No Contest: Can Financial Reporting Standards Achieve Comparability in the Face of Financial Engineering
32 Pages Posted: 12 Nov 2019
Date Written: October 31, 2019
By comparing the accounting of 10 transaction methods designed to achieve the same net economic effect for a firm borrowing a given amount of money, we show that these 10 methods, under the current financial reporting standards, have markedly different consequences for a firm’s financial reporting. It follows that agents (e.g., managers, auditors, shareholders, and regulators, etc.) with different interests in financial reports may employ different methods of achieving the same net economic result. Accounting regulators can only specify how preparers should account for a given transaction; regulators have little control over the transactions and instruments firms choose to use. The broad range of financial reporting consequences of a given economic transaction, with regard to financial engineering, points to the difficulty — and even virtual impossibility — of regulators achieving comparability and consistency among firms’ financial reports. Despite attempts at regulation and the voluminous GAAP regulations, we reveal that managers remain free to engineer their transactions to publish their firm’s desired (or engineered) financial reports since these accounting methods are largely reported inconsistently with no comparability.
Keywords: financial reporting standards, comparability, financial engineering, regulation
JEL Classification: G23, G28, M48
Suggested Citation: Suggested Citation