You bet it is. It’s the dirty secret that everyone on the inside knows, but don’t talk about. Look at what accounting standards make us do. You filed a tax return for last year, and in it was probably a deduction for a computer. Now, there’s a good chance you didn’t buy a computer last year; the deduction you took was actually depreciation for a computer you bought years ago. You have something in your personal P&L statement that is simply a made up number. It’s not your fault, it’s just what the system demands you do.
It’s the same for business. Accounting standards decree that computers lose their value in even increments over a specific number of years. Of course, that doesn’t reflect reality at all. A business pays for things and sees cash go out the door; each transaction has a direct and immediate impact on returns and performance. Accounting standards, however, try to smooth the impact of investments in an attempt to give a picture of business in steady-state. How? They do things like apply arbitrary depreciation schedules – as for computer depreciation over seven years – and completely reshape all the numbers.
It is as though accounting regulators believe investors and others are not smart enough to understand the idea and longevity of investments. The accounting industry is substantially build up on arcane adjustments like depreciation; millions of FTE hours are spent compiling these numbers, and then, analysts in investments houses spend hours trying to unwind them to divine cash profits. It’s a silly game with one very bad outcome; within businesses, managers are misled in their decision-making by fictional numbers – investing in negative-return areas, and fully driving at highly-attractive ones. Rarely does a business build a parallel system giving real cash profitability, let alone one that looks at future prospects, and so business leaders rely on systems made for regulatory reporting.
As a result, business leaders are directing investments around their businesses using profit measures that are based on artificial adjustments, and expenses that have been allocated to parts of the business using inappropriate schemes. They are misled into growing unprofitable areas, and not emphasizing attractive ones. It’s a serious problem.
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