Accounting Simplification

After much backing and filling, it is time to get serious about talking about financial statements that the average investor can understand — simplified accounting. This is not what an accountant means when she talks about simplification, however. To her, simplification is anything that makes her life easier: particularly, fewer and less detailed rules. In almost every case, the two views of simplification are at war. That will be the topic tomorrow.

There is one, easy first step toward real simplification: standardization of the form of financial statements. Today, no 2 companies’ financial statements look alike. The statements themselves have different names. Microsoft’s “balance sheet” is GE’s “statement of financial position.” Also, the items are presented differently using different language. Microsoft’s balance sheet shows 12 types of asset. GE, which is a much more complicated empire, has only 11. (GE’s “other assets” are almost twice the size of their property, plant, and equipment.)

More in the footnote.

Further simplification can be achieved as part of this standardization. The categories of the items measured and disclosed should be chosen so as to be optimally useful. For example, any investor should know what “property, plant, and equipment” are. This is a useful category. In contrast, the largest type of asset on Enron’s financial statements right before the bankruptcy were “assets from price risk management activities.” Much evil slept in this black box.

Which gets us back to our earlier discussion of whether it is even possible for the average investor to understand modern business. Perhaps it is not possible to come up with a comprehensible standard form for the financial statements for all businesses. But, of course, nobody has tried. As a lawyer, I cannot understand what accounting regulators have been doing for the last 73 years (since the first federal securities act).

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