Step by Step

Another week has come and gone. It is becoming more and more apparent that after every class session with Prof. Owolabi, my understanding of corporate finance is galloping enormously. Most recently, I have transitioned from zero accounting knowledge to communicating using several financial jargons such as balance sheet, journal, ledger, posting, T-account, and so much more. Even my colleagues in the finance department at work have noticed the new additions to my vocabulary during our weekly group meetings.

But the modules don’t get any easier with the new challenges created by learning a new financial concept. A few days ago, during our Corporate Financial Accounting (CFA) class at the Lagos Business School, we were introduced to a new accounting term that explained how organisations record transactions that change their financial statements over a period of time. The two distinct approaches that the professor had explained included accrual-basis accounting and cash-basis accounting.

Interestingly, I had heard accountants use this term frequently but had never given it much thought as to what it meant or how it might affect the organization’s financial statements. But the last session opened my eyes to how timing could determine what financial statements is reported to give a clear indication of the firm’s financial health for proper decision making. Accountants could report their organization’s balance sheet during its fiscal year, as well as divide the entity’s economic life into artificial timelines like monthly or quarterly intervals to provide immediate feedback to management, satisfying their request for periodic information.

Prof. had explained in class, that the accrual basis method requires a company to record balance-sheet transactions in the period in which they occur. This implies that organisations recognize revenue when it is earned as opposed to when cash is collected. Similarly, the organization records expenses when they are incurred rather than when they are paid. For medium and large organisations, that have a lot of account receivables (yet to be collected cash payments) or accounts payable (expenses that are yet to be paid), accrual basis accounting is crucial to ensure the correctness of the financial statement since it ensures that both accounts are captured irrespective of the fact that cash is yet to be collected. This, however, is not really practicable with small businesses that mostly have no receivables and payables.

Despite the acceptance of the accrual basis by global accounting bodies such as the Generally Accepted Accounting Principles (GAAP), it dawned on me that many organization, local and global, have actually abused this accounting principle, thereby presenting incorrect information about their financial state. Some organisations delay capturing massive expenses incurred in a particular month to prevent reporting a loss in that month. Some sales teams ship out more products to their customers to ensure that they meet their sales targets and do not lose their sales benefits. I have often also heard some professionals sarcastically refer to this act as “cooking the books.”

As the class ended, I couldn’t help but appreciate how much I had learned in such a short time. A lot of it comes from how the professor handles his class, his enthusiasm for ensuring everyone understands, and the practical exercises. Thank you, Prof., for everything. As we approach the marathon week, here’s to taking it step by step.