Balancing Act

Sometimes all it takes to swing from loss to profit is the stroke of a pen:

Changes in accounting rules allowed Deutsche Bank to avoid a loss for the third quarter.

The new rules enabled the bank to reduce its write-downs by nearly $1 billion, giving it a net profit of 435 million euros, or $573 million. Analysts had widely expected a loss.

Many people have a perception of accounting as being a tedious but straightforward and formulaic process, but the truth of the matter is that accounting rules are necessarily based on subjective assumptions; whether a company realizes a loss or profit can be entirely dependent on nothing more than how it is thought things should be accounted for.

This idea became clear to me when I thought about the accounting I do for my own budget. Let’s say that in December, for example, I make a big purchase with my credit card such that I spend more than I earn in the month. Since I made the purchase in December, I could record the expense in December and realize the loss. However, because I made the purchase with my credit card, I’m not actually spending any money until when the bill comes due in January, so I might choose to log the expense when I pay the bill rather than when I made the purchase. If I choose this second option, I’ll realize a profit in December rather than a loss, and the only difference was how I recorded the expense:

Option 1

December

January

Income

1,000

1,000

Less Expenses (350 on Credit)

1250

600

= Profit/(Loss)

(250)

400

Option 2

December

January

Income

1,000

1,000

Less Expenses  (350 on Credit)

900

950

= Profit/(Loss)

100

50

Deutsche Bank, probably mindful of Enron and Germany’s high intolerance for perceived corporate duplicity, did to its credit make certain in its statement to make clear the profit was due to a rule change:

Deutsche Bank reclassified certain assets, for which no active market existed in the third quarter and which management intends to hold for the foreseeable future, out of trading assets and assets available for sale and into loans. If these reclassifications had not been made, the income statement for the quarter would have included negative fair value movements relating to the reclassified assets of 845 million euros.

My example is not strictly analogous to what Deutsche Bank did (which has to do with this), but I’ll save that lesson for another time.