The reason we focus on Economic Earnings as opposed to Accounting Earnings is because Accounting Earnings are subject to too much manipulation – as Charlie Munger states below. This problem is not going away anytime soon. It was, in many ways, obfuscated by the Easy Money Days – but as I state in The End of the Speculative Movement, the Easy Money days appear to be behind us. XBRL does little to help. Companies are not going to help. As Munger points out, we should not rely on the SEC or accounting profession to help. The only answer is to do your homework and study the Financial Footnotes or rely on someone who does.
“On accountants: The accountants utterly failed us. And by the way, there’s practically no sign of any intelligent reversal of the failure of that profession. I have yet to meet many accountants who are the least bit ashamed for their contribution to our recent troubles. But it was immense. Imagine when Enron comes down to the SEC and says “we want to write a little contract with A, and a little contract with B, and take all the profit we’re going to make from these complicated contracts over the next 20 years into earnings immediately, and put an asset on our balance sheet of $28 billion from signing two pieces of paper.” And the SEC, led by wonderful accountants who studied at great places, [says] “Why, of course you should have that kind of accounting!” What the hell were they thinking? How can anybody have any respectable understanding of human nature without realizing that the kind of people who were going to be tempted by that accounting were not going to be able to resist the temptations? It was disgusting.
On why accountants got it so wrong: Partly the establishment accountants want to please the people who are writing the checks. And partly the academic accountants get full of people who overdosed on mathematics. They want everything to be in balance. And they don’t think that that really isn’t rational when creating rules for a human behavioral system. They’re too mathematical and not rational enough when dealing with their fellow humans. You can’t give the average Wall Street CEO really lenient standards of accounting and expect the figures to be good.”
The link to the story that has the quotes above is here.