One of the most important reasons why Generally Accepted Accounting Principles (GAAP) exists is so that there can be a standardized way to track the effects of business transactions that take place over an extended time period. If someone signs up for a $120 one-year magazine subscription, should you report the money as though it arrived in $30 increments every quarter? Should you report $120 in the quarter in which the sign-up occurs? Should you report $120 in the quarter in which payment is received?
These are all decisions that affect how we evaluate the “E” part of the P/E ratio and is supposed to give us a latticework for quickly figuring out where each company stands without having to wade into details to determine the rules of each company’s self-constructed accounting universe. Because GAAP accounting (necessarily) requires discretion, you end up finding bits of a self-constructed accounting universe.
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