Few Examples Of When You Would Use The Midpoint Formula The Unresolved Flaws in Financial Accounting

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The Unresolved Flaws in Financial Accounting

Users of accounting information include company owners, managers, investors, creditors, and government agencies. It is generally accepted that most financial reporting is “primarily externally oriented” and that most users are non-accountants who are frustrated when trying to understand the statements. Since they are not part of the management team, they are more or less on the outside looking in.

Although there are many accounting associations, from the Accounting Principles Board to the American Institute of Certified Public Accountants to the Financial Accounting Association establishing the Financial Accounting Standards Board, there are alternative methods of reporting that add to the confusion and limitations of financial reporting.

Identification and Reporting Methods:

FIFO vs LIFO:

FIFO and LIFO are the two major methods of reporting transactions. Because these alternative methods are left to the discretion of the institutions, two similar companies in the same industry may report the same transaction for the same items and reach two different conclusions. The FIFO method assumes that goods purchased first are sold first. The LIFO method assumes that the most recent goods purchased are the first to be sold “so that the first cost assigned to ending inventory is the cost of beginning inventory.” So goods purchased in September can be included in the previous month’s cost of goods sold. Although acceptable, this method changes the final reporting for better or worse.

ACCRUAL Vs CASH:

Under current generally accepted accounting principles, financial accounting is backward looking. By reporting past transactions that depend on accrual accounting in accordance with the matching principle, the financial statements do not record how much the accumulated debits under accounts receivable will actually accrue. This can mislead non-accountants into overestimating assets in the period immediately after the report is issued because adjustments for non-collection are made much later. In this scenario, a report issued at the end of the year might estimate that a firm has $10,000.00 in accounts receivable. This projects a $10,000.00 addition to the firm’s assets column. This may give a more positive outlook when in reality the firm may recover only $3,000.00 of its accounts receivable. An investor who is attracted to a company based on its strong outlook may later be disappointed to learn that only a third of the effort to collect on accounts receivable was actually received. This weakness was due to the now inactive cash base compared to the current accrual base. In cash basis accounting, the actual units of measure of revenue or expenditure (money) are recorded as they exchange hands.

Subjective versus objective reporting:

A major existing flaw in financial accounting is the subjective latitude given to accountants preparing financial statements to use their “professional” judgment. This flaw gives some accountants the latitude to manipulate reports as we saw in the Enron debacle of 2001. Business transactions between organizations, individuals or businesses are recorded tangible events. For example in the United States, the unit of measurement for these events is the dollar. As a result, there should be no basis for subjective judgment when reporting an empirical event or transaction. It is strange that different accountants should come to different acceptable conclusions for the same phenomenon. This creates room for more questions and more doubt from the public. As a quantitative unit of measure, dollar amounts should always be the same as reported.

Lessons from other subjects: Economics

The aforementioned errors do not exhaust the list of limitations of financial statements that include reporting quantitative versus qualitative values; The principle of cost does not reflect the current market value after the purchase of the property; and inability to compare firms in the same industry because of different reporting methods eg Coke and Pepsi.

Economists have their share of disagreements, most of them on the future effects of policy. But financial reporting lags behind. It reports events that have already happened. But when it comes to measuring quantitative values, the kind accountants handle in reporting, economists have a more integrated angle to measure transactions. For example, when calculating the price elasticity of demand, which measures the responsiveness of quantity demanded to changes in price, economists understand that the price elasticity of going from point A to point B is not the same as going from point B to point A, a. Mathematical approach. So they developed a midpoint method of measuring elasticity that gives the same answer regardless of the direction of change.

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