How to bring value back to the financial statements and auditing

The accounting profession has recognized over the years that improvements need to be made to the financial statements prepared under US GAAP and their related to audits. The solutions have been:

  • Modifying or adding to the accounting standards (increased complexity)
  • Oversight (PCAOB)
  • Laws (SOX, Dodd-Frank),
  • Attempted convergence with IFRS (failed)
  • Altering the audit report to improve transparency (current solution)

And the result has been an expensive compliance document that has no value and no one uses.

There is a better solution. Simplify financial reporting by:

  • Substantially reducing the accounts on the balance sheet
  • Focus on “cash” transactions during the reporting period (in simple terms, what were the sources and uses of cash)
  • Remove estimates, accruals, fair values, impairments, etc.

The result is a new financial reporting method (KFRM) (see white paper included in this website) which has the following benefits:

  • Substantially easier to prepare, understand and audit
  • Reduction in internal costs and audit fees
  • Far Less complexity
  • Greater transparency
  • Method can be used for budgeting and forecasting throughout the organization
  • Ability to use at the highest level to the most granular level of an organization
  • Core financial information for better decision making
  • Provides flexibility to tailor the financial statements (see below – 1)
  • No changes or additional costs for accounting software
  • Use across all lines of business
  • Used in any industry
  • Used by any country
  • Creates new service line (see below – 2)
  • Can be incorporated into Blockchain and AI technology (see below – 3)
  • No alteration of tax filings or forms
  • and many others
  1. Flexibility – After I prepared my white paper, I discovered a distinct and significant advantage KFRM has over all other reporting methods. It has the ability to be flexible. This creates distinct benefits to Issuers, external users and auditors. For the Issuers and external users, KFRM allows the financials to be tailored to the needs or requirements of the Issuer and/or external user. If an organization needs or is required to record certain accruals, fair value reporting and/or estimates to the balance sheet, an Issuer or external user has two options. Option one, conduct a separate audit of the specific element (receivables, payables, revenue recognition, leases, a subsequent event, etc.) and its impact on financial statements. Option two, include the element in the financial statements prepared under KFRM. KFRM is flexible enough to allow the recording of these items with no impact to the overall cash-based reporting on the statement of sources and uses. This flexibility provides a unique ability to add specific value to an Issuer or external user should they feel it is required or necessary to better reflect the financial results of the organization.
  2. New Service Line –  In addition, as a result of the flexibility, audit firms service offerings can become something quite different than it is today. I envision three distinct service offerings,
    • Audit of the new financial statement reporting method.
    • Specialized audits of accounting standards or specific accounts – Specialized audits centering on a range of accounting standards and issues. If an Issuer or external user wanted to know what accounts receivable, accounts payable or the impact of implementing the revenue recognition standard would have been as of the reporting date, a separate audit of each them and its impact on the financial statements could be prepared. An entire field of specialized auditing would be established. Thus, the Audit transforms from a commodity of an overly complex compliance document to a specialized service offering providing Audits of specific standards or accounts the Issuer or external user actually wants to receive (i.e. value).
    • Consultation with external users of financial statements – This last point is auditors can now be consultants to external users of financial statements. The auditor can provide guidance to an external user on what financial information the external user should request from an Issuer. For example, if an audit firm audits a financial institution, it could also consult with that financial institution on what financial information should be included in the audited financial information it receives from the financial institutions customers/borrowers as long as that the audit firm does not audit the customer/borrower (conflict of interest).
  3. Blockchain and AI – As I continue to read more about these technologies, companies are implementing them into their operations. Eventually, financial reporting will need to be included in Blockchain. I can see how auditors can use Blockchain but how do Issuers and preparers use Blockchain for current US GAAP. I do not believe they can. However, KFRM can be incorporated as part of the overall transaction. If currency is exchanged, the information needed to report in KFRM is already present. Whereas a transaction which requires a valuation, an estimate or impairment testing by a third party must be done separately and outside the scope of the Blockchain. This will cause delays and additional cost in financial reporting. It is the reason I do not see US GAAP surviving this type of technology.

Of course, change does not come without challenges and KFRM does have its challenges. Below are a few of the challenges,

  • Matching Principle – A primary challenge is the removal of the matching principle. This is a primary concept of our current financial statement presentation model. The goal is to ensure revenue and expenses are being “Matched” in the appropriate reporting period. KFRM merely explains the sources and uses of funds during a given reporting period and does not to ensure revenue and expenses are being “Matched” in the appropriate reporting period.
  • Revenue Recognition – This issue is a constant focus of the profession. The white paper addresses this in more detail but in simple terms, unless cash is received no revenue is recorded.
  • Net Income (Loss) – How does a company or organization measure this? KFRM does not measure net income (loss). It focuses on cash or lack thereof from operations. If net income (loss) needs to be presented separately (see flexibility above), it allows a company or organization to use whatever method (EBIT, EBITDA, tax, cash, IFRS, US GAAP, etc.) it deems most appropriate.

I address other challenges in my white paper. These challenges are overcome by providing better financial information so all Issuers and external users can make more informed decisions about a company or organization.

Imagine having audited financial statements include only financial information that an Issuer or external user needs to help them make a more informed decision. Now, that is value. KFRM will accomplish this and much more.

 

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