If you read my Sunday Supplement at the weekend and made it all the way through the extract from my latest book, you’ll have seen that an appendix to the book is a detailed explanation of why accountants use estimates and assumptions when preparing accounts and how these estimates and assumptions can make accounts misleading unless you understand
them.
I also talk about accounting principles such as prudence and matching which I was taught as a student.
Somehow since then these principles seem to have got lost.
This was no more evident than in
an article in the Financial Times on Monday about how some banks are accounting for interest-free credit cards, warning they are a “ticking time bomb” that could lead to the kind of revenue scandal that hit supermarket Tesco.
Some lenders that offer zero per cent balance transfer cards book upfront some of the revenue that they expect to get once a customer ends the interest-free period and starts
paying a higher rate, based on the assumption that customers will still have the debt on the card when the deal ends.
At the heart of this is something simple: it is imprudent accounting.
As a young man training to be an accountant I learned that I was to be prudent on all
occasions. Profits were never to be anticipated. And the exact opposite was the case with losses, which should be anticipated whenever there was a chance that they might arise. Bob, my training manager and still a reader of my blog, will remember this well.
The accounting for banks shows just how far in the other (wrong) direction accounting has moved since then. Losses are not recognised now
until they are ‘realised’, which means they have been proved to exist by the failure to pay. This is why bank profits were over-stated before the 2008 crash. Anticipation had disappeared from loss accounting when once it was ever-present.
And as the accounting for credit card profits that might never arise demonstrates, profits are now anticipated. Is it any wonder the public see banks and
big corporates as greedy and self-serving.
There were - and still are - reasons for prudent accounting.
- It makes directors face the reality of their actions when it comes to losses.
- It prevents directors making up
profits for their own gain.
- it protects creditors by ensuring that capital is never overstated and the true level of risk that creditors faced is known to them.
- It encourages a culture of respect for the responsibilities owed to others that should be at the heart of corporate governance, but is not
now.
Apart from a feeling that the accounting profession is doing its clients (and itself) a disservice – which is not the purpose of this blog – it is a stark reminder that a profit and loss account and balance sheet are only as useful for decision making as the estimates and assumptions underlying their preparation. Do you know the assumptions your accountant makes before you see your
accounts?
It is also the reason I advocate that hard-working business owners review the third financial statement that is often missing from their accounts – their cash summary – and ask for a reconciliation of profit and cash each month. I doubt many will see an item for 'future profit from zero-rate credit cards' but you might just find some other items you didn't expect. Its
never been more important to know your business numbers.
To your success
Noel Guilford