Fred argues, "The standards that I like most are the ones that eliminate all management discretion in reporting—that way I get uniform numbers across all companies and don't have to worry about doing accounting analysis.". Do you agree? Why or why not?

Answer 1

We don't agree with Fred because the delegation of financial reporting decisions to corporate managers may provide an opportunity for managers to convey their superior information to investors. Corporate managers are typically better than outside investors at interpreting their firms' current condition and forecasting future performance. Since managers have better knowledge of the company, they have the potential to choose appropriate accounting methods and accruals that portray business transactions more accurately. Note that accrual accounting not only requires managers to record past events, but also to make forecasts of future effects of these events. If all discretion in accounting is eliminated, managers will be unable to reflect their superior information in their accounting choices.
When managers' incentives and investors' incentives are different and contracting mechanisms are incomplete, giving no accounting flexibility to managers may result in a costlier solution to investors. Further, if uniform accounting standards are required across all companies, corporate managers may expend economic resources to restructure business transactions to achieve a desired accounting result. Manipulation of real economic transactions is potentially more costly than manipulation of earnings.