Key Point

Some believe it is acceptable to move profits ahead but not to overstate profits this year. Both are deceptive practices—and both hide the facts you need to make informed decisions.

Accountants within the corporate structure, and auditors reviewing the books, know that GAAP provides enough flexibility to allow some questionable movement of profits. The flexibility of GAAP is itself a serious problem. The general "rule of thumb" within the accounting industry is that decisions to move profits from one year to another are all right as long as there is a documented justification. This is unfair to investors because it represents intentional distortion of the results, done under the guise of GAAP. Consider the following fictional example of an explanation accompanying the deferral of sales and profits to a future period:

Revenues and associated costs, expenses and net profits, reduced for the purpose of deferring for estimated current-period and reported results estimated to belong properly to next year's revenues, costs and expenses; based on assumed preordering from major customers for inventory to be applied to customers' future-year activity and in anticipation of lower than normal levels of future orders to be placed.

This explanation justifies the movement of current-year profits, essentially arguing that this year's orders were exceptionally high and, therefore, it may be that the following orders will be lower because customers are stocking up. However, even if this is an accurate observation, it is not justification for moving profits forward. A basic rule in accounting is that all transactions are supposed to be reported in the proper year. Moving transactions forward based on a belief about ordering volatility is not accurate.

0 0

Post a comment