Our accounting system is riddled with numerous problems. These are inevitably the result of attempting to numerically capture the essence of a business whose management attempts to put that essence in the best light. In order to improve honesty, accounting rules have attempted improved precision. Unfortunately, this has led to heightened complexity, reduced understanding and, ironically, increased opportunities for dishonesty.
SFAS 109 is a good example. SFAS 109 requires that the future benefit of Net Operating Losses (NOLs) and other tax deductions be estimated and put on the balance sheet as an asset called Deferred Income Taxes. This estimation and capitalization may increase both earnings and volatility significantly.
For example, as long as a company has NOLs, it will report income tax expense far greater than is paid, and must also reduce the previously capitalized deferred tax asset. To even further obscure matters, every year a company must re-estimate the usability of the remaining NOLs and other tax deductions and, if necessary, adjust the deferred tax asset. It was much simpler to report paying very little tax and disclose in the financial statements that it had NOLs.
