“The accounting profit figure is simply ameasure of the true profit of an organisation.” Discuss. My understanding of accounting profit was developed throughthe introduction to financial accounting module in year 1. Accounting profit iscalculated in accordance to the general accepted accounting principles (GAAP).Profit is the difference between revenue earned and expenses incurred whichinclude costs such as operating expenses. However, it is crucial to point outthat we have two profit figures, gross profit and net profit.
Gross profit isthe profit figure from the trade of the business, and measures the sellingprice and purchasing price. Besides, expenses deducted from gross profit areregular on-going costs of a business, which is referred as overheads, forexample, salaries, rent and insurance. Whereas, the net profit figure measuresthe performance of a business.
In order to determine the net profit value thegross profit is deducted from running costs, such as interest and taxes.Nevertheless, the profit figure can vary from business to business, for exampleconsidering two businesses that have the same costs and revenue; they can havea different profit figure, as it depends on the accounting policy that has beenused in order to produce the profit figure. This links to techniquesestablished in creative accounting that allows businesses to manipulate figuressuch as profit, in order to gain the confidence of stakeholders. Furthermore,it is vital to indicate that expenses are matched against revenue earned in aperiod, which is identified as the matching concept. For profit, revenues donot have to be received in the form of cash and expenses do not have to bepaid, but will still be accounted for in the income statement. If we haveestablished what the accounting profit is, then essentially the question ofmatter is what is true profit? (Author 2017, Part 1)On my journey through this module, I have greatly expandedmy understanding of accounting profit. Initially, my understanding was limited.I was aware the way in which profit is calculated with regards to GAAP and howthe term is defined.
The importance of understanding profit was also apparentto me but that was the limit of my knowledge at the time. This module has beena valuable catalyst in helping me to grasp the essence of a variety oftheories, thus allowing me to truly understand different factors that influencehow accounting practises are used but also appreciate what we mean by truth inaccounting. There are two areas that I will focus on to highlight the ‘truth’in accounting. Firstly, subjectivity, which will discuss the power thataccountants have to manipulate figures such as profit, and the impact this hason the organisation and stakeholders.
Then I will focus on how accounting isregulated, and how regulators ensure accounting information presents the’truth’ (complete, neutral and free from error)My initial answer touches on the concept of subjectivity inaccounting, an issue that is of particular interest in determining the disparitiesbetween accounting profit and whether it is a measure of the true profit. Ipreviously mentioned that accounting policy dictates calculation of profitfigures for organisations which, when considered with creative accounting intendsto gain the confidence of stakeholders. Hines discusses how in realityaccountants have the discretion to ‘creating the reality’ of figures inaccounting. (HINES PG 254). It is also worth noting that choices are activelybeing made to include or not include information and based on this information userssuch as shareholders or potential investors to ‘think and act’ based on theinformation presented to them. However, if we defined the rules differently,such as if we value assets at historical costs as opposed to market value.Therefore, we end up with a different profit figure, so hence there are rangeof possible truths in accounting. Thisleads to identifying the agency theory.
Managers having the choice to adopt aparticular accounting policy allows for ‘opportunistic behaviour’. (SCOTT W,FAT) PG 34 Also, certain figures in annual reports are presented in bold,colourful and highlighted to attract the attention of the reader. This modulehas allowed me to question the information and what judgments were made. Insupport of this, one of the Positive Accounting Theory hypotheses, the bonusplan hypothesis underlines that managers, for self-interest will intend toadopt certain accounting policies, which conveys strong profits, as managerswill be rewarded if the organisation ‘performs well’. PG 277 Book. A recentexample of Tesco, whom overstated their profits and recognised ‘future periods’revenue.
Another way to examine the issue of subjectivity in accounting isbased on IAS 16 which is based upon the judgement, but also what accountingpolicies accountants decide to adopt. IAS 16 highlights the issue ofsubjectivity in accounting as figures can be manipulated, when for example, International Accounting Standards Board (IASB) was foundedin 2010 to overcome the subjectivity in accounting, and prevent different waysof preparing FS, but more so it was founded in the publics intrest. InternationalAccounting Standards Board is an organisational responsible for settingstandards, whom intitate rules and conventions that set a procedure foraccountants.
In my initial answer I did not consider the point about regulatorsand the impact they have on the profession.. which showed my lack of awarenessof the impact This brings forth the question of the quality of auditing,as shareholders appoint auditors to ensure that managers are effectivelymanaging the business, but this leads us to the problem that auditors are giventhe information provided by the managers. As mentioned previously regardingTescos, the Financial Reporting Council was able to determine that it could notchallenge the auditing firm, or whether it ‘failed to act appropriately on theinformation they were given’. (FT) This suggests that. Previously, I believedthat auditing firms were responsible for ensuring that the information isaccurate, but that cannot be achieved to the required standard as they will auditwhatever is disclosed by the organisation. CONCLUSION: 2points why it is impossible for AP to be a measure of true profit.True profitMoreover, the problem caused by the level of subkectivity inaccounting is consistency, which causes zzz when comparing financial accountswith businesses operating in the same market, which essentially questions therelevance of the information WEdecide on a truth, because it has the qualities we are looking for, it isuseful, it is not the singular truth, it is one possible truth/.Furthermore, understanding subjectivity in accountinghas allowed me to think about the importance of transparency in accountinginformation, and if missing, the effect it can have.
