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If a need for accountancy exists, what qualities make it sufficient?

5 August, 2015 - 14:41

If it is given that a need exists for accountancy - e.g. some hotshot is playing with some retiree's lifetimes earnings, and could lose it to some undeserving employee of a merchant bank who spends it on cocaine and a collection of porsches , it may be useful to name what qualities might make the results of doing accountancy useful.

4 memorable qualities might be understandable, relevant, reliable, and comparable.

Financial statements should be understandable : usually they are, because there is almost a standard format for statements of income, change in equity, balance sheet, and cash flow. Even so, it is still common practice that these understandable items aren't analysed by spruikers of investing opportunities in a standard way.

Even if the statements are understandable, they could suffer from being irrelevant or unreliable.

Relevance / materiality means if something is included or excluded from financial statements, it can affect the economic decisions of investors if the opposite was true. Including immaterial stuff can paint a too rosy picture, and excluding material stuff can be hiding big problems.

Reliability sounds like relevance, and it begs the question as to whether something can be relevant and unreliable, but it appears to mean that one should not take the accrual principle too far. Examples of accrual in action, is the allowance for bad debts, and provisions for contigent liabilities. As an example of something unreliable is making a recording of an asset some financial product backed by subprime mortgage parcels. Another , which might also lack relevance, is having a major controlling shareholding in a company financed by margin lending, and this amount of equity included in the previous balance sheet. The major shareholder is a separate accounting entity, so doesn't have to reveal his liabilities in the balance sheet, but the amount stated as shareholder equity is in hindsight , unreliable, after a margin call is made.

Another example of unreliable accounting, is having an accumulated provisions for the possibility of fire account as a cash account reserved in theory for the provision, instead of buying prepaid insurance for a specific amount , as the latter is more reliable because there is documentation , a provisioned amount is certain and it is probable that it sufficiently provides for the contingency.

Finally , comparability means that accounting is done similiar enough to other companies to make comparisons , as well being able to compare the accounts between different accounting periods of the same company, because enough information is given when policy changes are made, e.g. to the type of accounting made for inventory.