November 17, 2018

Is there now an overwhelming case for cash accounting?

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Cash accounting would make accounts simpler to understand. Companies could only account for revenue when they receive the cash and expenses only once they have paid for them. At a stroke, gone from a set of accounts would be subjective items such as depreciation, amortisation, difficult-to-comprehend revenue recognition, accruals, provisions and so on.

With recent accounting scandals, there is an increasingly loud clamour from investors, employees and the general public, to make companies’ accounts more transparent to the lay reader.

Recent high-profile examples of ‘creative accounting’ include Tesco PLC, which, in 2014, overstated its profits by £326m by accounting for a supplier payment scheme in an advantageous manner, allegedly to meet investors’ ever-increasing profit expectations.

A potential current example relates to lenders that offer ‘0% balance transfer cards’ (‘Interest-free credit cards a “ticking time bomb”, bankers fear’, Financial Times 30 April 2017).

Some lenders appear to account for, and report, future expected revenue in their current profit and loss accounts. This revenue comprises interest that will be earned by the lender only if a customer ends the interest-free period without paying off the balance transferred and starts paying a high rate on these transferred balances.

I would suggest that this practice is clairvoyant at best, founded on the assumption that customers retain the debt on the card, do not pay off the transferred balance and then have to pay high rates of interest on this balance. This assumption will, no doubt, be justified by the historical observation, ‘That’s what the majority of our customers usually do.’ Hardly, I would suggest, a sound basis on which to report today profits that will only be earned on some event that may or may not take place in the future.

What happens if the future does not turn out as predicted? Massive hits to the profit will occur but bonuses may have already been paid out in previous periods on the basis of revenue/profit that supposedly, has already been earned. Does that sound familiar? I sense déjà vu!

So my point is simply this. Is it now time to revert to compulsory cash accounting for companies?

I can already hear the howls of protest from at least two vested interests.

  • From companies, because using subjective/flexible assumptions to prepare accounts can allow reporting of ever-increasing profits (potentially fuelling an upward-moving share price).
  • From accountants, because it would remove at a stroke the need for complex rules regarding revenue recognition and accounting for costs, thus leading to many accountants being superfluous to requirements plus making many complex accounting standards redundant.

I suspect, however, that my proposed simplicity and transparency will not suit all and will therefore never come to be. In fact, I am certain of it!

Colin Garvie, Teaching Fellow About Colin Garvie, Teaching Fellow

Teaching Fellow and Chartered Accountant, delivers Accounting to on-campus students in Edinburgh, Malaysia and Dubai.