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Accounting Analysis
Accounting Analysis
Accounting
Accrual Accounting distinguishes between
the recording of costs and benefits
associated with economic activities and the
actual payment and receipt of cash.
Expected, not necessarily actual cash
receipts and payments.
Accounting
While basic definitions of the elements of a firm’s
financial statements are simple, their application in
practice often involves complex judgements
Because corporate managers have intimate
knowledge of firms’ businesses they make
appropriate judgements in portraying myriad
business transactions using basic accrual
accounting framework
Accounting
Accounting discretion
Potentially valuable as it allows managers to reflect
inside information in reported financial statements
But managers have an incentive to use this discretion to
distort reported profits by making biased assumptions.
Use of accounting numbers in contracts between firm and
outsiders provides motivation for manipulation of
accounting numbers.
Distortion makes financial statements less valuable to
external users. Difficult for outsiders to determine whether
managers have misused flexibility.
Delegation of financial reporting decisions to managers has
both costs and benefits.
Accounting rules and auditing reduce cost and preserve
benefits
Accounting
Conventions
Historical cost
Accounting Standards
Lease
Uniformity in accounting standards
Reduce ability to record similar economic transactions in
dissimilar ways either over time or across firms
Increase credibility of financial statements
Comes at the expense of reduced flexibility for managers to reflect
genuine business differences in a firm’s accounting decisions
Rigid Standards
Good – Economic transactions whose accounting treatment is not
predicated on managers proprietary information
Dysfunctional – Significant business judgement involved in
assessing a transaction’s economic consequences
Induce managers to expend economic resources to restructure
business transactions to achieve desired accounting result
Factors Influencing Accounting Quality