Monday, December 29, 2008

Generally Accepted Accounting Principles

Ever since Numeric Life dropped off the net and Mike gently prodded Amanda into taking up blogging about numbers and statistics to fill the gap, I've been lost on the raging sea of numbers as I try to make sense of the smoking wreckage of the economy. You all know that I'm a verbal, not a numeric person. German and Russian grammar, creative writing, semantics, and stuff like that - no problem; manipulating low-digit numbers much beyond addition, subtraction, long division, and the multiplication tables - my head starts to smoke and my eyeballs melt.

Semantics (the study of meanings), economics (the science of fooling all of the people as much of the time as possible), and statistics (the science of torturing data until it tells you what you want to hear) come together in a field we call "Accounting." At the level of the individual, accounting deals with how we try to match income to outgo; at the level of the corporation, accounting deals with the numeric alchemy of turning bad news into good in time for the big shots to get their bonuses and run.

Which brings me to the subject of Generally Accepted Accounting Principles, as defined by the Federal Accounting Standards Advisory Board.

Good luck understanding the explanation.

One reason I have such a problem understanding the disaster which has befallen the economy deals with those accounting principles. I just don't understand how it is that an accountant can take the same set of numbers, apply different sets of generally accepted accounting principles, and show either a profit or a loss. At the checkbook level (which is the last level before my understanding of higher economics peters out), the accounting principles are pretty simple: my employer gives me money every two weeks in exchange for my work; I use that money to pay bills, buy food, and (when possible) put something away in savings; whatever is left over is our discretionary income, used for books, dining out, dance coaching, or whatever. Ideally, on the day before each payday, the balance in the checkbook is not preceded by a minus sign.

Things are different for big corporations. Depending on which of the generally accepted accounting principles they choose to apply, they can show a profit to the stockholders, and a loss to the IRS. The corporation can appear huge and strong, or weak and gasping like a fiscal fish flopping on a shore washed with waves of red ink. And governments can exert pressures to force the use of one set of principles or another. I don't understand this.

You and I, Dear Readers, make it from payday to payday by matching income to outlay. Some of us do it better than others, of course, but most of us understand at some level that we can't spend more than we have (yes, we know credit cards are bad, but they're so good for instant gratification that we just can't let them go). Why should corporations be different? Why should we accept (or governments allow) the use of accounting principles that can obfuscate the picture of the health of a corporation, a bank, or whatever?

I know that there are vast armies of MBAs, PhD economists, CPAs, and corporate lawyers out there who would read this and shake their heads at how dumb and simplistic I am for asking silly questions like these. I see things in terms of Occam's Razor. I think things ought to be fair and equal across the board...sauce for the goose, sauce for the gander and all that.

Until we accept that there ought to be a simple set of accounting principles based on income, outgo, and the fair evaluation of assets, we'll never dig our way out of the economic crater the financial wizards have dug.

And I'll stick to manipulating my checkbook on the basis of my generally accepted accounting principles: addition, subtraction (mostly subtraction), multiplication, and division. At least I understand those.

Have a good day. More thoughts tomorrow.



Amanda said...

I don't use a checkbook but I did use an ordinary notepad to note down each and every one of my expenses each week during my time in Australia. Its the most effective way I know of to curb spending, especially when I'm usually short by some amount each week.

I scrolled down through your post and have to tell you that your tree was magnificent. My family does not have a 'tree tradition'.... best we've done is a tiny 2ft one I bought and decorated with origami foldings. And Leya has grown into such a pretty little girl!

Malaise Inc said...

As an MBA, let me state that when you get right down to it, corporations live and die by the simple addition and subtraction that you are familiar with. Certainly, the accounting may be complex, but when all is said and done, their income has to exceed their outgo or they will eventually cease to exist. Enron and Bernie Madoff are examples of the eventual triumph of elementary school mathematics over complex accounting.

The Mistress of the Dark said...

I almost majored in Accounting and those principals still make no sense to me.

KKTSews said...

Sorry, I have to disagree. You're appearing to blame the major corporate and banking mess on the accounting folks, and I think that's misplaced. I didn't major in accounting, only taking 2 semesters, but I loved it because of the simplicity. The accounting principles come in to play, as I undertand it, when there are ambiguous situations. Such do you account for depreciation (that's a simple one). You should not keep the full original value of hardware on the books after it's used, but just how quickly that is depreciated and what it's value can count against are issues that can be different in various businesses.
I think the mess in the economy comes down to corporate leadership and shareholders pushing the envelope in the name of greed. And yes, probably some accountants were eager or pushed to figure out ways to hide problems. But the fault is not with accounting, it's with the greed and our current tendency to want immediate results of unreasonable porportions.

Bilbo said...

Amanda - good to have you back! It really is interesting to keep track of every cent you spend...I've done that before, and it's an eye-opening lesson in where the money goes.

Malaise - so why does the accounting need to be so complex, or to offer different sets of rules to implement that simple elementary school mathematics?

Andrea - stick with the music. You'll be happier and less likely to go to jail.

Katherine - I'm not so much blaming the accounting folks as the system that they have developed over time which, I beg to differ, is anything but simple. You're right in asserting that greed and a willingness to push the envelope of legality and prudence is what caused the economy to tank...but a lot of people we used to trust fell asleep at the switch, and now we have to clean up the mess.

Jean-Luc Picard said...

Math is way too complex here!

Mike said...

You were much to kind in your description of economics.

@kktsews - "depreciation (that's a simple one)"

I worked for the phone company in cost accounting for awhile. Depreciation was the biggest fight the phone company had with the government. The phone company wanted short depreciation, the government wanted long. And what ever got decided for each item was a compromise that had no basis in fact.

Malaise Inc said...

Accounting is complex because the workings of a corporation is complex and the tax code is complex. My recollection of my accounting classes (which were a dozen years ago) was that the various accounts, and the rules that apply to them, when studied in some level of detail, are rationally contrived.

I realize that sounds flippant, but it isn't meant to be. It is just something that cannot really be justified in the abstract.

craziequeen said...

I don't do accounting, I don't understand big banking and I am shocked how they seemed to have dug this big whole and threw the world into it....and then left us to dig ourselves out.

But then after 40[mumble] years nothing really surprises me about how countries and economies are run....usually by a bunch of lying stealing cheating crooks!

So I'll stick to my little Crazie world, trying to make my salary cheque meet the next one!