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Chapter 3 Overview of Accounting Analysis
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Introduction Purpose of accounting analysis To evaluate the degree to which a firm’s accounting captures its underlying business reality. How to assess the degree of distortion in a firm’s accounting numbers? 1. By identifying places where there is accounting flexibility 2. By evaluating the appropriateness of the firm’s accounting policies and estimates How to adjust a firm’s accounting numbers? 1. Use cash flow 2. Use footnote information
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The Institutional Framework For Financial Reporting Information asymmetry Owners use financial statements to keep track of their firm’s financial situation. Primary financial reports Income statement Balance sheet Cash flow Statement of stockholder’s equity / Statement of retained earnings
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Accrual Accounting Net income is the primary periodic performance index under accrual accounting Transactions are recorded on the basis of “expected” Revenue recognition: realization principle Expense recognition: matching and conservatism principles Profit= Revenues-Expenses Assets= Liabilities + Equity
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