It is always good as a business owner to follow up on accountants to ensure that they are competent and that they are up to date with all accounting standards. This will ensure the business books are up to date and as per requirement.
Especially when business is good, it’s tempting to assume that your accountant has everything under control. But many accountants focus primarily on filling out quarterly tax returns without really tracking the performance of the underlying business. Most successful business owners understand that if they really want to manage their business, they need to get comfortable with the fundamentals of accounting. Here’s where to get started.
A Little-Known Accounting Change Could Have a Big Impact
A tsunami of change is coming to the regulations that govern corporate America, if President Trump and Republicans in Congress get their way.
But there is also a little-noticed change coming down the pike that will have a major impact on business. And this one has corporate executives up in arms — and scrambling to comply.
It’s a new accounting rule promulgated by the Financial Accounting Standards Board, known as FASB. The rule, with the blandly mellifluous title “Financial Instruments–Overall: Recognition and Measurement of Financial Assets and Financial Liabilities,” or Accounting Standards Update 2016-01, will change the way companies, both big and small, account for their equity investments in other companies, specifically for those stakes smaller than 20 percent.
Like much of what the accounting standards board tries to do, the new rule is intended to provide investors and creditors with better information and more clarity around a company’s financial statements, with the lofty goal of helping them make more informed decisions when providing capital to a company or business.
But Update 2016-01 could significantly affect — and distort — the way companies like Alphabet, Intel, IBM and Salesforce.com, which make a lot of small investments in other companies, report their earnings. It could also curtail such investments from being made in the first place, because some businesses say the costs of complying with the rule are too high.
Here’s how things would change with the new rule: Now, when a company buys a stake of less than 20 percent in another company, it usually accounts for the investment on its balance sheet at cost — the price it paid for it. Over time, under the old rules, if the value of the investment goes down, the rules required a corresponding write-down of the value, both through the company’s income statement and on its balance sheet. But if the value increases over time, the investment can still be kept at cost.
While investors were fully informed when an investment lost value, there was less transparency for them when an investment increased in value. What investors lost in transparency on the upside, it has been argued, was gained in not requiring corporate executives to place a number on these often difficult-to-value investments every quarter.
That’s what is going to change after Dec. 15. From then on, each minority investment a public company makes will have to be valued quarterly, whether that value has increased or decreased. That potential volatility will soon be required to flow through a company’s income statement, with the possibility of causing fluctuations to earnings per share from something that is not even a core business.
Accounting procedures and financial statements determine investor’s decisions. This leads to sometimes the accountant trying to cover up on the company’s financial mistakes by giving wrong statements.
Let’s back up. Current accounting standards require corporations to make financial disclosures of information that “could” influence investors. If this sounds wishy-washy, it is. The accounting board’s proposal would rewrite this already subjective standard to require corporate disclosure only when there is a “substantial likelihood” that information “would” significantly alter investor decisions.
The language change is troublesome because it lowers the bar for excluding important or “material” information. Even just changing “could” to “would” is a big deal. “Could” connotes possibility and invites broader disclosure; “would” connotes more certainty and can be used by firms to exclude disclosure.
Imagine a pharmaceutical company that discovers that a promising new drug in the pipeline is performing poorly in patient trials. Such information “could” sway investing decisions, and, under current rules, there’s a strong case for disclosure. But it’s much harder to establish that there is “substantial likelihood” that disclosing this information “would” significantly alter investor choices. If the new proposal is enacted, the drug company gets a free pass to avoid disclosure.