Reasons for Differences in Financial Statements - dummies

Reasons for Differences in Financial Statements

By John A. Tracy

The financial statements reported by a business are just one version of its financial history and accounting performance. A different accountant for the business undoubtedly would have recorded a different version, at least to some extent. The income statement and balance sheet of a business depend on which particular accounting methods the accountant chooses. Moreover, on orders from management, the financial statements could be tweaked to make them look better.

The dollar amounts reported in the financial statements of a business aren’t simply “facts” that depend only on good bookkeeping. Here’s why different accountants record transactions differently. The accountant

  • Must make choices among different accounting methods for recording the amounts of revenue and expenses
  • Can select between pessimistic and optimistic estimates and forecasts when recording certain revenue and expenses
  • Has some wiggle room in implementing accounting methods, especially regarding the precise timing of when to record sales and expenses
  • Can carry out certain tactics at year-end to put a more favorable spin on the financial statements, usually under the orders or tacit approval of top management

A popular notion is that accounting is an exact science and that the amounts reported in the financial statements are true and accurate down to the last dollar. When people see an amount reported to the last digit in a financial statement, they naturally get the impression of exactitude and precision. However, in the real world of business, the accountant has to make many arbitrary choices between ways of recording revenue and expenses and of recording changes in their corresponding assets and liabilities.

It’s always possible that the accountant doesn’t fully understand the transaction being recorded or relies on misleading information, with the result that the entry for the transaction is wrong. And bookkeeping processing slip-ups happen. The term error generally refers to honest mistakes; there’s no intention of manipulating the financial statements. Unfortunately, a business may not detect accounting mistakes, and therefore its financial statements end up being misleading to one degree or another. (A business should institute effective internal controls to prevent accounting errors.)