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“The accounting profit figure is simply a measure of the true profit of an organisation.” Discuss
I will start by criticising my initial identification of accounting profit (a calculable amount, with set answer!). Profit is not just a set of calculations which has a defined/set-in-stone answer it can be described as the result after particular accounting rule and conventions have been employed (Deegan and Unerman 2006). These rules and conventions are created by standard setting bodies for example the International Accounting Standards Board in relation to conceptual frameworks also created by these bodies. Conceptual frameworks aim to assist creation of consistent and logical standards with an emphasis on the decision usefulness of accounting information however problems occur when highlighting whether accounting profit=true profit as key definitions in the framework need to be addressed; Who are the accounting users? And what are the objectives of financial statements?
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In the IASBs Framework for the Preparation and Presentation of Financial Statements users are defined as “present and potential investors, employees, lenders, suppliers and other trade creditors, customers, governments and their agencies and the general public” (IASplus 2009) As you can see the framework aims to apply to a wide range of users but in practice the scope is normally significantly reduced and typically tends to be skewed towards being useful for current and potential investors. This means financial reports and the accounting profit figure tends to be economic in nature ignoring any social and environmental factors (sustainability reporting) which affect business performance. Puxty (1998) identified the idea of a ‘traditional accounting paradigm’ for management accounting and I believe this can be related to modern financial accounting too, in the approach that the accounting profit figure is a way to solve the economic problem of how a business has performed therefore it cannot simple be a measure of true profit as it is calculated solely with quantifiable economic values. My views are further strengthened by how the IASB framework identify the objectives of financial reports “The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions” again common practice and prescribed standards leads to information being solely economical as these figures are seen to be useful for economic decision making. Influences on standard setting also back up my view on how accounting profit is mostly an economical figure. ‘Capture theory’ describes how “the ‘regulated’ tend to capture the ‘regulator'” (D&U 2006:40). Relating this to modern accounting standard setting we can witness how the big 4 accounting/audit firms (the regulated) have a large influence over the standard setting bodies and lobby for and against standards in order to satisfy their needs (private interest theory) which tend to try and protect the traditional paradigm of accounting to allow them to continually reap the rewards of monopolising the accounting industry. This leads me onto my second topic of discussion, how accountants craft the accounting profit figure.
My previous answer talks about subjectivity, I still believe this is a large factor in differentiating accounting and true profit and will discuss here in more depth. Hines (1988) talks about how accountants have the power to shape reality and questions “Who knows what the ‘full picture’ is?..depends on people deciding that they have the full picture.” So ignoring for a minute the fact that the accounting profit ignores sustainability reporting then many users may see the accounting profit as true profit if they believe accountants are showing the ‘full picture’ then again this is typically false as accountants have the power to recognise and realize assets, liabilities and revenue (slightly constrained by IAS and IFRSs although they do influence their creation) in line with the picture they want to create of the organisation. Therefore accounting profit depends on the assumption that accountants work professionally, ethically and in accordance with public interest theory to sculpt a ‘full picture’ of an organisations performance. Looking at an example IAS16 Property, Plant and Equipment it states that the carrying amount of an asset can measured at cost base (historic cost minus depreciation) or a revaluation model where a fair value can be measured reliably consequently accountants have the ability to choose when/if to revalue an asset at a time which could improve the perceived performance of the business. IAS 16 also relies on professional judgement firstly when calculating the amounts used in recognising the initial cost of an asset and when estimating the useful life of an asset for depreciation purposes, these judgements can be manipulated to affect the reliability of accounting profit measuring true profit.
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My final statement in part 1 is now redundant and to conclude it is shown that it is nearly impossible for accounting profit to simply be a measure of true profit as the accounting profit figure is trapped in a traditional paradigm which focuses on using economical figures in financial statements ignoring the idea of sustainability reporting which should be included to measure true profit and even when ignoring this fact the accounting profit figure is far too subjective and exposed to professional judgement to even portray a ‘full picture’ of an organisation let alone true profit.
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