The Analysis and use of Financial statements Chapt.docx
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The Analysis and use of Financial statements Chapt.docx
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TheAnalysisanduseofFinancialstatementsChapt
TheAnalysisanduseofFinancialstatementsChapter1FrameworkforFinancialStatementAnalysis
TheAnalysisanduseofFinancialstatements
Chapter1FrameworkforFinancialStatementAnalysis
CHAPTEROBJECTIVE
Explainwhyfinancialstatementanalysisneeded3>.
Discussthegeneralprinciplesofthefinancialreportingsystem.
ComparetherolesoftheFinancialAccountingStandardsBoardandthesecuritiesandExchangeCommissioninsettingUS.GAAP
ReviewtheelementsoftheFASB’sconceptualframework.
DiscusstheprogressinsettingglobalaccountingstandardsandtheroleoftheInternationalAccountingStandardsBoard.
Brieflydescribetheprincipalfinancialstatements:
Balancesheet,IncomeStatement,statementofComprehensiveIncome,StatementofCashFlows,andStatementofStockholders’Equity.
Discusstheusefulnessoffinancialstatementfootnotesandsupplementarydisclosures.
DescribetheusefulnessoftheManagementDiscussionandAnalysisandothersourcesoffinancialinformation.
Discusstheroleoftheindependentauditorandinformationconveyedbytheopinion.
INTRODUCTION
Thischapterprovidesaframeworkforthestudyoffinancialstatementanalysis.
Thisframeworkconsistsoftheusersbeingserved,theinformationsystemavailabletothem,andtheinstitutionalstructurewithinwhichtheyinteract.
NEEDFORFINANCIALSTATEMENTANALYSIS
Inanidealworld,theuseroffinancialstatementscouldfocusonlyonthebottomlinesoffinancialreporting:
netincomeandstockholders’equity.
Iffinancialstatementswerecomparableamongcompanies(regardlessofcounty),consistentovertime,andalwaysfullyreflectingtheeconomicpositionofthefirm,financialstatementanalysiswouldbesimple,andthistextaveryshortone.
Thefinancialreportingsystemisnotperfect.
Economiceventsandaccountingentriesdonotcorrespondprecisely;theydivergeacrossthedimensionsoftiming,recognition,andmeasurement.
Financialanalysisandinvestmentdecisionsarefurthercomplicatedbyvariationsinaccountingtreatmentamongcountriesineachofthesedimensions.
Economiceventsandaccountingrecognitionofthoseeventsfrequentlytakeplaceatdifferenttimes.
Oneexampleofthisphenomenonistherecognitionofcapitalgainsandlossesonlyuponsaleinmostcases.
Appreciationofarealestateinvestment,whichtookplaceoveraperiodofmanyyears,forexample,receivesincomestatementrecognitiononlyintheperiodmanagementchoosesforitsdisposal.
OtherexamplePg3
FOCUSONINVESTMENTDECISION
1.ClassesofUsers
(1)Creditandequityinvestors
(2)Government(executiveandlegislativebranches),regulatorybodies,andtaxauthorities
(3)Thegeneralpublicandspecialinterestgroups,laborunions,andconsumergroups
Eachoftheseusergroupshasaparticularobjectiveinfinancialstatementanalysis,but,astheFASBstated,theprimaryusersareequityinvestorsandcreditors.
However,theinformationsuppliedtoinvestorsandcreditorsislikelytobegenerallyusefultootherusergroupsaswell.
Hence,financialaccountingstandardsaregearedtothepurposesandperceptionsofinvestorsandcreditors.Thatisthegroupforwhomtheanalyticaltechniquesinthisbookareintended.
TheunderlyingobjectiveofFA:
riskreturn
Equityinvestor:
long-termearningpower;abilitytogrow;abilitytopaydividendsandincreaseinvalue.
short-term:
liquidity
Creditors
long-term:
thelong-termassets
positionandearningpower
2.FinancialInformationandCapitalMarkets
Thatresearchoftheusefulnessofaccountinginformationhasexaminedtheinterrelationshipofaccountinginformationandreportingstandardsinfinancialmarketsingreatdetail.
Theresearchconclusionsarehighlycriticaloftheaccountingstandards-settingprocessandoftheutilityoffinancialanalysis.
Thesefindingsdonotnegatetheusefulnessoffinancialanalysisofindividualsecuritiesthatmaybemispricedorofdecisionsmadeoutsideacapitalmarketsetting.
Someresearchersarguethatfinancialdataareusefultoinvestorsonlyforpredictionofafirm’sriskcharacteristics.
Toagreatextent,thislineofreasoningisinfluencedbythefinanceliteratureandtheprevalentacceptanceoftheefficientmarkethypothesis.
Othersarguethattheimpactofaccountingisnotsomuchinitsinformationcontentperse,butratherinthe“economicconsequences”tothefirmresultingfromcontracts(implicitorexplicit)
thatarebasedonordrivenbyaccounting-determinedvariables.
Byandlarge,theearlyconclusionsoftheacademicliteraturehaveproventobesomewhatpremature.
Morerecentresearchdemonstratesthatinterplaybetweenmarketsandinformationisricherandmoresophisticatedthanoriginallythought.
Infact,thetrendinresearchisnowtoincorporatetechniquesoffundamentalanalysisinmodeldevelopmentandresearchdesign.
THEFINANCIALREPORTINGSYSYEM
Fiveprincipalfinancialstatements:
Balancesheet(statementoffinancialposition)
Incomestatement(statementofearnings)
Statementofcomprehensiveincome
Statementofcashflows
Statementofstockholders’equity
1.GeneralPrinciplesandMeasurementRules
Thefinancialreportingsystemisbasedondatageneratedfromaccountingeventsandselectedeconomicevents.
primarilyexchangetransactions
Othereventsincludethepassageoftime,theuseofservicesorassets,estimatesandtheimpactofsomecontracts.
Selectedexternaloreconomicevents,includingsomemarketvaluechanges,manycontractualarrangementsandmarketvaluechangesaredisclosedonlyinthefootnotesorinsupplementaryschedules.
Underaccrualaccounting,revenuesarerecognizedwhengoodsaredeliveredorservicesareperformedandexpensesarerecordedasservicesareused,ratherthanwhencashiscollectedorexpendituresareincurredforthesetransactions.
Accrualaccountingrestsonthematchingprinciple,whichsaysthatperformancecanbemeasuredonlyiftherelatedrevenuesandcostsareaccountedforinthesameperiod.
Financialstatementsarepreparedusingamonetaryunittoquantify(measure)theoperationsofthefirm.
Transactionsaregenerallymeasuredattheirhistoricalcost,theamountofcashorotherresourcesexchangedfortheassetorliability;changesinvaluesubsequenttoacquisitionareusuallyignored.
Theadvantageofhistoricalcostisthatitisobjectiveandverifiable.
Financialreportingalsoreliesonthegoingconcernassumptionthatthefirmwillcontinueinoperationindefinitely.
Thealternativeassumesliquidationorsaleofthefirm,whichrequiresdifferentmeasuresofassetsandliabilities,sofinancialreportingreliesonbreak-upbasis.
Onlybyassumingnormalfutureoperationsisitpossible,forexample,todepreciatefixedassetsovertheirusefulliferatherthanvaluingthemattheirestimateddisposalvalue.
THEUS.FINANCIALREPORTINGSYSTEM
1.SecuritiesandExchangeCommission
IntheUnitedState,theSecuritiesandExchangeCommission(SEC)throughitsregulationS-Xgovernstheformandcontentofthefinancialstatementsofcompanieswhosesecuritiesarepubliclytraded.
2.FinancialAccountingStandardsBoard
TheFASBisanongovernmentalbodywithsevenfull-timemembers.Theboardsetsaccountingstandardsforallcompaniesissuingauditedfinancialstatement.
TheFASBisanindependentbodywhosemembersarerequiredtoseveralltieswithpreviousemployers.
FinancialReportingEnvironment
Regulators
FASB
AICPA
IndustryPractices
GAAP
EnforcementandMonitoringMechanisms
SEC
CorporateGovernance
Managers
Auditors
StatutoryFinancialReports
(FinancialStatements)
AlternativeInformationSources
EconomyandIndustryInformation
VoluntaryDisclosure
Users
Analysts
InvestorsandCreditors
OtherUsers
Litigation
Form10-K
(AnnualReport)
10-Q
(QuarterlyReport)
Other
SECFilings
14-A
(ProxyStatement/
Prospectus)
StatutoryFinancialReports
8-K
(CurrentReport)
20-F
(RegistrationStatement/
AnnualReport[Foreign])
3.FASBConceptualframework
HierarchyofAccountingQualities
Constraints
User-specificqualities
Primaryqualities
Ingredientsofprimaryqualities
Understandability
Relevance
Reliability
Feedbackvalue
Predictivevalue
Comparabilityandconsistency
Neutrality
Verifiability
Secondaryqualities
Benefits>Costs
Materiality
Usersofaccountinginformation
Decisionmakersandtheircharacteristics
Decisionusefulness
Representationalfaithfulness
Timeliness
(1)QualitativeCharacteristicsofAccountingInformation.
Derivesfromtheneedforinformationthatfacilitatescomparisonoffirmsusingalternativereportingmethodsandisusefulfordecisionmaking.
(2)Relevance
Relevanceisdefinedas“thecapacityofinformationtomakeadifferenceinadecision”
(3)Timeliness
Timelinessisanimportantaspectofrelevance.
Informationlosesvaluerapidlyinthefinancialworld.Marketpricesarepredicatedonestimatesofthefuture;dataonthepastarehelpfulinmakingprojections.
(4)Reliability
Reliabilityencompassesverifiability,representationalfaithfulness,andneutrality.
Verifiabilityandrepresentationalfaithfulnessareconcernedwithwhetherfinancialdatahavebeenmeasuredaccuratelyandwhethertheyarewhattheypurposetobe.
(5)Neutrality
Neutralityisconcernedwithwhetherfinancialstatementdataarebiased.
Theprincipleofneutralitystatesthattheboardshouldconsideronlytherelevanceandreliabilityofthedata,notanypossibleeconomicimpact.
(6)Consistencyandcomparability
Consistencyreferstouseofthesameaccountingprinciplesovertime.
Consistencyisaffectedbynewaccountin
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