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Unformatted text preview: Ferris-Wallace Book Chapter 1 The Economic Environment of Accounting Information Learning Objectives By the time you complete this chapter you should be able to: • Identify the primary financial statements – the income statement, the balance sheet, the statement of cash flows, and the statement of shareholders’ equity. • Understand that companies acquire capital from investors who purchase the equity and debt securities issued by such firms to obtain an expected return commensurate with the risk the investors assume. • Understand the role of accounting standards in facilitating a properly functioning capital market. • Understand the conflicts of interest that may arise between the executives, shareholders and debtholders of a corporation, and the costs associated with the divergent incentives which may arise when the ownership and management of a company are separated. Where are we? In this chapter, the financial statements of Amazon.com Inc. are used to illustrate the accounting information that companies provide to shareholders and debtholders. The chapter discusses how the demand for capital by companies that have insufficient funds to meet their investment needs and the supply of capital come together in a capital market to set equilibrium prices for stocks and bonds. The chapter also discusses how the credibility of accounting information is enhanced when a reputable external auditor provides an opinion about the accounting information. Finally, the chapter investigates the use of accounting data in internal decision-making by management and its use in contracts between shareholders and managers and between shareholders and debtholders to attenuate the conflicts of interest that may arise between the various constituencies. Where are we going? In the next chapter we illustrate how accounting events are analyzed, quantified, summarized, and ultimately disclosed in a company’s basic financial statements. Concepts such as assets, liabilities, revenues, expenses, and cash flows are defined and used in an example that demonstrates the preparation of the basic financial statements. The chapter also discusses the use of financial statements for purposes of evaluating a company’s financial performance. Finally, several recent accounting scandals are used to illustrate how some managers enhance their company’s reported financial performance through the judicious selection and use of alternate accounting methods. 1-1 Ferris-Wallace Book Chapter Outline • Financial Accounting and Its Relevance o Seven Accounting Myths o Financial Accounting: What is It? o Why Accounting Information is Important o Qualitative Attributes of Accounting Information o Amazon’s Accounting Methods and the Role of the Independent Auditor • Generally Accepted Accounting Principles o Accounting Standards • The Demand for and Supply of Investment Capital o The Role of Accounting Information in the Capital Markets • Agency Costs and the Separation of Management and Capital...
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