He’s not really got it, has he?
Third, there is intolerance to the needs of users. Take for example the recent change to UK accounting standards represented by new Financial Reporting Standards 102, now coming into widespread use for the preparation of accounts in the UK. These do, for example, embrace concept that many users of accounts, including the owners of the vast majority of SMEs will find entirely alien. As example, FRS 102 says that:
When a financial asset or financial liability, ie a receivable or payable, originates from an arrangement that is a financing transaction, that receivable or payable is measured at the present value of the future cash payments discounted at a market rate of interest for a similar debt instrument1 (paragraph 11.13 of FRS 102).
Very politely, whoever dreamt this up had never tried to explain what this meant to the director and shareholder of a company who finds the language alien, the maths of discounting incomprehensible, and considers the fact that this deems part of what they might be paid under a deferred payment arrangement to be interest is just wrong because that is not the commercial agreement that they reached with their customer. And yet despite all this an accountant is required to impose this rule on that director and prepare accounts as if they have done something they quite consciously disagree with, and tell the director in question to sign the accounts which they may well consider incorrect and mis-stated, or decline to provide them with professional services. That is the action of a profession disconnected from the reality of the interests it is meant to serve.
Firstly, it’s not deeming any part of the payment to be interest. It’s saying that the current value should be equated to a debt financing instrument. This obviously falls out of the accounts, with no interest on it, as the payment is made.
But think about this the other way around. Imagine that such future payments were not valued at net present value. I’m due £100 million in 50 years time (my new Nigerian mate promises, honest). What value should that have in my accounts today? £100 million?
And as to directors not understanding the point. It’s actually the smaller the company is the more they understand cash flow. Ask an FD of a 200 people SME whether he’d rather have money today or in 3 months. And then ask him how much – you’ll get to a high notional interest rate pretty quickly.