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1、Copyright(c)2008 Thomson South-Western,a part of the Thomson Corporation.Thomson,the Star logo,and South-Western are trademarks used herein under license.,Chapter 3:Overview of Accounting AnalysisPalepu&Healy,Chapter 3:Overview of Accounting Analysis,Copyright(c)2008 Thomson South-Western,a part of
2、the Thomson Corporation.Thomson,the Star logo,and South-Western are trademarks used herein under license.,Chapter 3:Overview of Accounting AnalysisPalepu&Healy,The Importance of Accounting Analysis,Accounting practices govern the types of disclosures made in the financial statements.Understanding ac
3、counting allows the business analyst to effectively use the financial information disclosed by companies.,Copyright(c)2008 Thomson South-Western,a part of the Thomson Corporation.Thomson,the Star logo,and South-Western are trademarks used herein under license.,Chapter 3:Overview of Accounting Analys
4、isPalepu&Healy,Key Concepts in Chapter 3,Various factors influence the quality of accounting-based financial reports.Managers have some discretion in accounting choices used in financial reporting.Incentives for the management of financial reporting items must be considered by the analyst.,Copyright
5、(c)2008 Thomson South-Western,a part of the Thomson Corporation.Thomson,the Star logo,and South-Western are trademarks used herein under license.,Chapter 3:Overview of Accounting AnalysisPalepu&Healy,Accrual Accounting,Financial reports are prepared using accrual accounting instead of cash accountin
6、g.GAAP defines the following financial statement elements:RevenuesExpensesAssetsLiabilitiesEquity,Copyright(c)2008 Thomson South-Western,a part of the Thomson Corporation.Thomson,the Star logo,and South-Western are trademarks used herein under license.,Chapter 3:Overview of Accounting AnalysisPalepu
7、&Healy,Managements Responsibility for Reporting Financial Information,Applying accounting principles is the responsibility of management,who has superior knowledge of a firms business.Incentives exist for management to distort accounting numbers in their favor.ContractsReputationMitigating effects o
8、f the Sarbanes-Oxley Act.,Copyright(c)2008 Thomson South-Western,a part of the Thomson Corporation.Thomson,the Star logo,and South-Western are trademarks used herein under license.,Chapter 3:Overview of Accounting AnalysisPalepu&Healy,Generally Accepted Accounting Principles(GAAP),The SEC has relied
9、 on the FASB to set accounting standards(GAAP).GAAP allows for consistency in reporting between firms and over different time periods of the same firm.Uniform accounting standards minimize managers ability to manipulate financial statement informationInternational harmonization of accounting standar
10、ds is gaining popularity.,Copyright(c)2008 Thomson South-Western,a part of the Thomson Corporation.Thomson,the Star logo,and South-Western are trademarks used herein under license.,Chapter 3:Overview of Accounting AnalysisPalepu&Healy,External Auditing of Financial Statements,Required for publicly t
11、raded companiesConducted according to standards(GAAS)SOX requires external auditors to report to or be overseen by a companys audit committee,Copyright(c)2008 Thomson South-Western,a part of the Thomson Corporation.Thomson,the Star logo,and South-Western are trademarks used herein under license.,Cha
12、pter 3:Overview of Accounting AnalysisPalepu&Healy,Factors Influencing Accounting Quality,It is necessary to allow managers some discretion in applying accounting standards.As a result,three potential sources of noise and bias in accounting data include:Noise from accounting rules2.Forecast errors3.
13、Managers accounting choices,Copyright(c)2008 Thomson South-Western,a part of the Thomson Corporation.Thomson,the Star logo,and South-Western are trademarks used herein under license.,Chapter 3:Overview of Accounting AnalysisPalepu&Healy,Noise From Accounting Rules andForecast Errors,The fit between
14、accounting standards and the nature of the firms transactions may introduce some distortion in the reported financial statements.Managements estimates may result in accounting forecasting errors reflected in the financial statements.,Copyright(c)2008 Thomson South-Western,a part of the Thomson Corpo
15、ration.Thomson,the Star logo,and South-Western are trademarks used herein under license.,Chapter 3:Overview of Accounting AnalysisPalepu&Healy,Managers Accounting Choices,Managers have a number of incentives to choose accounting disclosures that are biased:Debt covenantsCompensation contractsContest
16、s for corporate controlTax considerationsRegulatory considerationsCapital market and stakeholder considerationsCompetitive considerations,Copyright(c)2008 Thomson South-Western,a part of the Thomson Corporation.Thomson,the Star logo,and South-Western are trademarks used herein under license.,Chapter
17、 3:Overview of Accounting AnalysisPalepu&Healy,Steps in Performing Accounting Analysis,Step 1:Identify Principal Accounting PoliciesKey policies and estimates used to measure risks and critical factors for success must be identified.Step 2:Assess Accounting FlexibilityAccounting information is less
18、likely to yield insights about a firms economics if managers have a high degree of flexibility in choosing policies and estimates.,Copyright(c)2008 Thomson South-Western,a part of the Thomson Corporation.Thomson,the Star logo,and South-Western are trademarks used herein under license.,Chapter 3:Over
19、view of Accounting AnalysisPalepu&Healy,Steps in Performing Accounting Analysis,Step 3:Evaluate Accounting Strategy-Flexibility in accounting choices allows managers to strategically communicate economic information or hide true performance.-Issues to consider include:Norms for accounting policies w
20、ith industry peersIncentives for managers to manage earningsChanges in policies and estimates and the rationale for doing soWhether transactions are structured to achieve certain accounting objectives,Copyright(c)2008 Thomson South-Western,a part of the Thomson Corporation.Thomson,the Star logo,and
21、South-Western are trademarks used herein under license.,Chapter 3:Overview of Accounting AnalysisPalepu&Healy,Steps in Performing Accounting Analysis,Step 4:Evaluate the Quality of Disclosure-Managers have considerable discretion in disclosing certain accounting information-Issues to consider includ
22、e:Whether disclosures seem adequateAdequacy of footnotes to the financial statementsWhether MD&A sufficiently explains and is consistent with current performanceWhether GAAP restricts the appropriate measurement of key measures of successAdequacy of segment disclosure,Copyright(c)2008 Thomson South-
23、Western,a part of the Thomson Corporation.Thomson,the Star logo,and South-Western are trademarks used herein under license.,Chapter 3:Overview of Accounting AnalysisPalepu&Healy,Steps in Performing Accounting Analysis,Step 5:Identify Potential Red Flags-Some issues that warrant gathering more inform
24、ation include:Unexplained transactions that boost profitsUnusual increases in inventory or A/R in relation to salesIncreases in the gap between net income and cash flows or taxable incomeUse of R&D partnerships,SPEs or the sale of receivables to finance operations,Copyright(c)2008 Thomson South-West
25、ern,a part of the Thomson Corporation.Thomson,the Star logo,and South-Western are trademarks used herein under license.,Chapter 3:Overview of Accounting AnalysisPalepu&Healy,Steps in Performing Accounting Analysis,Step 5:Identify Potential Red Flags,continued-More issues that warrant gathering more
26、information:Unexpected large asset write-offsLarge fourth-quarter adjustmentsQualified audit opinions or auditor changesRelated-party transactions,Copyright(c)2008 Thomson South-Western,a part of the Thomson Corporation.Thomson,the Star logo,and South-Western are trademarks used herein under license
27、.,Chapter 3:Overview of Accounting AnalysisPalepu&Healy,Steps in Performing Accounting Analysis,Step 6:Undo Accounting Distortions-Some issues that warrant gathering more information include:Unexplained transactions that boost profitsUnusual increases in inventory or A/R in relation to salesIncrease
28、s in the gap between net income and cash flows or taxable incomeUse of R&D partnerships,SPEs or the sale of receivables to finance operations,Copyright(c)2008 Thomson South-Western,a part of the Thomson Corporation.Thomson,the Star logo,and South-Western are trademarks used herein under license.,Cha
29、pter 3:Overview of Accounting AnalysisPalepu&Healy,Accounting Analysis Pitfalls,Conservative accounting may also be misleading.For example,historical cost and accounting for intangible assetsNot all unusual accounting practices are questionable.Earnings management does not necessarily motivate some
30、accounting phenomena that seem unusual,Copyright(c)2008 Thomson South-Western,a part of the Thomson Corporation.Thomson,the Star logo,and South-Western are trademarks used herein under license.,Chapter 3:Overview of Accounting AnalysisPalepu&Healy,Concluding Comments,Accounting analysis is an essential step in analyzing corporate financial reports.A methodology consisting of six steps in analyzing accounting data was presented in this chapter.Research suggests earnings management is not so pervasive as to make earnings data unreliable.,
