The Objectives of the Financial Analysis Process Distinguish between Computations and Analysis Analysts often need to communicate the findings of their analysis in a written report. Their reports should communicate how conclusions were reached and why recommendations were made. For example, a report might present the following: An effective narrative and well supported conclusions and…
The cash flow statement consists of three sections:
How Accounting Choices and Estimates Affect Earnings and Balance Sheets Assumptions about inventory cost flows provide another example of how accounting choices can affect financial reporting. Companies may assume that their purchases of inventory items are sold to customers on a first-in, first-out (FIFO) basis, with the result that the remaining inventory reflects the most…
An understanding of the choices that companies make in financial reporting is fundamental to evaluating the overall quality—both financial reporting and earnings quality—of the reports produced. Choices exist both in how information is presented (financial reporting quality) and in how financial results are calculated (earnings quality). Choices in presentation (financial reporting quality) may be transparent…
Market Regulatory Authorities Typical features of a regulatory regime that most directly affect financial reporting quality include the following: Auditors Audit opinions provide financial statement users with some assurance that the information complies with the relevant set of accounting standards and presents the company’s information fairly. Private Contracting Aspects of private contracts, such as loan…
If motivation exists, an analyst should consider whether the reporting environment is conducive to managers’ misreporting. It is important to consider mechanisms within the reporting environment that discipline financial reporting quality, such as the regulatory regime. Motivations Managers may be motivated to issue financial reports that are not high quality to mask poor performance, such…
Some investors may prefer or be perceived to prefer conservative rather than aggressive accounting choices, because a positive surprise is acceptable. In contrast, management may make, or be perceived to make, aggressive accounting choices because they increase the company’s reported performance and financial position. Aggressive accounting choices in the period under review may decrease the…
Financial reporting that departs from GAAP generally can be considered to be low quality. In such situations, earnings quality is likely difficult or impossible to assess because comparisons with earlier periods and/or other entities cannot be made. At the bottom of the quality spectrum, fabricated reports portray fictitious events, either to deceive investors by misrepresenting…
