AFM291-ch04

AFM291-ch04 -...

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AFM 291 chapter 4 1     Chapter 4 Chapter 4             Reporting Financial Performance: The Income Statement Reporting Financial Performance: The Income Statement
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AFM 291 chapter 4 2 Financial Reporting Business model identifies three activities 1. Financing Getting cash 2. Investing Acquiring resources 3. Operating Using resources to generate profits Financial statements are designed to effectively communicate the results of these activities
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AFM 291 chapter 4 3 Financial Reporting 1. Balance Sheet Reports financing and investing activities Assets = Liabilities + Owner’s equity 1. Income Statement Reports operating activities Profits/Losses = Revenues - Expenses 1. Statement of Cash Flows Reports interrelationship between all 3 activities Beg Cash + Change in cash from operating, investing, and financing activities = End Cash
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AFM 291 chapter 4 4 Uses and Limitations of the Income Statement Uses: Evaluate past performance and profitability Assist in predicting future performance Assess potential risk or uncertainty in achieving future cash flows Limitations: Items are excluded if they cannot be measured reliably Amounts reported are affected by accounting methods used Use of estimates in measuring income Different ways of measuring income
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AFM 291 chapter 4 5 Quality of Earnings High quality earnings information has the following attributes: 1. Content Unbiased, objectively determined. Represents economic reality and complete Has predictive and feedback value ( sustainability of earnings ) Correlate closely with cash flows from operations Based on sound business strategy/model 2. Presentation No attempt made to disguise or mislead ( transparent ) Information presented is understandable Information is clear and concise
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AFM 291 chapter 4 6 Earnings Management Earnings management occurs when “managers use judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of the company or to influence contractual outcomes that depend on reported accounting numbers” Often to increase current income (sometimes to decrease current income) Decreases the quality of earnings
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AFM 291 chapter 4 7 Earnings Management (1) Earnings Management that is consistent with GAAP (Transaction Structuring ) e.g. Contingent convertible debt and diluted EPS Reading “The Latest Magic in Corporate Finance” BusinessWeek 2003 http://www.businessweek.com/magazine/content/03_36/b3848080_mz020.htm (2) Earnings Management that is difficult to distinguish from GAAP (Accruals Management ) e.g. Extension in the useful life of depreciable assets (3) Earnings Management that is clearly not GAAP (Fraud ) e.g. Misclassification of maintenance costs as capital (WorldCom)
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AFM 291 chapter 4 8 Basic Elements Income Statement Revenues : increases in economic resources,
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This note was uploaded on 12/10/2010 for the course AFM 291 taught by Professor Clark during the Spring '10 term at Waterloo.

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AFM291-ch04 -...

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