Interpretations

by Humphrey Nash

GAAP has been characterized as a retrospective financial reporting model whereas AFTF has been proclaimed a prospective model.   GAAP has some quasi-prospective elements, such as, the balance sheet, current year-end accruals, and capitalized "expenses".   AFTF has some retrospective elements, such as, current period cash flows, current period value added, and the historic cost of capital.   AFTF is similar to GAAP accounting and may be considered a more complete interpretation and refined implementation of accounting principles, or not.   The point is that there are substantial similarities as well as differences.   An instructive example of the similarities and differences can be found in the accounting definition of assets.

Assets have been defined¹ as,

"probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events"

This definition seem reasonable and fits both GAAP accounting and prospective accounting, depending on interpretations.   The table below differentiates the general interpretations.


Probable:  Accountants crave certainty, but certainty is not a characteristic of the future so that the traditional accounting interpretation has reverted to "reasonable certainty".   Does this mean 51%, 95% or 99.44% probable?   This all-or-nothing approach has been supplanted in recent GAAP pronouncements by a prescription to consider "the likelihood of possible outcomes".   This is the expected cash flow approach illuminated by FASB.   AFTF uses expected cash flows.

Future:  The GAAP future is short term.  This may mean current assets such as cash, receivables payable within a short time, or current market values.  In some cases the GAAP future is the past, for items that are valued at cost or adjusted cost.   Intangible assets whose value is realized in the more distant future are often excluded from GAAP assets.   For AFTF the future includes all the future that significantly affects values.   As a practical matter this may be 25 to 50 years.²

Economic Benefit:  GAAP assets do not represent economic benefits is the normal sense.   GAAP assets are far removed from the economic benefits measured by the capital markets.   For example, intangibles that have real future benefits are omitted.   AFTF measures economic benefits and conforms to the above definition of an asset.

Obtained By:  Again GAAP emphasizes the tangible and the past.   If the company has not taken physical possession of a tangible thing (building, bond, or cash) the asset has not been obtained.   AFTF does not exclude intangibles so that R&D, training, internal discoveries, structural strengths, efficiencies, reputation, etc. are all implicitly valued.   All economic benefits (expected cash inflows) that will accrue as a result of current year experience, actions, or commitments are included.

Controlled By:  GAAP requires absolute control or command for an asset to be measured.   AFTF only requires that expected cash flows take proper account of contingencies.   For example, GAAP attaches little or no value to the premiums from a block of inforce insurance policies.   AFTF would include the expected premiums from that block (and future issues), taking into account the mortality, lapse and maturity decrements.   There is no command over those premiums since the policyholder can generally discontinue premiums (without forfeiture), but there is a reliable expectation.

Transaction:  The GAAP interpretation generally requires an "external" financial exchange to qualify an a transaction.   For example, a purchased bond would be an asset; an employee hired or trained would not be a GAAP accounting asset.   This tie to an external expenditure leads naturally and unfortunately to a cost basis approach to assets.   AFTF interprets transaction to be any current period action with expected cash flow consequences; this leads naturally and fortunately to a value basis approach to assets.

Event:  GAAP requires that the event have some current period financial consequences.   Hence nothing is measured unless booked.   AFTF interprets transaction to be any current period event with expected cash flow consequences.   In particular, decisions may be included if the are informed and committed decisions (see the AFTF text for a description).   AFTF includes any action or event with future consequences without much qualification.   It is all inclusive since it is the future consequences we are trying to capture, not some past accounting tangible.

Measure:  GAAP assets are measured in various ways,

1.  often retrospective entity specific methods such as historical cost, amortized or depreciated value,
2.  sometimes a current external market value, fair value, or current cost,
3.  occasionally an entity specific present value of cash or accounting flows using various interest and/or contingency discounts.

Prospective accounting assets are always measured as a present of expected cash inflows discounted at the shareholder's cost of capital.

Prospective accounting is a generalization of historical GAAP.   AFTF provides a setting which disciplines that generalization so that it is useful for a variety of purposes, including financial reporting.

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¹ http://www.Rutgers.edu/Accounting/raw/gsm/mba/hollander/Lecture2/sld005.htm Basic Accounting Concepts
² Projecting 50 years may seem daunting but once a computerized cash flow model is developed it is almost as easy to run 50 years as it is 5 years.