Jargon serves two main purposes: to simplify communication between insiders, and to baffle outsiders. I have never worked out whether the second purpose is a deliberate choice or just a happy outcome. In the first in a series, I have tried to translate some common accounting terms into simple English – and in the process highlighted a few anomalies.
Other comprehensive income (OCI): notional profits or losses that the accounting profession can’t decide what to with. They don’t really belong in the income statement but to have to go somewhere, so OCI was invented. It’s not comprehensive, it’s not income, but it’s definitely ‘other’.
Balance sheet: a record of all the assets and liabilities that a company has amassed over time, which must always match. Unfortunately, many of the numbers on the balance sheet are estimates and the balance sheet only balances because it includes balancing items designed to make it balance. Non-accountants would call these items ‘plugs’.
The CGU selection process is secret and can be changed whenever convenient
Goodwill: to an accountant, the asset created when a company acquires a business at a premium to net assets. To a layman, a plug that is created to make sure that the balance sheet still balances (see above). It is called an asset despite being impossible to value or sell.
Goodwill impairment test: despite being impossible to value, companies are required to conduct regular impairment tests to assess whether the goodwill can still produce commensurate economic benefits. The tests are based around expected future cashflows from the cash-generating unit (see ‘cash-generating unit’), discounted to a present value (see ‘discounted cashflow’) and are opaque, complicated and easy to manipulate.
Cash-generating unit: a collection of assets that management has decided is appropriate for the goodwill impairment test. The selection process is secret and can be changed whenever convenient without telling investors.
Discounted cashflow (DCF): a sequence of estimated future cashflows that are plotted out to an expected terminal growth rate or value, and then discounted back to derive a current value. Most DCFs are based on numerous, questionable assumptions, and the choice of discount rate is key to ensure that the result is robust.
The mixed model is an mess of differing approaches being used to create one number
Tangible fixed asset: the value of property, plant and equipment on a company’s balance sheet after being depreciated to reflect its age and expected life. This looks simple but is usually an opaque blend of original cost, revaluations and fair value adjustments from acquisitions. This blend is called a ‘mixed model’.
Mixed model: an impenetrable mess of differing approaches being used to create one number, with the result that the number ceases to have a single economic meaning (see above).
Tax (income statement): a layman might imagine that this is the tax bill that a company expects to pay as a result of that year’s economic activity. In reality, it is a mix of expected tax costs adjusted for timing differences, tax settlements and amortisation of deferred tax assets. It usually bears little or no relation to actual tax being paid. Note that the tax authorities will base their assessment on information not available to investors and using their own definition of taxable profits.
Deferred tax assets and liabilities (balance sheet): these exist as the result of timing differences, use of tax allowances and historical losses being utilised to reduce future tax bills. Possibly the most opaque numbers on the balance sheet.
Cash tax paid (cash flow statement): this usually bears no relation to the tax expense in the income statement or the deferred tax on the balance sheet. The only tax number in the accounts that has genuine economic significance. Almost impossible to forecast without assistance from the company.
Historic cost: really means historical cost, not ‘important in human history’ cost.
