W r u eo dioo 0 rkoi 101 ulf 1 j 10 010 a p pen d ix

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-" -, _,w r .,,-~"--, ~ u~ •• ~ eo- _ •••••.•••••••. .... dioo"~,~-:: ~ \.. "'-" - -"', .. ,,:.. -,,,,,,,.,, .... ::::;..""- =::-- ,0 .•• ::::::. .... '" : ~_'rK<OI ........... 101. •••..•.•Ulf.. ~ -- --~ ''''''' ......... ,,-'''''.-.. .... 1'.••••. "...,. !~~:-; ...•... ~:j." ",""_';10< •• ,,,... •.••• "'010.."._ --.- .... -- ... "" .. _- ~, ... -- --"""""''' -- A P PEN D IX 1B: ACCOUNTING PRINCIPLES AND GOVERNANCE Financial Accounting Environment Information in financial statements is crucial to valuing a company's debt and equity securities. Financial statement information can affect the price the market is willing to pay for the company's equity securities and interest rates attached to its debt securities. The importance of financial statements means that their reliability is paramount. This includes the crucial role of ethics. To the extent that financial performance and condition are accurately communicated to business decision makers, debt and equity securities are more accurately priced. When securities are mis-priced, resources can be inefficiently allocated both within and across economies. Accurate, reliable financial statements are also important for the effective functioning of many other markets such as labor, input, and output markets. To illustrate, recall the consequences of a break- down in the integrity of the financial accounting system at Enron. Once itbecame clear that Enron had not faith- fully and accurately reported its financial condition and performance, the market became unwilling to purchase Enron's securities. The value of its debt and equity se- curities dropped precipitously and the company was un- able to obtain cash needed for operating activities. With- in months of the disclosure of its financial accounting irregularities, Enron ,with revenues of over $100 billion and total company value of over $60 billion, the fifth largest U.S. company, was bankrupt! Further historical evidence of the importance of fi- nancial accounting is provided by the Great Depression of the 20th century. This depression was caused, in part, by the failure of companies to faithfully report their fi- nancial condition and performance. LOS Describe the accounting principlesand regulationsthat framefinancial statements. [ SEe ] •• Oversight of Financial Accounting The stock market crash of 1929 and the ensuing Great Depression led Congress to pass the 1933 Securities Act. This act had two main objectives: (1) to require disclosure of financial and other information about securities be- ing offered for public sale; and (2) to prohibit deceit, misrepresentations, and other fraud in the sale of securities. This act also required that companies register all securities proposed for public sale and disclose information about the securities being offered, including information about company financial condition and performance. This act became and remains a foundation for contemporary financial reporting. Congress also passed the 1934 Securities Exchange Act, which created the Securities and Exchange Com- mission (SEC) and gave it broad powers to regulate the issuance and trading of securities. The act also provides Companies prepare and auditors examine financialstatements Balance Sheet Income Statement
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Module 1 I Framework for Analysis and Valuation 1-28
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