orgtheory.net

Brayden

If there is an organizations-related discipline that has a claim to factuality, I would think it was accounting. They're the number guys. They deal with facts, not subjectivity. Alas, my idealistic view of accounting is a little off.

Late last night, during another bout with insomnia, I found myself reading Baruch Lev's "Corporate Earnings: Facts and Fiction." Accounting can be very philosophical….

Fraudulent earnings can be conceptualized and identiŽfied only relative to true earnings. But what are true earnings? Generations of philosophers, scientists and writers have struggled with the concept of truth. To Socrates, truth was a fundamental attribute of God, whereas Descartes believed truth to be an essential way of life. In contrast, Nietzsche declared that truth cannot be recognized and Goethe that truth is contrary to our nature (Campbell, 2001). But to people of worldly affairs, engaged in business and finance, a true statement is simply one that corresponds to reality, or facts….

But is General Electric’s statement that it had earned $13.7 billion during 2001 "true”? What facts or reality correspond to these earnings? Consider: GE reports in its 2001 income statement an expense of $2.5 billion for “expected losses onŽ financing receivables” (money owed from customers). As GE says in a footnote, this expense “reflects management’s best estimate of probable losses” based on “historical experience.” Certainly, this is not a fact….

Some accounting measurement principles also bear little resemblance to reality. For example, accounting measurements typically assume an unchanging purchasing power of the dollar, thus justifying the subtraction of depreciation at historical cost from current revenues in the process of measuring earnings…With all this subjectivity and judgment, can true earnings corresponding to reality be measured? (pp. 30-31, italics added)

How very postmodern! Lev goes on to explain that the best accounting can do to truly capture reality is to assess earnings statements after some ten years have passed. Once a firm has collected all of its dues and payed out its debts, reality becomes more clear. But this just emphasizes the main point: measuring value is a highly subjective process with lots of wiggle room for error. In fact, it is this wiggle room that creates the conditions and opportunities for fraud. Management, intent on conveying as optimistic (or sometimes pessimistic) outlook as possible, often hide certain details in the earnings statement. It would be more straightforward though if forensic auditors could go back to records and accurately reconstruct the bottom line. But as Lev makes clear in this essay, even the auditing process is highly subjective and relies on norms and standards to make reasonable judgments about quantitative values and managers' intents when creating the earnings statement.

My head is spinning….I'm going to convert to postmodernism later today.