Clueless on Accounting in Atlantic Monthly

There is a post in the Atlantic Monthly’s online business section about the Wall Street CEO’s testimony

Some of the CEOs testifying before Congress yesterday tried this one too: “Sure, we took the bailout and we awarded bonuses, but the two pots of money are distinct.” And the problem with this argument is that money is fungible: A dollar of bailout funding is a perfect substitute for a dollar of operating revenue. The two pots of money are in no sense distinct.

Is it too much to ask that people who report on Business have a basic grasp of Accounting 101. This is not a defence of the CEO or Wall Street compensation practices, but the CEO’s are right when they say that the two pots of money, one from their operating revenues and another from the preference shares infusion of bailout money are different.

They are different because the bailout money goes directly to the liabilities side of the Balance Sheet, which the operating revenue goes to the Income side of the P&L, while bonuses go to the expenses side of P&L. There is nothing which stops the bank from using capital to pay bonuses and one can argue that when a loss is made they are paying out of capital. But the impairment is of common equity rather than of the preference shares.

However, the point is that the pots are in fact different, are treated differently in a legal and accounting sense and have completely different characteristics.

Infact the more I see the reporting on the crisis, the more convinced I have become that there is a basic dearth of accounting knowledge both on part of the pundits as well as by the investors.

They seem to look at profits as simply dollars earned, without bothering to look at where do those dollars come from. Are they exceptional in nature arising out of risky propritary trades? Do the cashflows from separate operations support the model?

But then maybe it’s all the fault of the Chinese!

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