Abstract
Businesses are the backbone of commerce, employment, and entrepreneurship. The lack of systematic accounting practices is attributed to an inadequate understanding of audit requirements and poor accounting methodologies. Managers and owners need to implement more accurate accounting standards, which eventually affect their growth, decision-making, profitability, and operational efficiency. Poor accounting methodologies translate to a lack of reliable data, which makes it difficult for a company to make decisions on cash flows, profitability, and expenses.
Introduction
Businesses play a crucial role in economic development and a country’s GDP. Besides creating employment, businesses alleviate poverty, promote entrepreneurship, distribute income, train employees, and promote regional development. Small and Medium Enterprises (SMEs) have been among the four major drivers for growth globally. According to Gherghina et al. (2020), in the European Union, 99 per cent of businesses are SMEs, and they have provided 85% of new jobs in the last five years. Despite such importance, these businesses need better accounting methodologies that eventually affect their performance. Poor accounting procedures can provide inaccurate financial reports, which eventually result in misinterpretation of an organization’s financial performance. In case of misinterpretations in a business’s financial position, investors may begin to distrust an organization, disrupting operations and market perceptions.
Problem Statement
The accounting methodologies related to income taxes, long-term liabilities, and leases are complicated and pose several challenges to businesses, regulatory authorities, and investors. Although the significance of accurate financial reporting is emphasized, some challenges are persistent, affecting a business’s transparency and performance. In long-term liabilities, businesses usually face the challenge of properly distinguishing short-term and long-term debts, which eventually affect calculations for debt-to-equity ratio, current ratio, and other financial health determiners. Also, businesses need help with accounting for income taxes. The differences existing between accounting principles and tax law complicate tax returns prepared through tax laws from those financial statements from Generally Accepted Accounting Principles (GAAP). The temporary and permanent disparities between net income from GAAP and taxable income based on tax law create complications when properly reflecting tax obligations and liabilities on financial statements. Misinterpretations of these differences can result in inaccurate financial reporting and non-compliance with regulatory requirements.
Additionally, the evolution of accounting standards in leases from off-balance sheet financing to the current FASB guidelines calls for transparent and consistent reporting practices. However, the criteria for classifying a lease vary in terms of lease agreement interpretations. When one fails to account for lease obligations properly, the reported financial position of the organization becomes unclear, exposing investors to potential risks.
Variables
The primary variables in the study are recognition and measurements of long-term liabilities, lease accounting practices, and accounting of income taxes. In lease accounting, the variables include lease term, the type of lease, and lease payment. In long-term liabilities, the variables include maturity date, interest rate, principal amount, and the type of long-term liability. In accounting for income taxes, the variables include deferred tax assets, taxable income, and effective tax rate.
Literature Review
Long-Term Liabilities
Liability is an obligation or a debt that is reported on a balance sheet. It can be settled through a service, money, or goods. In financial reporting, liabilities finance business operations or support large expansions (Tombi Layuk, 2023). Liabilities are divided into two categories: long-term and short-term liabilities. Short-term liabilities are debts settled within a year, while long-term liabilities are obligations that require more than 12 months to be settled (Tombi Layuk, 2023). The common types of long-term debts include bank debts, bonds, and mortgages like real estate. Liabilities are classified based on the maturity period (Ahmed & Siddiqui, 2019). According to Ahmed and Siddiqui (2019), methods like effective interest and fair value can be used to assess various measurement issues in long-term liabilities. The fair value of a liability is estimated based on growth potential, current market value, and replacement costs. According to Shakespeare (2020), businesses depend on debt and equity financing. Debt financing involves borrowing funds from external sources to raise capital for a business, while equity financing involves raising capital for a business through stocks or shares.
The debt-to-equity ratio of an organization is determined by dividing the total liabilities of a company by shareholder’s equity. In corporate finance, the debt-to-equity ratio evaluates the financial leverage of an organization. Organizations restructure troubled debts when lenders receive borrowers’ concessions or when borrowers are facing financial challenges. Accounting treatment for troubled debt restructuring (TDR) involves recognizing and restructuring an already identified TDR through fair value. Also, gain or loss can be measured during TDR. According to Shakespeare (2020), there are disparities in fair value measurements, classification criteria, disclosures, presentation, and discount rate measurement when recognizing and measuring liabilities under GAAP and IFRS. Although IFRS and GAAP define and recognize initial liabilities similarly, the two accounting standards have differences.
Accounting for Income Taxes
Accounting theory has evolved based on government imperatives, complex structures in business organizations, and technological advancements. The history of accounting can be tracked around 2000 BC in Mesopotamia using clay tokens that tracked herds or crops. From around 600 BC to 476 AD, the Romans developed public finance systems that articulated public funds, disbursements, and receipts. The systems were doubled during the 15th century when bookkeeping was developed. Even with accounting having several pronouncements, accounting for income taxes has minimal growth. Before the 20th century, there were no guidelines when accounting for income taxes. When income taxes were introduced in several countries in the 20th century under the Revenue Act, many organizations required a framework to account for income taxes. As a result, during that period, provisional accounting for income taxes emerged. However, its methodologies needed to be standardized, causing uniformity when making financial reporting. The Income Tax Act was developed in 1952 to guide in meeting the requirements when reporting income taxes (Cousins, 2021). When documenting financial statements, organizations were required to disclose information related to taxes. Around the 1970s, the IRS developed requirements for reporting deferred assets and liabilities to standardize accounting practices (Gnanarajah, 2017). During the 1990s, the FABS issued a statement, SFAS No. 109, that used tax convections to measure deferred tax assets and liabilities. According to Shakespeare (2020), IFRS and GAAP are recent developments in income tax accounting. In financial statements, under GAAP and IFRS, deferred taxes on assets and liabilities are recognized as temporary differences. The two standards differ on tax rates, disclosure, and valuation allowance (Shakespeare, 2020).
Leases
In a financial statement of lessors, finance leases are recorded as receivables in a balance sheet when the amount is equal amount to the net investment. Leases are classified into capital and operating leases. Short-term leases where leases do not gain ownership are known as operating leases. Whereas, capital leases are long-term leases that resemble asset purchases where leases gain ownership after the lease payments (Sorrentino et al., 2020). Lease accounting has standards under GAAP and IFRS. The two standards improve transparency and compliance in financial reporting. However, their criteria for measurements, classification, and recognition differ (Sorrentino et al., 2020).
Evidence from Previous Articles
There are few articles on financial reporting for small and medium enterprises since several businesses in this sector are owned by family members or individuals who need more knowledge of financial and accounting issues (Chakraborty, 2015). According to Chakraborty (2015), based on the Accountants European Federation, poor reporting and accounting provide inaccurate decisions and financial information, leading to problems that can threaten the solvency of the organization. Also, poor record-keeping can affect loan proposals, liquidity management, credit management, investment evaluation, and operation decision-making. Gyamera et al. (2023) articulate that credit accessibility is a challenge to SMEs since banks demand financial statements before processing such requests. In a study conducted to examine the effect of lending technologies like financial statement lending on financial performance on business performance, the research should have included accounting services and how they influence business performance (Gyamera et al., 2023).
Theoretical Frameworks
Agency Theory
Based on the Gyamera et al. (2023) study, when addressing the poor accounting methodology issue, the researchers proposed theoretical perspectives like the technology acceptance model and agency theory to provide an understanding of the accounting complexities and their impacts on shareholders. The agency theory was proposed to companies that principals delegate duties to agents to conduct on their behalf. The agency theory was developed to ensure everyone performs in their best interest. The theory controls agents through contracts, purchasing insurance, checking their actions, and engaging the agents (Amin et al., 2022). The theory helps in examining social phenomena from managers’ standpoints. While, through contracts, the agency theory provides decision-making power to agents (Amin et al., 2022). Although agency theory is practical and widely applied, the framework has some drawbacks. Through contracts between owners and agents, the theory creates an unpredictable future. Also, the agreements are not permanent and agents hired may use the opportunity for self-interest like fraud.
Technology Acceptance Model (TAM)
Information technology has transformed several businesses in the past fifty years. In the past, technology was expensive, and only large corporations could afford microprocessors and computers. Currently, online trading has made IT present in several businesses. The theory of TAM promotes the use of technology by guiding accounting methodologies that eventually help in improving business performance (Gyamera et al., 2023). The theory of TAM educates users on the perceived usefulness and simplicity of the technology. Although TAM does not address poor accounting technologies directly, its principles, like perceived simplicity and perceived ease of use, can be used to improve and assess accounting methodologies and practices. Through software, users can navigate the system to identify errors or find inefficiencies in accounting practices.
Alternative Solutions
Alternative solutions for addressing poor accounting methodologies include creating training programs for the employees and reviewing the workflow process to identify inefficiencies in the business. By creating training programs, employees can be educated on the proper way of distinguishing long-term and short-term debts. By understanding short-term and long-term assets besides debts, employees can learn how to calculate current and debt-to-equity ratios accurately. Also, through education, employees can learn the conditions required to report an item as a liability and how to account for pension liability. In addition, training programs provide a platform for understanding the difference between income tax taxed based on GAAP and taxed based on tax law. Conducting reviews on the workflow process helps streamline inefficiencies within the accounting methodologies. Through continuous corrections, employees are capable of improving their efficiency and optimizing their accounting management.
Evaluation of Alternatives
Educational Training Programs
Implication and performance of training programs can be evaluated through Kirkpatrick’s four-level model. The model has four steps, that is reaction, learning, behaviour, behaviour, and results. During the first level (reaction), the model assesses the employee’s response towards training. Such reactions can be measured through surveys after employees complete the program. The second level involves learning, where participants are examined on what they have learned from the training. The step is carried out through quizzes and tests. Behavior is evaluated through observations while results are measured when employees meet the requirements of good accounting methodologies in the workplace.
Streamlining the Workflow Process
The implication of conducting reviews on employees’ workflow processes is to promote operational efficiencies in accounting to improve the entire business performance. A streamlined workflow process can be evaluated by flowcharting. In the accounting department, a flowchart illustrates how tasks are conducted and helps in identifying areas that require improvement.
Recommendations
When comparing the two solutions, training employees and streamlining the workflow process, the most relevant solution is streamlining the workflow process through a flowchart. A streamlined workflow system fulfils the agency theory by ensuring each employee is responsible for their tasks. Also, the solutions help a business in making sustainable improvements in accounting methodologies since principals can identify areas with challenges thereby optimizing business performance. To promote efficiency, employees who promote the streamlining of the workflow process should be recognized and rewarded. Also, when addressing the problem, companies should incorporate emerging technologies like cloud-based workflow management systems to help in automating the processes.
Conclusion
Poor accounting methodologies contribute to less clarity in financial statements. Understanding accounting methodologies related to income taxes, long-term liabilities, and leases lowers the level of challenges posed to businesses, regulatory authorities, and investors. Through educational training and workflow reviews, one can help employees differentiate liabilities and understand the criteria for classifying leases. Also, they can understand disparities associated with GAAP and IFRS. Through such solutions, companies can address poor accounting methodologies that disrupt business performance. The implementation of a streamlined workflow process promotes transparency and efficiency in business operations. However, the process calls for a change, but during execution, organizations can experience challenges like ineffective communications affecting the delegation of duties, and employees may be resistant to change, disrupting the workflow process. Internal and external factors that can enhance the streamlining process of workflow include technological advancements and digital literacy.
References
Ahmed, F., & Siddiqui, D. A. (2019). Impact of debt financing on performance: Evidence from textile sector of Pakistan. Available at SSRN 3384213.
Amin, A., Ur Rehman, R., Ali, R., & Ntim, C. G. (2022). Does gender diversity on the board reduce agency costs? Evidence from Pakistan. Gender in Management: An International Journal, 37(2), 164-181.
Chakraborty, A. (2015). Impact of poor accounting practices on the growth and sustainability of SMEs. The International Journal of Business & Management, 3(5), 227.
Cousins, K. O. (2021). The Commercial Interest and the Early Income Taxes, 1799–1842 (Doctoral dissertation, University of Sheffield).
Gherghina, Ș. C., Botezatu, M. A., Hosszu, A., & Simionescu, L. N. (2020). Small and medium-sized enterprises (SMEs): The engine of economic growth through investments and innovation. Sustainability, 12(1), 347.
Gnanarajah, R. (2017). Accounting and auditing regulatory structure: US and international (p. 2). Washington, DC: Congressional Research Service.
Gyamera, E., Abayaawien Atuilik, W., Eklemet, I., Adu-Twumwaah, D., Baba Issah, A., Alexander Tetteh, L., & Gagakuma, L. (2023). Examining the effect of financial accounting services on the financial performance of SMEs: The function of information technology as a moderator. Cogent Business & Management, 10(2), 2207880.
Shakespeare, C. (2020). Reporting matters: the real effects of financial reporting on investing and financing decisions. Accounting and Business Research, 50(5), 425–442.
Sorrentino, M., Smarra, M., & Briamonte, M. F. (2020). Lease accounting: Back into the past—A general review of different theoretical approaches. International Journal of Business and Management, 15(2), 136-148.
Tombi Layuk, V. (2023). The Effect of Short-Term Liabilities and Long-Term Liabilities on Net Income. Available at SSRN 4338323.
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