Question

How much discretion is there in the application of GAAP and is that good or bad?

Answer 1

Discretion that is provided under the accounting in GAAP is available to managers and management towards:

a) To managers, the decisions towards revenues and expenses and their magnitudes.

b) To management, the decisions on firm’s size, leverage, growth opportunities, operating level and risk taking

c) To management towards the presentation of the financial statement and the amount of disclosures.

d) To management towards maintenance of the same compensation with reduction in performance.

e) To management and the managers to exploit the corporate governance for their benefits or expose performance for investors benefits.

All these discretion in accounting in GAAP will results both in good and bad directions:

It is good when the managers are provided space to manipulate the operations and financial statement to makes the things clear to the shareholders and investors. But the same discretion is bad if the management uses them to hide their weaknesses and poor performance or bad market conditions or make wealth at the expense of shareholders.

It is good if management with its judgments brings earnings under bad market conditions for the shareholders, but would going to bad if management misses the earnings under the good market conditions and still present a rosy picture to shareholders and investors.