Slide 1Slide 2Slide 3GAAPEnvironmental FactorsSlide 6Slide 7Slide 8Slide 9Slide 10Slide 11Alternative information sourcesDesirable Qualities of Accounting InformationFinancial AccountingSlide 15Slide 16Accruals-The CornerstoneAccruals- The CornerstoneSlide 19Slide 20Slide 21Slide 22Slide 23Slide 24Slide 25Economic concepts of incomeAccounting concept of incomeAccounting Vs Economic incomeFair value accountingHistorical cost Vs Fair valueAdvantages & DisadvantagesImplications for AnalysisAccounting AnalysisSlide 34Slide 35Slide 36Slide 37Slide 38Slide 39Auditing And Financial Statement AnalysisMcGraw-Hill/IrwinCopyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.Financial Statement AnalysisK R SubramanyamJohn J Wild2-22CHAPTE RFinancial Reporting and Analysis2-3Statutory Financial Reports2-4GAAP Types of Accounting rules and guidelinesoStatements of Financial Accounting StandardsoAPB Opinions.oAccounting Research Bulletins (ARB).oAICPA pronouncements. The AICPA issues guidelines for certain topics yet to be addressed by the FASB in its Statements of Position (SOP) or for those involving industry-specific matters in its Industry Audit and Accounting Guidelines.oEITF Bulletins. EITF Bulletins are issued by the FASB’s Emerging Issues Task Force.oIndustry practices.Types of Accounting rules and guidelinesoStatements of Financial Accounting StandardsoAPB Opinions.oAccounting Research Bulletins (ARB).oAICPA pronouncements. The AICPA issues guidelines for certain topics yet to be addressed by the FASB in its Statements of Position (SOP) or for those involving industry-specific matters in its Industry Audit and Accounting Guidelines.oEITF Bulletins. EITF Bulletins are issued by the FASB’s Emerging Issues Task Force.oIndustry practices.2-5Environmental Factors2-6Environmental FactorsSecurities and Exchange Commission (SEC)Securities and Exchange Commission (SEC)oIndependent, quasi-judicial government agencyoAdminister securities regulations & disclosuresoCan modify & set GAAP, if necessary oRarely directly challenges FASBoMajor player in global accountingoIndependent, quasi-judicial government agencyoAdminister securities regulations & disclosuresoCan modify & set GAAP, if necessary oRarely directly challenges FASBoMajor player in global accounting2-7Environmental FactorsInternational Financial Reporting Standards (IFRS)International Financial Reporting Standards (IFRS)2-8Environmental FactorsManagers of CompaniesoPrimary responsibility for fair & accurate reportsoApplies accounting to reflect business activitiesoManagerial discretion is necessary in accountingoMajor lobbyist on GAAPoPrimary responsibility for fair & accurate reportsoApplies accounting to reflect business activitiesoManagerial discretion is necessary in accountingoMajor lobbyist on GAAP2-9Environmental FactorsAuditingoSEC requires Audit ReportoAudit opinion can be:oclean (fairly presented)oqualified (except for)odisclaimer (no opinion)oCheck Auditor quality & independenceoSEC requires Audit ReportoAudit opinion can be:oclean (fairly presented)oqualified (except for)odisclaimer (no opinion)oCheck Auditor quality & independence Auditors2-10Environmental FactorsCorporate GovernanceoBoard of directors oversightoAudit committee of the boardooversee accounting processooversee internal controlooversee internal/external auditoInternal AuditoroBoard of directors oversightoAudit committee of the boardooversee accounting processooversee internal controlooversee internal/external auditoInternal Auditor2-11Environmental FactorsInternal UsersInternal UsersExternal UsersExternal Users2-12Alternative information sourcesVoluntary DisclosureVoluntary DisclosureEconomic, Industry & Company NewsEconomic, Industry & Company NewsoImpacts current & future financial condition and performanceoImpacts current & future financial condition and performanceInformation IntermediariesInformation IntermediariesoIndustry devoted to collecting, processing, interpreting & disseminating company informationoIncludes analysts, advisers, debt raters, buy- and sell-side analysts, and forecastersoMajor determinant of GAAPoIndustry devoted to collecting, processing, interpreting & disseminating company informationoIncludes analysts, advisers, debt raters, buy- and sell-side analysts, and forecastersoMajor determinant of GAAP Motivation - Legal liability, Expectations Adjustment, Signaling, Managing expectations Motivation - Legal liability, Expectations Adjustment, Signaling, Managing expectations2-13Desirable Qualities of Accounting Information2-14Financial AccountingoHistorical Cost - fair & objective values from arm’s-length bargainingoAccrual Accounting - recognize revenues when earned, expenses when incurredoMateriality - threshold when information impacts decision makingoConservatism - reporting or disclosing the least optimistic information about uncertain events and transactionsoHistorical Cost - fair & objective values from arm’s-length bargainingoAccrual Accounting - recognize revenues when earned, expenses when incurredoMateriality - threshold when information impacts decision makingoConservatism - reporting or disclosing the least optimistic information about uncertain events and transactionsImportant Accounting Principles2-15Financial AccountingRelevance of Accounting InformationRelevance of Accounting InformationRelation between Accounting Numbers and Stock Prices Relation between Accounting Numbers and Stock Prices2-16Financial AccountingoTimeliness - periodic disclosure, not real-time basisoFrequency - quarterly and annuallyoForward Looking - limited prospective informationoTimeliness - periodic disclosure, not real-time basisoFrequency - quarterly and annuallyoForward Looking - limited prospective informationLimitations of Accounting Information2-17Accruals-The CornerstoneoEstablish company and invest $700 equityoPurchase plain T-shirts for $5 eachoFixed screen cost of $100oVariable print cost of $0.75 per T-shirtoSold 25 T-shirts at $10 each for cashoSold 25 T-shirts at $10 each on creditoEstablish company and invest $700 equityoPurchase plain T-shirts for $5 eachoFixed screen cost of $100oVariable print cost of $0.75 per T-shirtoSold 25 T-shirts at $10 each for cashoSold 25 T-shirts at $10 each on creditIllustration - Case Facts2-18 Receipts AssetsT-Shirt sales $250 Cash $275 PaymentsT-Shirt purchases $500 EquityScreen purchase 100 Beginning Equity $700Printing charges