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Intermediate Accounting

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23 Analysis of Financial Statements Overview Financial statement creation is a meaningless exercise if the users of the financial statements do not know what the financial statements represent and how to analyze them. Your intermediate accounting textbook, to this point, has focused primarily on various accounting treatments and how they flow into and affect the creation of financial statements. Financial statement analysis has been sprinkled in throughout, but this is the first chapter devoted solely to this very important topic. Various ratios can be pulled out of financial statement data to assist in the analysis process. These ratios can be compared to budgeted ratios, prior-year ratios for the same company, or other companies in the same industry to access company performance. Care must be taken to make sure that differing accounting policies between companies does not distort the ratios and provide a misleading picture. In addition, if, say, a manager was being provided a bonus based on a certain ratio, the ratio could potentially be manipulated by near end-of-period activities to provide for a more favorable view of performance. For example, if someone was compensated for a low average collection period (based solely on year-end data), they could possibly discourage credit sales just prior to year-end, write off as many receivables as possible just prior to year-end, or increase collection efforts only during December. While the average collection period looks good using only year-end data while implementing these strategies, the real average collection period during the year was higher. Ratios can be used not only in measuring company performance but also in analytical procedures used by auditors to detect errors or fraud that may have occurred. Sometimes required ratios are also built into loan agreements or contracts in order to obtain more favorable interest rates or terms. While financial statement information can be used to analyze a company, financial statement information can also be used to estimate the market value of a company. The final section of this chapter introduces you to four methods that are used to estimate the market value of a company’s equity securities.
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23-2 Chapter 23 Learning Objectives Refer to the Review of Learning Objectives at the end of the chapter. It is crucial that this section of the chapter is second nature to you before you attempt the homework, a quiz, or exam. This important piece of the chapter serves as your CliffsNotes or “cheat sheet” to the basic concepts and principles that must be mastered. If after reading this section of the chapter you still don’t feel comfortable with all of the Learning Objectives covered, you will need to spend additional time and effort reviewing those concepts that you are struggling with.
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