Industry Trends

Explaining Accounting and Trillions in Pentagon Adjustments

Caleb Newquist Editor-at-Large, Gusto 
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January 24, 2020

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Explaining Accounting, Explained

I write this newsletter mainly for accountants. But I try to write it in such a way that if non-accountants were to stumble upon it, they would understand it, and maybe even enjoy it. Sometimes getting technical is unavoidable, but by and large, keeping things jargon and acronym free and throwing in a few snide remarks goes a long way in communicating complex topics in a way that almost anyone can understand.

This approach isn’t always popular among accountants because, well, if anyone can understand it, then what would you need accountants for? The jargon, technical language, and alphabet soup of acronyms are a feature of GAAP (and tax accounting, too, for that matter), not a bug.

For the last several years, people have been pointing out that GAAP is not only harder to understand but increasingly irrelevant. This has led to the proliferation of non-GAAP metrics to illustrate how a company is performing. Unfortunately, not all non-GAAP metrics are created equal. Here’s Peter Margaritis in Accounting Today:

[C]omplexity and irrelevance have led to an increased use of non-GAAP metrics, which are perhaps intended to give investors more realistic information, but in reality, can be manipulated to conceal less than perfect performance. In 2017, 97 percent of companies reported non-GAAP financials. This likely contributed to the rapid downfall of WeWork — just what, exactly, is “community-adjusted EBITDA?”

This complexity means that GAAP is even less relevant for small businesses, and is a major reason why so many of them use the cash method of accounting instead (not to mention that most don’t have $25 million in annual revenue). But it makes little difference in the end; whether a business uses the cash or accrual method, I suspect most owners still don’t have a good idea which metrics are useful for understanding their business’s performance or why they’re useful.

Which strikes me as odd. Deciphering accounting and financial metrics for their clients seems like the one thing that every accountant would be doing all day every day. If you’re running a niche firm, you identify the most important metrics for that industry and talk them through with each of your clients as often as necessary. Or — shameless plug alert — if you want to get into people advisory, you start with half a dozen KPIs to track for your clients and go from there.

“Once they know all the secrets, won’t they just fire us?” you might ask. Well, for one thing, don’t start off by giving them all the secrets. Second, sure, I guess they could fire you, but why would they? If you’re the sage accounting and financial whiz imparting wisdom on clients in plain English that they can use to track performance and improve their business, and they get results from those insights, I’m willing to bet that they’ll keep coming back to you for more of it.

Nightmare clients

Hey, look, I know you’re going into a busy time of year, and many of you are dreading a client or two or 10, but I assure you, things could be worse:

The Pentagon made $35 trillion in accounting adjustments last year alone — a total that’s larger than the entire U.S. economy and underscores the Defense Department’s continuing difficulty in balancing its books.

“Difficulty” is a bit of an understatement, isn’t it? “Severe distress” seems more appropriate for 35 trillion dollars in accounting adjustments. Basically, if you have a mistake the size of Apple, add that to a mistake the size of Microsoft, add that to a mistake the size of Google and then make that collective mistake 10 times, you’ve got the Pentagon’s situation.

So how does one get to the point where $35 trillion in accounting adjustments are necessary? The Bloomberg article has some details, but because this is 2020, I think a trigger warning is appropriate.

Auditors, the following contains: antiquated legacy systems, a negligent lack of documentation, unsupported adjustments, and a client making BS claims about incremental improvements:

Pentagon spokesman Christopher Sherwood said that “annually, DoD has hundreds of billions of dollars of financial activity, and accounting adjustments are sometimes used to record activity in our financial reporting systems due to a lack of system capabilities or interfaces.”

Many of these older systems “were designed without consideration for current financial accounting standards,” Sherwood said. What’s most important to an auditor is whether the adjustments “are properly supported” because “properly supported adjustments ensure financial statement values are accurate. We have made significant progress in reducing the number and dollar value of unsupported adjustments by over 30% and 70%, respectively,” he said.

I mean, just imagine the adjustments they’re passing on. “How much are we off, Bob? 10 billion? Okay, that’s out of scope.”

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Updated: March 11, 2021

Caleb Newquist
Caleb Newquist Caleb is Editor-at-Large at Gusto. In 2009, he became the founding editor of Going Concern, the one-of-a-kind voice on the accounting profession, serving in the role for 9 years. Prior to Going Concern, Caleb worked as a CPA for nearly 6 years in New York and Denver. He lives in Denver with his wife, two daughters, and two cats.

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