09class05

09class05 - 1. Accounting information should be a fair...

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1. Accounting information should be a fair  representation of the firm’s economic  performance.  (theme 2 at the firm level)   2. Accounting information should provide  relevant information to forecast the firm’s future  earnings and cash flow.  •1
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•2 Earnings, 51% Revenues, 12% Cash flows from operations, 12% Free cash flows, 10% Pro forma earnings, 12% Other, 2% EVA, 1%
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A.  A Central Idea   In addition to knowing the total net income  for the period the reader wants to know which  income items are persistent/  recurring/continuing and which are transient/  nonrecurring/one-time.  Why? Investors are  concerned about the future. Transient,  nonrecurring or one-time items presumably  won’t impact the future.  •3
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The accounting rules require companies to classify  income into one of three categories.  1. Income from continuing operations.  2. Income, gain and losses from discontinued  operations.  3. Extraordinary gains and losses.  The idea behind the classification is that earnings  (or losses) which are not likely to repeat in the  future (nonrecurring items) should be classified  separately. Categories 2 and 3 are the categories  which are not likely to repeat. The FASB is  implementing the Central Idea.   •4
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Simple Example: Company A Company B Company C Earnings per share 2.00 Earnings per share 2.00 Earnings per share 2.00. All three companies look equally profitable. •5
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Company A Company B Company C Income from Continuing Operations: 2.00 per share. Income from Continuing Operations: 2.50 per share Income from Continuing Operations: 1.50 per share Extraordinary Items: 50 cents per share loss Extraordinary Items: 50 cents per share. EPS 2.00 EPS 2.00 EPS 2.00 Which company now looks the best to a reader/analyst? •6
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09class05 - 1. Accounting information should be a fair...

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