Question

A standard unqualified audit opinion states that financial statements “present fairly” a company’s results “in accordance with generally accepted accounting principles.” Does following GAAP necessarily “present fairly” a company’s operating results?

1) State and discuss you answer. Provide examples to support your opinion.
What should a company do if following GAAP does not “present fairly” its operating results?

2) Write a clear and concise response to the above question.

Answer 1

Financial statements are prepared based on GAAPs. Compliance with GAAPs ensure that all the transactions are presented fairly. However, this statement has some limitations. The statement can be justified through following explanations.

1. Accrual concept of Accounting: As per Accrual system of Accounting, the incomes and gains have to be recognised when earned and expenses and losses, when incurred. As a result of this treatment, cash flows and profits never match. The companies have to carry separate exercises to calculate the cash flows and profits.

Also, if revenues are recognised when earned and not when received, the Accounts receivable may be shown at high value. Though GAAPs stipulate that provision for doubtful debts has to be made, provision is only an amount of estimate by the management, which may not be accurate.

Also, some companies provide warranty services. As a result of this, the company will not exactly know the revenue earned if the warranty spreads across more than one accounting year.

2. Fair value concept: The assets were initially recognised at historical cost. Now, the assets are valued at fair values. However, the fair value is not fixed or constant as per every person. The idea or amount of fair value differs according to different people. Also, there is no one fixed method to calculate / determine the fair value. Because of this, we cannot say that the fair value, the asset is represented at is accurate.
3. Monetary concept: The GAAPs contain that the transactions which can be expressed in terms of money should be presented in financial statements. However, company enters into so many transactions which cannot be expressed monetarily. The most common example of this is human services. Though salaries are expressed monetarily, the value of human capital cannot be determined in terms of money. The same is nowhere presented in financial statements.

The company can opt not to follow GAAPs in the following cases:

• If the regulation (or law of the land) stipulates any conflicting treatment
• If following GAAPs result in misstatements or incorrect understanding to the users of financial statements

If the company chooses not to follow GAAPs, the company has to:

• Disclose the fact that specific GAAPs have not been followed
• Disclose the reasons for choosing not to follow GAAPs and how the same has resulted in better presentation
• Wherever possible, quantify the impact