Financial statements are a vital source of information. Thus, accounting standards have been improved over the years to enhance the transparency and quality of business reporting. Today, the representation of financial statement has become complex making it hard for investors to get a clear picture of the performance of the business. There are some complex transactions that an investor may not understand. Additionally, there are complex accounting transactions that companies treat differently such as mergers and acquisitions and divestitures. The complexity of accounting transactions is not only felt by investors but also by corporations. Some transactions such as hedging, pension, and divestitures have been identified as complex accounting transaction. Businesses and investors must understand how these complex operations should be treated to ensure that financial reports offer investors with the accurate representation of the performance company.
One of the complex issues that prevent investors from understanding financial statement is complex intercompany transactions. In the global environment, businesses are operating in different countries. Additionally, some companies such as General Electric have different business segments. The involvement of a single business entity in different businesses activities and operating in different countries has made the financial statement complex. Intercompany transactions are daily operations of a company which arises where there is a multinational which have multiple business entities with different lines of businesses which are consolidated in a single parent company. The enterprises are merged into one parent company for purposes of financial reporting. Some of the important organizations will develop a centralized an accounting process. The company will consider the cost that has been accumulated by the entire business entity and then allocates the cost to each business line to calculate the profits or losses of each business. For instance, a company Y with business lines in health, and network technology will get accumulated costs and then allocate these values to each of business line to determine the profits and loses of the two business lines. The only way the business can make a fair report on each of the business line is if it fairly allocates the costs. However, if it disproportionally allocates price, it will manipulate the business reports and mislead investors.
Business usually develops consolidated financial statement which does not indicate how one business activity impacts on other business segments. For the case of General Electric, if an investor is provided with a consolidated financial statement, they may not determine how an item such as research and development is impacting on the aviation segment of the business as opposed to other sectors. Accounting regulatory bodies faced the issue in addressing these concerns. A review of accounting standards in 2002 required multinational companies to provide additional disclosures to enable investors to understand financial statements. General Electric started making disclosures on the off-balance sheet and structured financing arrangements. In recent years, there have been reports on how intercompany transactions are used to mislead investors. Some businesses will create complex off-balance sheet structures with some complex operations that may mislead investors. When a company fails to make sufficient disclosures concerning the intercompany sale, the real value of the business cannot be determined.
Investors and lenders should be careful when dealing with the consolidated financial statements. They must read all the footnote disclosures and look at the disclosures carefully. Investors are advised to read between the lines because the consolidated financial statements will not adequately reflect the position of a company. Investors should not only rely on the disclosures but also ask the management of the company questions in areas that are not clear. They should demand further disclosures if they feel that there are areas that have insufficient information.
The complexity of accounting is not only felt by investors, but businesses have also identified transactions that are complex to handle. A good example is treatments of business mergers. Globalization is encouraging more business to combine in mergers and acquisitions. When the merger or acquisition involves two large companies, it becomes a complicated accounting transaction. The process of accounting for mergers and acquisition involves many interdependent steps. These include valuation, taxation, and legal services. When merging two companies the financial statements of both organizations must be disclosed, and companies will be required to deal with accounting system issues and records and coordination of internal and external auditors. Some reasons cause mergers and acquisition accounting to become complicated. They include:
• Different accounting standards, for instance, if a company located in the United States is merging with United Kingdom Company the different accounting standards used by each entity will impact on the treatment of various items in financial reports.
• Complex accounting transactions which include:
Debt modification
Stock-based compensation
Foreign currency
Hedging
Consolidation
Derivatives
• Purchase price allocation among the assets and liabilities of different entities
Divestitures have also been identified as a complex accounting issue. There is some reason divestitures are complex accounting transaction. They include
• Divestitures include some different countries hence the legal framework and the various accounting standards applied in the states will complicate accounting transactions
• It is hard to estimate the corporate cost allocations
• Complexity of dealing with debt, goodwill and other intangible benefits, and employee benefits
In the IFRS besides mergers and acquisitions and divestitures, there are some other complex accounting issues. The first one is the deferred tax. Deferred tax has been identified as a challenging topic. The deferred tax is recognized if carrying the income tax forward will make future tax payment larger or smaller than they would have if the asset and liability in the current state have no tax consequences. The second issue is the financial risk disclosure which requires businesses to disclose the extent to which financial instruments are exposed to risk. The risks that are mainly addressed are the credit risk, market risk and liquidity risk which are hard to estimate.
Business can deal with complex accounting issues by hiring accounting firms. There are firms which have specialized in taxation and accounting issues. The companies can offer business with right solutions to the complex accounting issues.
