Balancing Objectivity Against Judgment

Some adjustments will benefit from the judgment of top management or the board to fully account for the likely economic impact of certain activities.

Judgment can be viewed on a scale:

For example, the EP measure may include a policy regarding litigation liabilities. So, for instance, if the company has a contractual amount owed to it, but the contract is in dispute, they could decide:

  • Stick with the accounting, whose rules would require a conservative recovery estimate to be accrued,
  • Enable management to propose an estimate based on their lawyers' confidence in prevailing that might provide a better matching of revenues with the period in which it was earned,
  • Reverse the accrual, and await the realization of the recovery, in essence making a judgment about eliminating judgment.
  • Decide to apply judgment or not on a case-by-case basis for liabilities above a certain threshold.

Thus, policies on the application of judgment should seek to balance preserving good matching, which occasionally requires significant judgment, and objectivity, which implies minimal application of judgment.

___________________

© 2015 by Hodak Value Advisors.