© 2000 John Petroff
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© 2000 John Petroff |
B- The problems with traditional Russian accounting system
The traditional Russian accounting system is a tax reporting system, and not an accounting system. The first problem that is immediately apparent, is that there is just one format for recording transactions, for maintaining accounts and for financial reporting; and a format that is extremely rigid, detailed and severely regulated by official laws. The leeway that is supposed to exist in choice of analytical accounts or accounting policy (which mostly pertains to allocation of profits after tax) is trivial compared to the differences that exist between accounting needs in specific industries. The guideline stated in Russian accounting to emphasize substance over form is clearly contradicted by the minute specifications on what forms must be used, what documents must back entries, what expenses are allowable, etc. An accounting system must adapt to informational needs of the business it is intended to serve, and not put that business into a straight jacket. The Russian system is not designed for business needs but for the needs of government to assess taxes, measure performance with quantitative (rather than accounting) statistical indicators, and for non-privatized companies develop aggregate production plans in the form of quotas and prices. In 1995, Russian accounting laws have not changed accounting much from what it was under communism.
The second problem of the Russian accounting system stemming from its nature as a tax accounting system is that it is inappropriate for analysis of managerial decisions. An accounting system should be designed to make financial and managerial decisions. This is not possible with this system because the data is oriented toward the past which is illustrated by the emphasis of the balance sheet and the conservation of company assets, and not toward the future. It was argued in Chapter 2, that balance sheet asset values original costs are not useful for valuation purposes, nor for managerial decisions. What is needed is the projection of future revenues, and relate that to the assets that must be put in use to produce these revenues. But since Soviet management was not accountable for revenues because it had no control over prices or demand for the product, the entire Western approach of assessing performance on the basis of revenues would have been meaningless. It is still that way today for many sectors of Russian economy where prices are set by government. And indeed, disregard for revenues is flagrant in Russian accounting and financial analysis described above. Instead, performance is measured by statistics of quantities produced and employees used which do not appear on the balance sheet. The goal of the Soviet organization was to meet or exceed its production quota, not increase revenue or profits. Today, that attitude is still widespread in even private businesses in Russia. This can be seen in business plans that focus on production technology but neglect to analyze customer preferences or competition. It is a fact of everyday Russian life that many products are just not available, or available as imports at unaffordable prices.
The neglect of the income statement is flagrant, misguided and damaging. The results of operations consist of two lines: revenues and cost of goods sold. Most of the lines of the income statement are for non-operating income or loss (such as gain/loss on securities and gain/loss on currencies) and for the allocation of profits after tax. The gain or loss on securities and on currencies is clearly not useful for managerial decisions. Those are one time outcomes that are unlikely to be repeated in the future. Management should still obviously be accountable for these securities and currency gains or losses but future cash flows can not be expected from these sources. As far as the allocation of profit after tax is concerned, it was described previously that this is in substantial part made of bonuses and disallowed expenses. From a managerial point of view, these are clearly justifiable and necessary expenses. It does not make sense to keep one portion of the same expense in cost of goods produced and another in allocation of profits. For instance, bonuses are part of what management considers it should pay to retain its most productive employees: these bonuses should be combined and shown with salaries. The allowed portion of salaries is lumped into cost of goods produced, and bonuses are hidden in social goals or other allocation of profits.
The tax authority does not care how the data is presented, as long as the official format is used, and as long as the tax inspector can verify (i.e. trace to a document) each number and ascertain that it does not violate limitations. For financial and managerial analysis this is just not so. The breakdown of expenses (as it will be shown in Chapter 13) is of great importance because many expenses are future oriented. This is the case of advertising, employee training, research and development and maintenance of equipment. None of these are reported in Russian traditional accounting, nor even the need for them is foreseen in the chart of accounts. Likewise, buried in the cost of goods produced is the expense for depreciation. While even in international accounting, making sense of depreciation expense is a real challenge, at least comparison to assets value, and comparison over time can shed some light on whether it could be out of line. In Russian traditional accounting that is not possible.
Another pervasive problem throughout almost all accounts and in the reporting, is the deliberate effort to maintain the status quo in all aspects of asset, liabilities, revenues and expenses. It was previously mentioned that there was an expectation of the Soviet government that assets be maintained and used. And the accountant complies with that expectation by using the modest depreciation according to law and avoiding writing off any asset. Liabilities are potentially also inflated by liabilities to suppliers and employees. Special efforts are made to report revenues as close as possible to assigned quotas but not more. All allowable expenses are included in cost of goods produced, even if some documents represent bogus employees and supplies.
(To the extent that all these items are overstated for most other business as well, accounting is less meaningful than it should be, but the distortion may not be substantial to be a very serious limitation. Just as in Western accounting, it can be expected that the assets of all firms will be somewhat understated. If a bias is roughly uniform throughout a series, one could adjust for the presence of such bias.)
It is certainly not the purpose of this writing to formulate an indictment of Soviet economic system or Soviet business practice. However harmful central planning, neglect of profit motive and payment crisis may have been, is not of direct concern here. The concern is only with the accounting system. Has the accounting system contributed to the economic problems, or mitigate them? Has the accounting system been distorted by them, or unaffected? The answers to these questions can be gathered from the description of an accountant's practical work: accounting has been distorted by these problems from what apparently it was originally intended to do, and in turn, accounting has aggravated the payments problem by providing means of going around it, and reinforced the neglect of revenue and profit motivation by concealing actual events.
This is a serious problem with the Russian accounting system. There is a generally accepted practice that accountants must give tax authorities what they want to see and what they want to know: prepare all forms and documents according to laws, no matter if the numbers reported hide reality. In 1995, almost all Russian private corporations that should be interested in attracting new shareholders, were asked to provide financial reports for a student project at the Moscow State University, but refused officially to do so, and students were forced to use any data they could find on condition of anonymity. The reason for this was known to all. These corporations did not want to give official financial information that was erroneous and would discourage investors.
This is the most serious problem. Accounting numbers are used for deceiving. Everyone (i.e. tax authorities, government, employees, the public at large, owners, investors, and especially management and accountants) knows that accounting numbers are what is given to the tax authority and not a reflection of actual performance. A flagrant example of this was a report of the bankrupt state of the Red October chocolate manufacturer by the media one week, that was denied the following week by sources showing to the media a brilliant strategy and a prosperous performance. When accounting becomes a tool of disinformation is ceases to serve its intended function. This is the state of affairs with Russian accounting.
Obviously, the remedy is to adopt a new accounting system, and that is precisely what is being done. Unfortunately, as previously observed, habits take a long time to change. Even if the international accounting system is taught and used throughout the former Soviet countries right away, it will take a long time for practitioners, managers and outsiders to start trusting accounting numbers. During that time, managers will continue to waste their time on dubious strategies of deception and barter, accountants will seek shelters by applying the strict letter of new accounting rules, missed opportunities will be chased by untrusting investors. It can be said that defective traditional accounting and the habits it has formed, has and will continue to be, a true calamity for the peoples of these countries.
| Accounting trickery is not limited to the past and to smaller Russian firms; it widely used even in such heavy weight giants as Gazprom, and it even goes through accounting laundering by western accounting firms such as PricewaterhouseCoopers. An article in The Economist of April 20, 2002, reports that a foreign investing fund, Hermitage, is suing PricewaterhouseCoopers for not revealing that billions of dollars of Gazprom assets have been diverted to relatives of Gazprom bosses. |
Notwithstanding this long term harm, it is necessary to find at least a temporary solution for now. That solution consist of converting the existing accounting numbers prepared in the traditional way into numbers that are intelligible in the Western accounting mentality and can be used to conduct financial analysis, knowing however that only part of the actual performance is captured in these data. Making corrections for the overstated assets and expenses is not something that a firm would ever be willing to do, or an outside analyst could ever accomplish. With that proviso, we turn to the process of conversion of accounting data.
See review questions Q-7B.1 through Q-7B.10
See research assignments R-7.4 and R-7.5.
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