May/June 2009 / Cover Story
Fair Versus Correct Financial Statements
Financial advisors, particularly certified public accountants, often ground their advice in arcane accounting rules without bringing to bear their personal judgment. While such advice can be technically correct, it may not lead to the production of what investors and analysts really want: fair financial statements. Executives need to focus on producing fair and not just correct financial statements. They also need to consider the possibility that their compensation policies may lead some in the organization to ignore fairness. Fair means presenting a realistic financial picture of the company. The purpose is to give stakeholders information that puts them in the best position to make decisions. This type of decision making is best for the long-term health of the organization.
Producing fair financial statements is challenging for several reasons. First, the securities laws do not define the word “fair,” and there is no objective test for it. Second, the training of most U.S. accountants has been rules-based, whereas the assessment of fairness is an exercise in principles-based judgment. Finally, compensation based on short-term measures of performance can create an incentive to ignore fairness.
Fair financial statements may not make the company look its best on a quarterly basis, but analysts and shareholders will learn over time that the company’s financial statements can be trusted. In the long run they are the best option.
David E. Hardesty, vice president of Wilson Markle Stuckey Hardesty & Bott in Lakespur, California, is a CPA specializing in tax planning and preparation, especially for Internet, software companies, and other entrepreneurial enterprises. He is adjunct professor at Golden Gate University’s Graduate School of Taxation, and he has written numerous treatises and guides for the Tax and Accounting business of Thomson Reuters, david@davidhardesty.com
