Accounting Complexity: What if “Truth in Labeling” were an Accounting Principle?

“I do not deny that what happened to us is a thing worth laughing at. But it is not worth telling, for not everyone is sufficiently intelligent to be able to see things from the right point of view.”  — Don Quixote

Battered and bruised from tilting at the windmill of accounting convergence, the FASB sets forth on another quixotic adventure against an immovable object: accounting complexity.

I’m sure that we can all recite the standard explanations for why accounting standards have become so complex, and why that complexity will prove impossible to undo: the growing complexity itself of commercial arrangements, special interests desirous of emasculating the plaintiffs’ bar or having sufficient tools to manage earnings, etcetera, etcetera, etcetera.

But, another explanation has recently occurred to me, which if not an original thought, is one that I wasn’t heretofore aware of: the absence of a “Truth in Labeling” principle.

To explain what I mean, let’s start with one of the most ubiquitous mis-labelings on the balance sheet: property, plant and equipment.  To an innocent reader of financial statements, “PP&E” should indicate that a number is a measure of some attribute of an asset, when in fact, it’s not.  It’s not any of the financial attributes we usually think of, like historic cost, current cost to replace, value received if sold, or the the expected present value of future benefits to be derived from the asset by the entity.

So, what is that number labeled “PP&E”?  In the best of circumstances, it is the “undepreciated cost of PP&E in (very) old units of purchasing power.”

If this hash of a number is the best information that we accountants are capable of producing for investors, who can blame us for not coming clean with a truthful label?  Right.

Next, let’s consider the issue of asset impairment.  Whoops, another mislabeling.

If a company owns a fleet of vehicles for which the carrying amount is supposed to be written down in accordance with the complex GAAP that is the “asset impairment” rules, is it because there is something wrong with the vehicles that impairs their usefulness?  Nope; it’s only that there is something wrong with the way the vehicles were accounted for in prior periods.

Truth in Labeling Will Set us Free

There are two points I want to make from this example.  The first, and smaller point is that without truth in labeling, accounting is not being as forthright as it could easily, and should, be.  We can argue about why mislabeling occurs, but that doesn’t change the fact that those who would address accounting complexity could do worse than by at least acknowledging the ubiquity of our truth in labeling problem.  PP&E is one of tens of examples we could come up with.

The larger point is that calling things what they actually are is the only way to understand whether complexity is necessary or unwelcome.  Of impairment, for example, if PP&E were labeled correctly we would have to ask of what use are such complex impairment recognition and measurement rules when applied to a number can never considered to be “correct” in any sense to begin with — i.e.,  merely an undepreciated cost stated in ancient units of purchasing power.

So, now, back to the future, the FASB’s latest convulsions for “improving” lease accounting.  If a “Truth in Labeling” policy had been operating at the FASB, the new rules we are about to get that few want, and even fewer see as making any sense, could not have been birthed.  At least with PP&E, I can imagine contriving a label that reasonably describes the process that led to arbitrary carrying amounts.

But with leases, the proposed standard is so convoluted that no label — most certainly not “lease obligation” or “right of use asset” — could come close to describing the dog food inside the can.