The other day I made the (probably unwise) decision to criticize someone for their driving. In my defense, they were spectacularly awful.
I pointed out two things:
- They were being dangerous, both to us and to others
- They were wasting gas by alternately flooring the accelerator and then breaking sharply in quick succession
Mentioning the latter was probably a mistake, as it allowed him to focus on this more minor sin and ignore the danger to life and property he was creating. But enough about my mistakes – what’s interesting was his.
He argued that being gas-inefficient didn’t matter, because he had a full tank.
Obviously this is nonsense – by using gas inefficiently now, he was hastening the need to re-fill the tank. A life-long strategy of doing so would substantially increase his lifelong gas expenditures, and as acausal decision theory teaches us, in choosing once we choose eternally.
But it also made me appreciate accruals accounting more.
Accruals Accounting involves recognizing costs and revenues when the economic activity to which they correspond occur – not when the cash is paid out. So if my company sells you a widget in 2014, but you only pay me in 2015, I record the revenue this year. Similarly, if I invest in some equipment this year but use it over the next few years, I will record the cost (as depreciation) over the next few years.
You might wonder about what would happen if sell you a widget but you never pay me. Surely I shouldn’t have recorded it as revenue if I never actually get the benefit? It shouldn’t count as profit if it’s driving me to bankruptcy! Excellent point – the answer is that at some point, when I realize you’ll never pay me, I have to ‘write it off’ – take a loss to cancel out the revenue I counted earlier.
Accruals Accounting has advantages and disadvantages. In particular, the company does need to produce cash at some point – Accruals Accounting can be abused if management make overly-optimistic assumptions about how likely they are to be paid.
But it’s a good way of analyzing cases like gasoline consumption. Assuming you will eventually use all the gasoline in the tank (you won’t have to write it off) the real time when you incur gasoline expense is not when you pump it, but when you use it. The time to save gasoline is when you’re driving – by coasting more, accelerating gently or perhaps even walking instead – not at the pump. Good driving technique represents a real savings, which accrual accounting recognizes – only filling up half way is a false economy.