1 Making Informed Judgments Part 1 Introduction Navigating Accounting, ® G. Peter & Carolyn R....

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Making Informed Judgments

Part 1

Introduction

Navigating Accounting,® G. Peter & Carolyn R. Wilson, © 1991-2009 NavAcc LLC. Modified by [Your Name].

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Menu

Why should you learn how to make informed judgments?

Decision making hierarchy

Characteristics of informed judgments

Closing thoughts

View in Slide Show Mode > click hyperlink.

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Identify bad advice and uninformed arguments

Bad advice is pervasive and it has dire consequences. Especially when it comes from reputable sources:

Media

Politicians

Special interest groups

Evaluate competing arguments

Make or evaluate accounting decisions requiring judgment

Why You Should LearnHow to Make Informed

Judgments?

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Who created this graphic?

A. Reputable accounting professor preparing a true/false test for an on-line course

B. Reputable economics professor explaining balance sheets on television

C. U.S. President during a press conference to win support for the Troubled Assets Relief Program (TARP)

D. Tina Fey impersonating Sarah Palin teaching accounting and economics to John McCain

Identify Bad Advice & Uninformed Arguments

http://www.pbs.org/wgbh/pages/frontline/video/flv/generic.html?s=news01p123


Judgments?

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B. Simon Johnson

Ronald A Kurtz Professor of entrepreneurship, MIT

Senior Fellow at Petersen Institute for International Economics

Member Congressional Budget Office’s Panel of Economic Advisors




Judgments?

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Chris Whalen

Vice President and Managing Director, Institutional Risk Analytics

Appeared before the US Congress and SEC to testify on various issues

Appears regularly on venues such as Bloomberg Television and CNBC



www.institutionalriskanalytics.com

Mr. Whalen told the NewsHour audience

that capital is the cash cushion banks

put aside in case of defaults.


Judgments?

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“I thought banks were

reporting profits. How can

they simultaneously be

losing money?

Because the profits or

earnings are being

reported before subtracting

the loan loss reserves.”

Paul Solman

Regular NewsHour

correspondent


Judgments?

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For mark-to-market“The new standards force companies to value or "mark" their assets according to a different set of standards and levels. The rules are complicated and arcane; the result isn't. Beginning last year, financial companies exposed to the mortgage market began to mark down their assets, quickly and steeply. That created a chain reaction, as losses that were reported on balance sheets led to declining stock prices and lower credit ratings, forcing these companies to put aside ever larger reserves (also dictated by banking regulations) to cover those losses.”

Against mark-to-market“Any move to abandon, or soften the impact of, mark-to-market accounting ignores the reality of the credit crunch. It was brought on by bad lending, coupled with insufficient capital. An accounting "fix" won't change that. It may make matters worse. The freezing up of credit markets is largely because investors and banks don't trust one another's books. As Federal Reserve Chairman Ben Bernanke noted in congressional testimony last week, eliminating mark-to-market accounting could further undermine investor confidence.”

Evaluate Competing Arguments

Bad accounting Rules Help Sink AIG, Zachary

Karabell, Wall Street Journal, September 18, 2008

Don’t let Bankers Run the Asylum, David Reilly,

Wall Street Journal, October 1, 2008


Judgments?

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Make decisions as a preparer of accounting reports

Measurement

Recognition

Classification

Disclosure

Evaluate preparers’ decisions as a user of accounting reports

What is the measurement objective of each reported number?

How relevant is this objective to my decisions?

How reliably does the number measure this objective?

Assess the confidence you should have in these judgments

Make or Evaluate Accounting Decisions Requiring Judgment


Judgments?

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Decision Making Hierarchy

Outside of companies:

Congress

SEC

FASB

EITF

Inside of companies:

Board

CFO

Division controllers

Record keepers

Media

Voting public Special interests

Education

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Characteristics of Informed Judgments

Continuum of informativeness

Judgments are more informed to the extent they are …

based on analyses that identify and rigorously examine competing alternative hypotheses

using empirical evidence, compelling logic, and/or broadly accepted theories

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Closing Thoughts

The controversy over the role of mark-to-market accounting culminated with the Chairman of the FASB being grilled relentlessly by congress in March, 2009 and the FASB significantly amending related standards one week later.

This situation vividly demonstrates the dire consequences for accounting and capital markets of uninformed judgments by the media, powerful special interest groups, and politicians.

Good arguments on both sides of this important debate were drowned out by uninformed arguments by powerful interests that often seemed more motivated by self interests than by facts, logic, or accepted theory.

One way to counter these forces is to educate ourselves and the public about accounting judgments and their consequences for both preparers and users of financial statements.

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1 Making Informed Judgments Part 1 Introduction Navigating Accounting, ® G. Peter & Carolyn R....

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