Chapter 02 - Financial Reporting and Analysis 2-1 Chapter 2 Financial Reporting and Analysis REVIEW Financial statements are the most visible products of a company’s financial reporting process. The financial reporting process is governed by accounting rules and standards, managerial incentives, and enforcement and monitoring mechanisms. It is important for a user of financial information to understand the financial reporting environment along with the accounting information presented in financial statements. In this chapter, the concepts underlying financial reporting are discussed with special emphasis on accounting rules. Next the purpose of financial reporting is discussed – its objectives and how these objectives determine both the quality of the accounting information and the principles that underlie the accounting rules. The relevance of accounting information for business analysis and valuation is also discussed and limitations of accounting information are identified. Last, accrual accounting is discussed including the strengths and limitation of accruals, and the implications of accruals for financial statement analysis.
Chapter 02 - Financial Reporting and Analysis 2-2 OUTLINE Financial Reporting Environment Statutory Financial Reports Financial Statements Earnings Announcements Other Statutory Reports Factors Affecting Statutory Financial Reports Generally Accepted Accounting Principles GAAP Defined Setting Accounting Standards Role of the Securities and Exchange Commission International Accounting Standards Managers Monitoring and Enforcement Mechanisms Securities and Exchange Commission Auditing Corporate Governance Litigation Alternative Information Sources Economic, Industry, and Company Information Voluntary Disclosure Information Intermediaries Nature and Purpose of Financial Accounting Objectives of Financial Accounting Stewardship Information for Decisions Desirable Qualities of Accounting Information Primary Qualities: Relevance and Reliability Secondary Qualities: Comparability and Consistency Important Principles of Accounting Double-Entry Historical Cost Accrual Accounting Full Disclosure Materiality Conservatism Relevance and Limitations of Accounting Relevance of Financial Accounting Information Limitations of Financial Statement Information Relevance and Limitations of Accrual Accounting Relevance of Accrual Accounting Conceptual Relevance of Accrual Accounting Empirical Relevance of Accrual Accounting Accruals Can Be a Double-Edged Sword Analysis Implications of Accrual Accounting Myths and Truths About Accruals and Cash Flows Accruals and Cash Flows – Myths