I commented on an interesting discussion about accrual accounting, which started with a blog by Jason Voss on the CFA Institute website.
Mr. Voss’s comments address the strengths and weaknesses of accrual accounting.
In response to one commenter, who pointed out that analysts rely on cash models that they develop, which he noted are imperfect, I offered the following comments:
This is the “chicken-or-egg” problem. As I understand it, analysts rely on financial reporting information to develop their valuation models. But, financial accounting includes many very soft accruals, among those are: (1) estimates on revenue from long-term contracts and estimates of the related costs associated with those revenues, (2) the allowance for losses on receivables and loans, (3) reserves for contingencies, (4) recorded amounts for intangibles and goodwill acquired in a business combination and the related subsequent impairment losses, (5) valuations associated with financial hedges and hedged instruments, etc. etc. etc.
As I say to my students, we don’t know the company’s actual “numbers”, we just know what they report. We’ll know the actual numbers when they are liquidated. That’s when cash accounting “catches-up with accrual accounting.
Thanks to Mr. Voss and the CFA Institute for an interesting discussion.