason for the decisions of GAAP, one consequence is the willingness of a corporation to control sales which is not an ethical decision. Even though earnings and cash flow are often related, management of earnings should have little impact on cash flow (except for tax consequences). Shareholder capital can be enhanced, if the investor is "fooled" and needs stable earnings at least temporarily. Nevertheless, despite the questionable ethics of this procedure, if the practice is revealed the company and shareholders will lose value. The ability to meet or exceed the earnings set is seen as being one of the greatest reasons to control earnings. When a decrease in market capitalization happens, it will generally result in the company's not achieving the target earnings. Some of the methods or strategies that financial managers follow are changing the method of depreciation or adjusting the method of inventory valuation. It generally does not affect the cash flows but somehow affects the wealth of the shareholder.

Answer 1

Stability matters a lot in case of investor confidence. Hence, some of the companies use different provisions of accounting standards to look their annual reports lucrative. However, inventor should keep their eyes open while analyzing the financial statements.

Though managers can not affect the cash flows by employing different accounting standards, cash flow can not truly represent performance of the company as cash flow does not support the concept of income recognition. Hence, we have to relay on the revenue and profits to understand the true performance of a company.

Further, it is to be note that company always focuses on generating money rather than ethical standards. Ethically correct may be legally wrong and legally correct may be ethically wrong. So, we can only question on whether company's way of doing things are legal & transparent or not .

Suggestions to stakeholders are as follows:

Investors: Understand why company is changing from one accounting standard to another and question is it really for what it is intended or for any malafide intention.

Auditors: Auditor should comment on why company is changing from one accounting standard to another accounting standard and financial impact has to be mentioned adequately in financial statements.