Question

Bonus, Capital and Smoothing would have an immeditae impact when making accounting changes. If GAAP allows such changes, what are the procedures for determining if a change can be made. Do you have an example or two of bonus, capital and smoothing ?

Answer 1

Under US GAAP, management is granted the flexibility of choosing between or among certain alternative methods to account for the same economic transactions. Examples of this are provided in this publication in diverse areas such as the different cost-flow assumptions used to account for inventory and cost of sales, different methods of depreciating long-lived assets, and different methods of identifying operating segments. The professional literature (in the areas of accounting principles, auditing standards, quality control standards, and professional ethics) is emphatic that, in choosing from the various alternatives, management is to choose principles and apply them in a manner that results in financial statements that are representationally faithful to economic substance over form and fully transparent to the user.

Changes can occur over time due to changes in the assumptions and estimates underlying the application of accounting principles and methods of applying them, changes in the principles defined as acceptable by a standards-setting authority, or other types of changes.

The accounting for and disclosure of changes in accounting for given transactions are issues that have confronted the accounting profession for many years. The matter is particularly sensitive because of the impact on financial statement analysis of differing methods of accounting for specific transactions, and of disclosing the effects of those changes, This impact can have a profound influence on investing and operational decisions. Financial statement analysis presumes the consistency and comparability of financial statements across periods and among entities within industry groupings. Any type of accounting change potentially can create inconsistency, and since some change is inevitable, the challenge is to present the effects of the change in a manner that is most readily comprehended by users of financial statements, who may make various adjustments of their own to make the information comparable for analysis purposes.

This concern is exacerbated by the fact that events in the late 1900s and early 2000s have created a growing crisis of confidence about the accuracy of financial reports and the credibility of the parties associated with preparing and auditing them. The number and magnitude of restatements of previously issued financial statements, with reportedly as many as 10% of all publicly traded companies having at least one such restatement over a recent four-year period, has raised disturbing questions about management manipulation and the possible complicity, or at least negligence, of external auditors. The enactment of the Sarbanes-Oxley Act of 2002 and the restructuring of oversight of the auditing profession were two consequences of this series of unfortunate developments. The move to "converge" US GAAP and international accounting standards is a further indicator of the premium now being placed on accurate, transparent, and uniform financial reporting.