Financial Statements Their Reliability and Lessons from the Financial Crisis

The usually elegant, glossy pages of Annual Reports released by big companies can lead one to believe that the financial statements contained therein are accurate and complete and that they fairly reflect the true financial condition of a company. This impression is all the more bolstered by the discovery that the company’s financial records had been audited by one of the world’s top accountancy firms. Yet our experience since the early part of this decade has shown this to be an illusion. The generally accepted accounting principles (GAAP) have been tagged as one of the fundamental causes of the recent financial and banking crisis that originated in the United States and sent shock waves throughout the world. According to the Accounting Dictionary, the GAAP consists of standards, conventions, and rules accountants follow in recording and summarizing transactions, and in the preparation of financial statements. There is no central authority that promulgates the rules of GAAP. instead, the Securities and Exchange Commission accepts and enforces the compiled issuances from FASB, AICPA, and other sources. The Accounting Principles Board (APB) of AICPA defines GAAP as encompassing the conventions, rules, and procedures necessary to define accepted accounting practice at a particular time, and that the principles are derived from experiences and reason that have proved useful. (AICPA, 1970, cited in Wolk et al., 1997). Voluminous rules under GAAP have been issued over the years, and the complexity of these rules which have not been consistently organized around fixed and commonly agreed principles have not increased our understanding of financial reports. In fact, they have fostered a lack of clarity and transparency. Although the GAAP is designed for the preparation of financial statements for external users, internal decision-makers also use them for various purposes including decisions regarding promotions and year-end bonuses to its executives.