When people hear “accounting,” they often picture dull number-crunching or meticulous cash counting. But accounting is far from the boring, mechanical process many assume. Beneath the surface of matching the debits and credits lies a fascinating world of interpretation, judgement, and subjectivity.
At its core, accounting is about storytelling — using numbers to convey the financial health of a business. And like any story, the way it’s told can vary depending on who’s telling it and why.
Three Big Statements
Every company’s financial narrative revolves around three main statements: the Balance Sheet, the Income Statement, and the Cash Flow Statement. Each plays a unique role in portraying a company’s financial picture:
Balance Sheet
The balance sheet is a snapshot of a company’s financial position at a specific point in time. It boils down to what the company owns (assets) versus what it owes (liabilities), with the difference being its equity. Think of it as a portrait of the company’s overall health.
Income Statement
The income statement tells the story of a company’s performance over a period — its revenues, expenses, and profits. In simple terms, it answers the question: how much money is the company earning (or losing)?
Cash Flow Statement
The cash flow statement is perhaps the most critical of all. It shows how cash moves in and out of a business. But why cash? Couldn’t we track assets like inventory instead?
Why the fixation on cash, instead of other assets? We could just as easily have an inventory statement. However, cash is the most valuable asset a company can have because of how fungible it is. Theoretically, if people start and invest in companies to earn cash, that is the only currency we should have – and everything else needs to be converted into cash. Everything else, has a measure of valuation to it, and most valuations can be debated. What is an unsold apple sitting on the supermarket shelf worth? Cash is the lifeblood of a business, because it is the most reliable instrument, and hence can stave off financial stress when the company is in distress. If a supermarket has to pay a debt of £1 million, but has no cash, it cannot pay its debtors in apples.
Valuation
There are surprisingly many ways valuation can be approached. If I bought a tractor, how should I represent that?
I can represent it as the value I bought it for. That would be an easy way, but that would also disregard any purchases that I overpaid for. If I paid £100 for a granny smith for my office pantry because I was smitten with the friendly farmer’s market smallholder, can I really say that I have an asset worth £100?
I can also represent it as the value needed to replace it. I know that apples are sold at £2, so that is my value. However, in a niche market, this might be difficult to find a benchmark for this. Apples are commonplace, an apple processing machine capable of processing millions of apples a day is less so. If we start bringing in comparable items deemed similar, we introduce subjectivity.
Attribution of time period
A company buys a piece of equipment – should we charge that at the point of purchase? If the equipment is used for 10 years, you would suddenly see a huge drop in profits in the year of purchase, before profits recover. That is why we use depreciation – which spreads out the value of long-lived equipment over their lifespan.
Now that we have depreciation, there provides room for subjectivity. Up for debate is the way in which an asset loses value. Does it lose value at a constant rate, or does it have an exponential decline? Furthermore, what is the useful life of a piece of equipment? These can materially impact the profits recorded by a business.
Dangers of subjectivity
By giving companies the ability to adjust numbers, we potentially allow them to massage numbers to portray a scenario to their advantage. Whether it’s in determining the bonus of management, selling a company, or getting suppliers/customers to trust a business, financial information is of utmost importance. Financial shenanigans (Schilit, 1993) covers the accounting tricks that are often used.
Accounting is far more than a dry exercise in matching debits and credits. It’s a discipline that balances precision with judgement, and objectivity with interpretation. Beneath the seemingly rigid framework of financial statements lies a world of nuance — one where seemingly minor assumptions can have big impacts.
Understanding this subjectivity isn’t just important for accountants. It’s crucial for anyone making decisions based on financial data, from investors to executives. Because in the world of accounting, numbers aren’t just a matter of counting beans, they’re derived from a series of judgement calls about these beans.
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