In describing how finance and accounting differ from each other as disciplines, someone recently made the following 3 statements about accounting:
- the accounting approach is backward looking and concerned with compliance against accounting principles and reporting obligations.
- it focuses on smoothing out the results of economic activity over time to match revenues and expenses.
- it’s also conservative in the recording and reporting of the results of economic activity.
I agree that accounting and financing are different (though related) activities. But I disagree with all 3 of these statements about accounting, particularly as they relate to financial accounting.
I suspect these statements are also not accurate for management accounting and cost accounting, but I won’t try to comment on that.
Just a compliance exercise?
Financial accounting is not ‘concerned with compliance against accounting principles and reporting obligations’. It is about reporting useful information to investors.
‘Accounting principles and reporting obligations’ are a means of trying to achieve that end. They are not the end in themselves.
Focus on smoothing and matching?
Financial accounting does not focus ‘on smoothing out the results of economic activity over time to match revenues and expenses’. It focuses on recording assets (rights) and liabilities (obligations) as transactions and other events occur, and continuing to record those assets and liabilities until they expire.
‘Matching revenues and expenses’ is not an objective in itself, though it is a common outcome of reporting assets and liabilities from when they arise until when they expire.
It isn’t entirely clear what is meant by ‘conservative in the recording and reporting of the results of economic activity.’ Financial accounting doesn’t try to value a business, though it does report some of the inputs (but by no means all of them) that may be useful in valuing the business.
Financial accounting doesn’t try to capture all assets in the balance sheet, and it doesn’t try to report all increases in the value of those assets that the balance sheet does capture.
Why doesn’t financial accounting try to capture all assets and all value increases? The reasons are generally:
- some assets are too difficult to measure;
- many assets generate returns in combination with other assets, and cannot be measured without valuing the whole business—which is not the purpose of financial accounting; or
- the cost of measuring some assets would exceed the benefits from the resulting information.