Accounting firms employ a variety of bookkeeping tactics to help drive profitability for their clients.
All of these tactics can be classified as either aggressive accounting and conservative accounting. Most business owners aren’t sure how or when to use aggressive accounting vs. conservative accounting practices. In this article, I’m going to explain each and provide common scenarios for each approach.
Defining aggressive vs. conservative accounting
Both aggressive accounting and conservative accounting approaches come with pros and cons. So what are the differences between the two — and more importantly, why does it matter?
Let’s get started by defining these two concepts.
Aggressive accounting is the practice of adjusting or overstating items related to a company’s financial performance.
With aggressive accounting, an accountant can delay recording the transaction of a loss or gain.
Industries that use aggressive or conservative accounting practices do so for specific reasons.
Businesses searching for investors or a buyout tend to focus on aggressive accounting.
Conservative accounting differs from aggressive accounting in that it requires financial verification before a company legally claims any profits or losses.
One main difference between aggressive and conservative accounting practices is that conservative accounting requires ‘cash in hand’ before the transaction is logged as a profit.
Whereas, companies looking to maintain and grow — often in highly regulated industries like food, pharmaceutical, and healthcare — typically use conservative accounting.
So far, we’ve covered how aggressive accounting is the adjustment of profits or losses related to financial performance. We’ve also highlighted that conservative accounting requires profit logging only when the transaction is finalized.
But there’s lots more to know about aggressive accounting vs. conservative accounting. These upcoming sections will help you to understand why the differences between the two matter.
Everything You Need to Know About Aggressive Accounting
When it comes to aggressive accounting, accountants use several creative tactics. These tactics focus on grey areas or optimistic projections. The goal is to shine a positive light on a company’s overall financial performance.
Some of these tactics include:
- reporting gross revenue
- deferring expenses
- inflating assets
Reporting gross revenue
For example, let’s say that a company records a sale revenue in the current fiscal year. However, that company received payment for the sale in the following year. Recording the sale revenue before receiving payment helps to increase the year’s total earnings.
Reporting gross revenue is one way companies can overstate revenue. Increased earnings make a company’s annual financial performance look more appealing to investors.
Another tactic used in aggressive accounting is to defer expenses.
Let’s say that a salesperson travels out of town for a work-related conference. They use their credit card to pay for the trip. The salesperson claims their expenses at the end of the month after they’ve returned.
This is a case of deferred expenses because they aren’t recorded until after the budget is consumed.
One last aggressive accounting tactic includes inflating assets. Overstating the amount of overhead on a company’s current inventory increases the value of current assets. In turn, it increases the value of the company. Increasing the value of a company can indicate positive financial performance.
The pros of using aggressive accounting vs. conservative accounting techniques include:
- Positive short-term financial profitability
- Can provide an accurate value assessment for potential investors, if done correctly
- Long-term profitability and sustainment issues due to over or understating actual profits and losses.
- Many strategies associated with aggressive accounting are illegal or considered unethical in the professional accounting industry.
It’s important to know that aggressive accounting techniques can cause problems if you aren’t careful in the long-term.
The main problem with aggressive accounting is that there’s a fine line between overstating and outright lying.
Fraudulent financial statements and reports can cost a company a lot more than fines and fees. Many companies, including Krispy Kreme, Enron, and WorldCom, have gone to court for taking too many liberties with aggressive accounting tactics.
Everything You Need to Know About Conservative Accounting
Conservative accounting provides an incredibly accurate snapshot of a company’s revenue and losses. This snapshot is created through inventory valuation and recorded revenue.
Inventory often represents a significant portion of the assets that a company owns. Inventory valuation is the practice of evaluating how much of an asset the company owns at any given time.
Immediate and up to date recording of inventory provides an honest indication of a company’s financial status.
The most important part of conservative accounting is when revenue is recorded. Revenue cannot enter the books unless it is received and in an account.
This requires a great level of attention to detail. Gains get recorded only when received. The same regulations apply to losses too.
The pros of conservative accounting vs. aggressive accounting tactics include:
- Reduced risk of litigation costs due to the inaccuracy of financial information
- Identified expenses earlier on in the fiscal year can have positive tax implications or advantages
- Management knows exactly how well the company is running financially
Conservative accounting tactics aren’t perfect, either.
Here are the cons of conservative accounting:
- It’s more difficult for investors to predict financial profitability
- Increases future performance but decreases current performance
When it comes to accounting, remember that the practices you choose to use will ultimately impact your financial reporting.
Knowing the key differences between aggressive accounting vs. conservative accounting is the first step to learning how you can increase your profitability.
Questions about aggressive accounting or conservative accounting?
Do you have questions about accounting methods like aggressive accounting or conservative accounting? MBS Accountancy can help you every step of the way. Our accounting firm is the ideal place to improve your accounting and tax planning strategies today.