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THE POWER OF ALLOCATION
Systematic and rational allocation is the cause of the distraction that GAAP introduces,the second failure.Adoption of the definition of accounting in the 1930s—and its retention to this day—as a process of allocation demonstrates that allocation is basic to financial reporting.Allocation characterizes most of financial accounting,including,for example,depreciation; reporting on inventories,investments,income taxes,pensions,goodwill and other intangibles; and liabilities.
Allocation uses smooth (“systematic”) formulas,such as the straight-line and double-declining-balance formulas for depreciation and the compound interest formula for reporting on liabilities.A company selects each formula at the beginning of the period of allocation,supposedly to represent the effects of prospective underlying economic events.Financial report issuers cannot possibly have that foreknowledge about events that may occur after they select the formulas.And events do not occur as regularly as the use of the formulas implies.
Moreover,allocation does not even reflect the effects of underlying economic events.Professor Arthur Thomas,whose pioneering works on the allocation problem were published in 1969 and 1974 by the AAA,said,“Financial accounting’s allocations actually do not reflect the real-world economic states and activities of [companies] to which they purport to refer.”
Allocation merely takes amounts from the financial reporting territory,such as costs,enters them in the financial reporting map and massages them there.Eldon S.Hendriksen and Michael van Breda,the authors from Southern Methodist University of a leading text on accounting theory,have said that annual depreciation,one kind of allocation,is simply a fraction of the total cost and is not necessarily related to occurrences within the year,so it has no real-world connotations.The AICPA said the same thing in Accounting Terminology Bulletin no.1,Review and Resume,in August 1953:“Definitions are unacceptable which imply that depreciation for the year is a measurement…of anything that actually occurs within the year.”
THE POWER OF ALLOCATION
Systematic and rational allocation is the cause of the distraction that GAAP introduces,the second failure.Adoption of the definition of accounting in the 1930s—and its retention to this day—as a process of allocation demonstrates that allocation is basic to financial reporting.Allocation characterizes most of financial accounting,including,for example,depreciation; reporting on inventories,investments,income taxes,pensions,goodwill and other intangibles; and liabilities.
Allocation uses smooth (“systematic”) formulas,such as the straight-line and double-declining-balance formulas for depreciation and the compound interest formula for reporting on liabilities.A company selects each formula at the beginning of the period of allocation,supposedly to represent the effects of prospective underlying economic events.Financial report issuers cannot possibly have that foreknowledge about events that may occur after they select the formulas.And events do not occur as regularly as the use of the formulas implies.
Moreover,allocation does not even reflect the effects of underlying economic events.Professor Arthur Thomas,whose pioneering works on the allocation problem were published in 1969 and 1974 by the AAA,said,“Financial accounting’s allocations actually do not reflect the real-world economic states and activities of [companies] to which they purport to refer.”
Allocation merely takes amounts from the financial reporting territory,such as costs,enters them in the financial reporting map and massages them there.Eldon S.Hendriksen and Michael van Breda,the authors from Southern Methodist University of a leading text on accounting theory,have said that annual depreciation,one kind of allocation,is simply a fraction of the total cost and is not necessarily related to occurrences within the year,so it has no real-world connotations.The AICPA said the same thing in Accounting Terminology Bulletin no.1,Review and Resume,in August 1953:“Definitions are unacceptable which imply that depreciation for the year is a measurement…of anything that actually occurs within the year.”
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