In accounting, what is the account most susceptible to overstatement and understatement and why?

Answer 1

Depends on what you mean by "susceptible".

If you mean "vulnerable to", then it is revenues and expenses. Managers are often compensated by stock, options or cash based on financial ratio performance (e.g. ROA, ROI, net profit growth). Managers will then want to make sure that revenues are as high as possible and expenses are as low as possible to make their benchmark ratios (which are usually based on the income statement) look better.

If you mean "likely to be", then it is liabilities and long-term assets. Accounting rules are based on a tenet of conservatism, whereby things are supposed to be recorded at the more conservative basis.

Why are liabilities likely to be overstated? Liabilities are recorded (with an offsetting expense) using the rules of measurable, past performance and probable. The last part - probable - makes some liabilities overstated. For example, if you get sued for $100k and it is probable that you would lose the case, you would accrued $100k even though there isn't a 100% chance of you losing. Another example is bad debt (i.e. receivables that you don't collect). Technically, this is a contra-account on the asset side, but it illustrates the same tenet. Specifically, companies typically write off receivables if they are not received in a timely manner (e.g. 15% for 30 days past due, 50% for 60 days and 100% for 90 days). Usually, they have a better collection rate than this, but are required to accrue a consistent and conservative contra-account for non-collectables.

Why are long-termed assets most likely to be understated.? Specifically, short term assets are now recorded at market prices rather than cost due to changes in GAAP. However, long-termed assets like fixed assets are still largely recorded at cost. For example, property and buildings appreciate in value but remain on the books at what you bought them long time ago.