BusinessAnalysisandValuationUsingFinancialStatementsCh3.Palepu

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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&HealyChapter 3:Overview of Accounting Analysis Copyright(c)2008 Thomson South-Western,a part of th

2、e Thomson Corporation.Thomson,the Star logo,and South-Western are trademarks used herein under license.Chapter 3:Overview of Accounting AnalysisPalepu&HealyThe Importance of Accounting Analysis Accounting practices govern the types of disclosures made in the financial statements.Understanding accoun

3、ting 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 AnalysisPale

4、pu&HealyKey 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(c)2008

5、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&HealyAccrual Accounting Financial reports are prepared using accrual accounting instead of cash accounting.GAAP def

6、ines the following financial statement elements:Revenues Expenses Assets Liabilities EquityCopyright(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&HealyMa

7、nagements 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.Contracts Reputation Mitigating effects of the S

8、arbanes-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&HealyGenerally Accepted Accounting Principles(GAAP)The SEC has relied on the FAS

9、B 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 information International harmonization of accounting standards is gain

10、ing 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&HealyExternal Auditing of Financial Statements Required for publicly traded compani

11、es Conducted according to standards(GAAS)SOX requires external auditors to report to or be overseen by a companys audit committeeCopyright(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:Overvie

12、w of Accounting AnalysisPalepu&HealyFactors Influencing Accounting QualityIt 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:1.Noise from accounting rules2.Forecast errors3.Managers accou

13、nting choicesCopyright(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&HealyNoise From Accounting Rules andForecast Errors The fit between accounting standa

14、rds 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 Corporation.Thomson,the

15、 Star logo,and South-Western are trademarks used herein under license.Chapter 3:Overview of Accounting AnalysisPalepu&HealyManagers Accounting Choices Managers have a number of incentives to choose accounting disclosures that are biased:Debt covenants Compensation contracts Contests for corporate co

16、ntrol Tax considerations Regulatory considerations Capital market and stakeholder considerations Competitive considerationsCopyright(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 A

17、ccounting AnalysisPalepu&HealySteps in Performing Accounting Analysis Step 1:Identify Principal Accounting Policies Key policies and estimates used to measure risks and critical factors for success must be identified.Step 2:Assess Accounting Flexibility Accounting information is less likely to yield

18、 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:Overview of Accountin

19、g AnalysisPalepu&HealySteps 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 with industry peers

20、 Incentives for managers to manage earnings Changes in policies and estimates and the rationale for doing so Whether transactions are structured to achieve certain accounting objectivesCopyright(c)2008 Thomson South-Western,a part of the Thomson Corporation.Thomson,the Star logo,and South-Western ar

21、e trademarks used herein under license.Chapter 3:Overview of Accounting AnalysisPalepu&HealySteps in Performing Accounting Analysis Step 4:Evaluate the Quality of Disclosure-Managers have considerable discretion in disclosing certain accounting information-Issues to consider include:Whether disclosu

22、res seem adequate Adequacy of footnotes to the financial statements Whether MD&A sufficiently explains and is consistent with current performance Whether GAAP restricts the appropriate measurement of key measures of success Adequacy of segment disclosureCopyright(c)2008 Thomson South-Western,a part

23、of the Thomson Corporation.Thomson,the Star logo,and South-Western are trademarks used herein under license.Chapter 3:Overview of Accounting AnalysisPalepu&HealySteps in Performing Accounting Analysis Step 5:Identify Potential Red Flags-Some issues that warrant gathering more information include:Une

24、xplained transactions that boost profits Unusual increases in inventory or A/R in relation to sales Increases in the gap between net income and cash flows or taxable income Use of R&D partnerships,SPEs or the sale of receivables to finance operationsCopyright(c)2008 Thomson South-Western,a part of t

25、he Thomson Corporation.Thomson,the Star logo,and South-Western are trademarks used herein under license.Chapter 3:Overview of Accounting AnalysisPalepu&HealySteps in Performing Accounting Analysis Step 5:Identify Potential Red Flags,continued-More issues that warrant gathering more information:Unexp

26、ected large asset write-offs Large fourth-quarter adjustments Qualified audit opinions or auditor changes Related-party transactionsCopyright(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

27、view of Accounting AnalysisPalepu&HealySteps in Performing Accounting Analysis Step 6:Undo Accounting Distortions-Some issues that warrant gathering more information include:Unexplained transactions that boost profits Unusual increases in inventory or A/R in relation to sales Increases in the gap be

28、tween net income and cash flows or taxable income Use of R&D partnerships,SPEs or the sale of receivables to finance operationsCopyright(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

29、of Accounting AnalysisPalepu&HealyAccounting Analysis Pitfalls Conservative accounting may also be misleading.For example,historical cost and accounting for intangible assets Not all unusual accounting practices are questionable.Earnings management does not necessarily motivate some accounting pheno

30、mena that seem unusualCopyright(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&HealyConcluding 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.