Financial Reporting and

Analysis
Dr. Rachappa Shette
Indian Institute of Management Kozhikode
Session 2: Agenda
1. Reporting environment
2. Nature and purpose of accounting
3. Accruals – Cornerstone of accounting
4. Fair value accounting
5. Introduction to accounting analysis
I. Reporting environment (1/3)
1. Statutory financial reports
• Annual financial statements :
• Balance Sheet,
• Income Statement (IS),
• Cash Flows Statement, and
• Other Comprehensive Income Statement (gains and losses not included in IS)
• Changes in revaluation surplus
• Actuarial gains and losses related to retirement benefits
• Gains and losses from translation of foreign operations
• Quarterly financial statements
• Income Statement
• Earnings announcement
• Prospectus
I. Reporting environment (2/3)
2. Factors affecting statutory financial reports
• Generally accepted accounting principles
• Collection of standards, interpretations, clarifications, and guidelines
• Setting accounting standards in India by Accounting Standard Board (ASB)
• Role of SEBI in setting the accounting standards
• International Financial Reporting Standards
• Managers
• Need for flexibility in accounting
• Managerial discretion and use of accounting
• Managerial incentives and abuse of accounting
• Managers oppose standards that reduce the earnings, increase the volatility of earnings
and make them to disclose strategic information
I. Reporting environment (3/3)
2. Factors affecting statutory financial reports
• Generally accepted accounting principles
• Managers
• Monitoring and enforcement mechanisms
• Auditors
• Corporate Governance
• SEBI
• Litigation
• Alternative sources of information
• Economic, industry and company information
• Voluntary disclosures
• Intermediaries’ (like equity analysts, credit analyst, sell-side & buy-side analysts) disclosures
II. Nature and purpose of financial reporting
(1/4)
• Desirable qualities of accounting information
• Primary qualities are relevance and reliability
• Secondary qualities are comparability (across the companies)and consistency
(across the time)
• Important principles of accounting
• Accrual accounting (Excel Sheet-1)
• Historical Cost and Fair Value (Excel Sheet -2)
• Materiality (magnitude of an omission or misstatement of a transaction)
• Conservatism
II. Nature and purpose of financial reporting
(2/4)
• Relevance of financial reporting information
II. Nature and purpose of financial reporting
(3/4)
• Limitations of financial statement information
or
• advantages of alternative sources of information
• Timeliness
• Frequency
• Forward-looking
II. Nature and purpose of financial reporting (4/4)
Declining relation between accounting numbers and stock prices
(Page 31, The End of Accounting and the Path Forward for Investors and Managers by Lev.B
& Gu.F)
III. Accrual Accounting Framework (1/4)
• Accrual concept (Excel sheet-1)
• Accruals and Cash Flows
• Net Income = Net CFO + Accruals
• Accruals = Short-term accruals and long-term accruals
• Fundamental Principles of Accruals
• Revenue Recognition
• Expense Matching (Product cost, period cost, and losses)
III. Accrual Accounting Framework (2/4)
• Relevance of Accrual Accounting
In summary
• Quality of financial statements depend on accounting environmental
factors.
• Relevance and reliability are primary qualities of financial statements.
• Accrual profit is superior to cash flows.
Questions?
 Reading

Chapter 2 of the course text book