As much as the standard setters try to guide the future direction of accounting, there is a danger that as they lead their followers, who are in many cases preparers of financial statements, will become more restless. The reason for this is that preparers of financial statements, analysts and investors focus on profits while the standard setters are focusing on assets and liabilities.

For many years there have been questions as to what an asset, liability, income and expenses are. The standard setters eventually decided it was easier to define assets and liabilities than income and expenses and have been setting accounting standards based on the definitions produced. Once assets and liabilities were defined and it was decided which items were to be reported directly in equity, everything else was either income or expenses.

This approach has led to the matching principle no longer being a fundamental accounting concept and the downgrading of the prudent concept. The result of this is that reported profits can be more volatile which is why companies can object to profit effects that they don't like or believe does not reflect what they believe is fair. This leads to them criticising accounting standards and to debates with their auditors as to what should be reported.

Sometimes the preparers have only themselves to blame; they do not use opportunities provided to comment on future accounting standards, and then complain when standards affect their companies. In addition by not being part of the comment process they do not always realise that accounting statements are now focusing on the balance sheet. For example, a year after the issue of the statement on the recognition and measurement of financial instruments was issued, the banking industry suddenly lobbied for a delay in the implementation date of the statement because they didn't like the effort it would take to comply with the statement as well as the effect it would have on their results.

Examples of problem areas that have been discussed with preparers of financial statements as a result of their focus on profits, as opposed to the balance sheet, are as follows:

• Not wanting to expense amounts that don't meet the definition of an asset, such as advertising costs, because they believe the advertising will result in additional sales in the next year.
• Not wanting to value forward exchange contracts and thereby report an unrealised gain particularly when the movement in the exchange rate reverses after the year-end. In this case the post year-end movement is an economic event of the subsequent period and should affect reported profits then.
• Believing that headline earnings is an measure of maintainable profits when in reality it is defined as reported profits excluding profits and losses on capital items.
• Believing that a company's performance can be captured in one figure, namely the increase in headline earnings, when the focus should be on explaining results.
• Changing comparative figures so that amounts can be compared on a like basis, when again the company should explain the differences when the criteria to change comparatives has not been met.
• Companies believing they are special cases and that they should not be required to comply with the accounting standards.
• The focus on reporting can be to present the efforts of management in the best light rather than presenting a balanced position of the positive and negative aspects of the company's performance.

Preparers and users of financial statements need to realise that the focus of accounting standards has changed and that this can affect their assessments of a company's performance.

Source: Garth Coppin, Audit, 011 772 3000, www.ey.co.za

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