Accounting Representation of Risk
Existing accounting systems are primarily "monovalent". That is, a single accounting value is attributed to a specific object or purpose. In contrast, risk and uncertainty are formally characterised by a whole range of possible values connected to an object.
- Financial accounting: Risks are mainly represented by the recognition of Provision (accounting) or Contingent liability. Fair value measurement partially includes considerations of risk. Hedge accounting allows for limited aggregation of mutually offsetting risks.
- Cost accounting: Risks in the sense of unexpected resource consumption is accounted for by using normalised costs for those events (expected value).
- Capital budgeting: Risk representation ranges from flat adjustments to cash flows and duration via risk adjusted discount rates to decision tree analysis, stochastic simulation and real options.
- Performance measurement: Risk is usually represented in form of risk adjusted discount rates or hurdle rates.
Special risk accounting techniques do exist but are in practice mostly restricted to financial instruments as accounting objects and financial institutions as accounting subjects. They include:
- At-Risk-Measures such as Value at Risk, Cash Flow at Risk or Earnings at Risk.
- Risk adjusted performance measures as RAROC and RARORAC.
In summary, it can be concluded that the representation of risk and uncertainty in accounting systems is limited in scope and technique as well as dispersed over different systems. As of now, no specialised comprehensive accounting system for the purpose of representing risk organisation wide in comparable terms has evolved. Such a system should allow for the representation of risk in accounting terms connected to the goals of the organisation such as liquidity and profitability on different organisational levels such as the organisation as a whole, business units and projects. Central to this is the configuration of adequate risk measures to capture the risk situation and measures for the capability of the organisation to bear risks (e. g. risk capital). These measures should also take into account behavioural and cognitive aspects of judgement and decision making under risk and uncertainty.
Read more about this topic: Managerial Risk Accounting
Famous quotes containing the words accounting and/or risk:
“At the crash of economic collapse of which the rumblings can already be heard, the sleeping soldiers of the proletariat will awake as at the fanfare of the Last Judgment and the corpses of the victims of the struggle will arise and demand an accounting from those who are loaded down with curses.”
—Karl Liebknecht (1871–1919)
“The appetite for power, even for universal power, is only insane when there is no possibility of indulging it; a man who sees the possibility opening before him and does not try to grasp it, even at the risk of destroying himself and his country, is either a saint or a mediocrity.”
—Simone Weil (1909–1943)