RECORDING FINANCIAL TRANSACTIONS 33
such as Microsoft, which have enormous goodwill and intellectual property but
a low asset base, have high MBRs because the stock market takes account of
information that is not reflected in accounting reports.
Going concern
The financial statements are prepared on the basis that the business will continue
in operation. Many businesses have failed soon after their financial reports have
been prepared on a going concern basis, making the asset values in the Balance
Sheet impossible to realize. As asset values after the liquidation of a business
are unlikely to equal historic cost, the continued operation of a business is an
important assumption.
Conservatism
Accounting is a prudent practice, in which the sometimes over-optimistic opinions
of non-financial managers are discounted. A conservative approach tends to
recognize the downside of events rather than the upside. However, as mentioned
above, the pressure on listed companies from analysts to meet stock market
expectations of profitability has resulted from time to time in ‘creative’ accounting
practices (discussed in Chapter 7), such as those that led to problems at Enron
and WorldCom.
Disclosure
The accounting standards and principles that have been applied in the financial
statements are described in the financial reports. In the UK, there is a substantial
body of principles governing what information is to be disclosed in financial
reports (see Chapter 6), although in the US the disclosure requirements are rule
based rather than principle based. As a result, it has been argued that it is easier
to find ways to get around rules that are set in explicit terms than principles
that are more general. The interpretation of the disclosure rules is important in
auditing and led to criminal charges against accounting firm Arthur Andersen in
the United States.
Consistency
The application of accounting standards and principles should be consistent from
one year to the next. Where those principles vary, the effect on profits is separately
reported under the disclosure principle. However, some businesses have tended
to change their rules, even with disclosure, in order to improve their reported
performance, explaining the change as a once-only event.
These principles are applied in the collection, recording and reporting of
financial information. It therefore follows that information used by managers
for decision-making is subject to the same principles, and therefore to the same
limitations. One of the most important pieces of financial information for line