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that is seen at the top of a profit and loss account is the value of the goods
dispatched and invoiced to customers in the period in question。
The accrual concept
The profit and loss account sets out to ‘match’ ine and expenditure to
the appropriate time period。 It is only in this way that the profit for the
period can be realistically calculated。 Suppose； for example； that you are
Accounting 21
calculating one month’s profits when the quarterly telephone bill es in。
The picture might look like Table 1。2。
This is clearly wrong。 In the first place； three months’ telephone charges
have been ‘matched’ against one month’s sales。 Equally wrong is charging
anything other than January’s telephone bill against January’s ine。
Unfortunately； bills such as this are rarely to hand when you want the accounts；
so in practice the telephone bill is ‘accrued’ for。 The figure （which
may even be absolutely correct if you have a meter） is put in as a provision
to meet this liability when it bees due。
ACCOUNTING CONVENTIONS
These concepts provide a useful set of ground rules； but they are open to a
range of possible interpretations。 Over time； a generally accepted approach
to how the concepts are applied has been arrived at。 This approach hinges
on the use of three conventions： conservatism； materiality and consistency。
Conservatism
Accountants are o。。en viewed as merchants of gloom； always prone to take
a pessimistic point of view。 The fact that a point of view has to be taken at
all is the root of the problem。 The convention of conservatism means that；
given a choice； the accountant takes the figure that will result in a lower
end profit。 This might mean； for example； taking the higher of two possible
expense figures。 Few people are upset if the profit figure at the end of the
day is higher than earlier estimates。 The converse is never true。
Materiality
A strict interpretation of depreciation （see above） could lead to all sorts of
trivial paperwork。 For example； pencil sharpeners； staplers and paperclips；
all theoretically items of fixed assets； should be depreciated over their
working lives。 This is obviously a useless exercise and in practice these
items are wri。。en…off when they are bought。
Table 1。2 Example of a badly matched profit and loss account
Profit and loss account for January； year 20XX
￡
Sales ine for January 4；000
Less telephone bill （last quarter） 800
Profit before other expenses 3；200
22 The Thirty…Day MBA
Clearly； the level of ‘materiality’ is not the same for all businesses。 A
multinational might not keep meticulous records of every item of machinery
under ￡1；000。 For a small business this may represent all the machinery it
has。
Consistency
Even with the help of those concepts and conventions； there is a fair degree
of latitude in how you can record and interpret financial information。 You
should choose the methods that give the fairest picture of how the firm is
performing and stick with them。 It is very difficult to keep track of events
in a business that is always changing its accounting methods。 This does not
mean that you are stuck with one method forever。 Any change； however； is
an important step。
THE RULE MAKERS
The accounting professional bodies； with a li。。le prodding from governments；
are responsible for ensuring that accounting reports conform to
what are known as Generally Accepted Accounting Practices （GAAP）。 A
new entrant； International Accounting Standards； is challenging that term
as GAAP rules have been interpreted differently on different continents
and indeed largely ignored on others。
The rule book has to be adapted to acmodate changes in the way
business is done。 For example； international business across frontiers is now
the norm； so rules on handling currency and reporting taxable profits in
different countries have to be acmodated within a pany’s accounts
in a consistent manner。
Although an MBA isn’t usually expected to know all the rules； you
should be able to get up to date before any meetings where the subject is
likely to e up。 You can keep track of changes in pany reporting
rules on the Institute of Chartered Accountants’ website （icaew 》
Accounting and corporate reporting 》 UK GAAP）。
Protecting investors
When confidence in US businesses was rocked badly with a series of
high…profile financial frauds； Enron and World for example； the US
government introduced the Sarbanes–Oxley Act； known less monly
but be。。er understood as ‘The Public pany Accounting Reforms and
Investor Protection Act – 2002’。 The Act’s purpose is to close the loopholes
opened up by creative accountants； who are always devising ways to overstate
profits and understate liabilities； and so make it easier for shareholders
Accounting 23
to see how profitable a business really is。 The act doesn’t just apply to US
panies； any businesses with shares listed on a US stock market that
does business in the United States is swept into the net。 Check out
sarbanes…oxley for the low…down on that Act。
The UK version is The panies （Audit； Investigations and munity
Enterprise） Act。 You can read up on the UK rules at the Office of the
Public Sector Information （opsi。gov。uk 》 Legislation 》 UK 》 Acts 》
Public Acts 2004 》 panies （Audit； Investigations and munity
Enterprise） Act 2004）。
Auditors – the gatekeepers
All public panies； that is； those listed on a stock exchange； are required
to have an annual audit by a qualified accountant appointed by the directors
and approved of by the shareholders。 Any pany with outside
shareholders and indeed all but the smallest private panies are
required by law to be audited。 The auditors’ job is to examine the accounts；
ensure that they conform with the prevailing accounting rules and give an
opinion about the financial statements。 Though the auditors’ report may be
50 pages long； with a score or more footnotes； the findings are summarized
in a single sentence： ‘The financial statements give a true and fair view of
the state of affairs of the pany at （a certain date） and the financial statem