Timing of Financial Information— Yesterday's News
In any reading of financial statements, keep in mind the fact that the information is dated. Even a report produced immediately after the close of the period in question is out of date because a new period has begun. It is not reliable to base today's status on yesterday's report.
History, however, is useful and may be instructive about the future. We can make some reasonable calculations about the present and the future, based on a corporation's financial statements from last month or last year.
The Problem of Financial Information
Those companies with publicly traded stock are regulated by the Securities and Exchange Commission (SEC), the federal oversight agency created as part of the Securities Act of 1933. The SEC has authority to regulate the securities business and especially the reporting of financial information by publicly traded companies. This includes. information reported in a prospectus, a registration statement, and financial statements. It also includes the power to prescribe the form for submitting information, accounting and auditing methods, and procedures used in valuation and calculations, in other words, toe SEC has broad powers to impose and enforce requirements on companies reporting financial results to you, the shareholder—even to the extent that the company's value and financial results are affected. SEC regulations are not merely advisory. The SEC can institute civil proceedings against companies not following its regulations and, in cases of extreme noncompliance or reporting fraud, it may file criminal charges. Penalties could include fines and even imprisonment for offenders.
In addition to having to comply with SEC regulations and submit to SEC audits, publicly listed companies are required to undergo periodic audits by independent certified public accounting firms. Accounting and auditing standards include more than 2,000 pages of rulings, procedures, and pronouncements issued by the accounting industry's national association, the American Institute of Certified Public Accountants (AICPA). The AICPA oversight of its own members has evolved into voluntary cooperation with another national board, the Financial Accounting Standards Board (FASB). This board has no authority or power of its own, but serves as a coordinating agency for the AICPA as well as numerous other agencies, including the SEC. The FASB actually sets accounting standards and makes rules in cooperation with the industry as a whole and with agreement from several involved agencies.
What has grown out of this large regulatory environment is a single national standard. This is a safeguard for investors. The rules, overall, are referred to as generally accepted accounting principles (GAAP). A GAAP rule mandates the methods to be used for reporting financial transactions.
To the nonaccountant, it might be puzzling that such a wide array of standards and procedures are necessary. After all, a transaction occurs and should be reported accurately. Where is the debate? In fact, though, a large number of decisions must be made that can affect value and profits significantly. There is a need for consistent treatment of many financial transactions. Some of these are:
• The valuation of inventory
• Placing a value on foreign exchange profit or loss
• Placing a dollar value on a reserve for bad debts
• Depreciation methods
• Treatment of extraordinary loss, unusual expenses, and nonrecurring expenses
• Simple timing
The auditor's job is to apply GAAP as consistently as possible. At times, the company's accounting department will disagree with an auditor's interpretation of the rales, and a discussion has to be held to settle the issue. With more than 2,000 pages of guidelines, it is entirely possible that each side may find some rule supporting its position. At times, the auditoris placed in the position of compromising with the company's accountant, and modifying its proposed adjustments. This does not mean the financial statement is not prepared honestly. As a rale, accountants and auditors want to report honestly the financial data for the company. Accountants and auditors have to determine which treatment best reflects the actual results for the year. The consequences of the treatment decision can be significant for the company's profit and, ultimately, for its stock's market price as well.
KEY POINT
The purpose of creating accounting standards is to strive for consistent and honest reporting. Still, much interpretation may occur, making comparisons difficult from one period to another, and from one company to another.
It takes several weeks of auditing and analysis just to ensure that the auditors agree with what the company has reported. Invariably, some adjustments are made as part of the audit. So the company cannot issue a financial statement with any confidence until the audit has been completed.
