Chapter 3 Accounting Analysis Flashcards
Ownership of Proprietorship and Partnership are generally _____.
Private
Corporations which are larger firms with diverse ownership that can be bought or sold in an open market are generally ________.
Public
What are the 3 reasons publicly traded corps. have to file financial reports?
- Monitoring 2. Contracting - example is bank contract for a loan, employee contract for bonus incentive 3. Valuation
TRUE OR FALSE? Because corporate managers have superior knowledge of their firms’ business, they are entrusted with making appropriate accounting estimates.
TRUE
Financial statements are __________ responsibility (not auditors)
management’s
TRUE OR FALSE? It is optimal to allow managers some discretion in applying accounting standards (e.g., allowance for doubtful accounts). Incentives exist for managers to distort accounting numbers positively (e.g., contracts, reputation)
TRUE
The ____ is a regulatory agency commissioned by Congress to monitor and enforce legal behavior in the U.S. capital markets.
SEC
What are the 2 financial reports that the SEC mandates that all publicly-traded firms file?.
10-Q: Quarterly report (filed at the end of each of the first 3 fiscal quarters) 10-K: Annual report (filed at the end of the last fiscal quarter)
The ____ has legal authority to enact civil or criminal penalties for lack of compliance or suspicion of fraud.
SEC
FASB = Financial Accounting Standards Board (private, non-profit) purpose is to establish and improve ____
GAAP
IFRS = International Financial Reporting Standards; they developed ____
GAAP
IASB developed the IFRS, which is the international accounting framework within which to properly organize and report financial information.
IFRS (International Financial Reporting Standards)
TRUE OR FALSE: Uniform accounting standards MAXIMIZE manager’s ability to manipulate financial statement information
FALSE, it minimizes a manager’s ability to manipulate
The Securities and Exchange Commission (SEC) U.S. government agency that _____ rules for financial statements by public companies.
enforces
The Financial Accounting Standards Board (FASB) is the private sector body given the responsible for developing detailed rules for ____ within U.S.; they ____ the rules.
GAAP set
Head Financial Accountant is usually called the _____
controller
An auditor is an independent agent hired by the firm. They typically work for a ____ firm.
CPA
Accounting is all about ____. (what Prof. Tang kept saying in class)
Timing
Cash basis of accounting: Method of accounting where income is calculated by recording revenues when cash is _____ and expenses when expenditures _____.
received occur
____ basis of accounting: Method of accounting where income is calculated by recording revenues when benefits are earned and expenses when resources are given up to produce the revenues (expenses are matched to revenues). – What GAAP requires
accrual
What is a downside to CASH BASIS ACCOUNTING? Financial statements reflect when cash comes into and out of a company, but not necessarily when business transactions take ____ between the company, customers, and suppliers.
place
What 4 criteria must by met under ACCRUAL BASIS for revenue to be posted or recognized? (remember DPPC)
- The company has delivered its goods/services to the customer.
- The price is fixed or determinable.
- There is persuasive evidence of an arrangement for customer payment (written orders)
- Collection of cash (or other benefits) is reasonably assured, though there may still be some uncertainty (uncollectible accounts, warranties). The degree of uncollectability should be estimated with reasonable reliability.
Goal of accrual accounting is to report inflows of assets (e.g., cash or A/R) when they are ____, and net them against outflows of assets ____ to generate them.
earned
used
The ______principle recognizes costs and/or assets used as expenses in the period in which they produce revenue. (Cost of the hat is not recognized until it actually sold)
matching
When are expenses recognized in accrual accounting?
- When the associated revenue is recognized.
- Matched to the timing of revenue.
- Reported in the income statement in the same period as the revenue they gave rise to.
- The revenue could be zero.
______method for bad debt accounting
- GAAP requires companies to estimate the amount of credit sales that they believe are uncollectible in the period those credit sales are made.
- Ensures accounts receivable (asset) is not overstated.
- Ensures bad debt expense is matched against revenue for the period.
This happens when A/R cannot be collected in full.
Allowance
Under ______ method, there is a contra asset account set up to keep track of the estimated bad debt: this account is called ___ for _____ accounts
allowance
allowance
doubtful - Allowance for Doubtful Accounts (AFDA).
Bad Debt Expense is reported on ______ statement among the ______ expenses (matching principle).
income
operating
Sources of accounting distortion in accrual-based accounting:
- _____ errors (e.g., allowance for doubtful accounts)
- Noise from accounting _____ (e.g., expensing R&D, GAAP)
- _____ management (i.e., intentional, can be manipulated)
estimation
rules
earnings
What are some of the reasons or incentives of EARNINGS MANAGEMENT occurs?
- Compensation
- Debt covenants
- Competitive consideration
- Reputation
- Tax considerations
- Stakeholder consideration
- Big bath (blame previous management for bad earnings)
- Corporate control contests (can be used to keep competitors away)
- Regulatory consideration
- Income smoothing (can be used to mask volatility.)
- Capital Market consideration
Earning management can be both legal and ____.
illegal
What are some of the forms of Earnings management?
1) Changing accounting estimates and policies that determine accounting numbers
2) Income shifting
3) Classificatory earnings management
Earnings management by distorting different accounts
assets
liabilities
equity
Common causes for asset distortions
- Improper write-down and impairment of assets
- Improper depreciation and amortization
- Improper capitalization of expenses
•Distortions may generally arise from ambiguities about:
- Whether an obligation has been incurred
- The proper measurement of an obligation
Since Assets = Liabilities + Equity, distortions in assets and/or liabilities lead to distortions in _______.
equity
All publicly listed companies are required to have their annual financial statements audited by an independent public _____ (quarterly reports are reviewed, but not audited)
accountant
audited
____ requires external auditors to report to or be overseen by a company’s audit committee
SOX or Sarbanes Oxley
Name the big 4
Deloitte
KPMG
Ernt and Young
Price Waterhouse Coopers
TRUE OR FALSE
An audit report is a written opinion of an auditor regarding an entity’s financial statements.
TRUE
An ____report is published in an annual report
audit
____(or clean) opinions (GOOD) are issued when
- Financial statements conform to GAAP
- Statements represent the entity’s financial accounts fairly
UNQUALIFIED
______ opinion or an adverse report (NOT GOOD) are issued when
- There are limits on audit scope
- Financial statements are materially misstated but such misstatement does not have pervasive effect on the financial statement These may indicate a firm’s aggressive attitude or a tendency to “opinion shop.”
QUALIFIED
______ opinion is issued when
•Financial statements are materially misstated and such misstatements have pervasive effect on the financial statement
ADVERSE
______ of opinion is issued when auditors choose not to render one. This is issued in either of the following cases
- When the auditor is not independent or when there is conflicts of interest
- When the auditee has going concern issues
DISCLAIMER
TRUE OR FALSE
The quality of financial analysis, and the inferences drawn, depends on the quality of the underlying accounting information
true
Accounting analysis is the process of
- evaluating the extent to which a company’s accounting numbers reflect economic reality
- identifying and assessing accounting _____in a company’s financial statements
reality
distortions
______ analysis is an essential step in analyzing corporate financial reports.
accounting
Research suggests _______ management is not so pervasive as to make earnings data unreliable.
earnings
What are the 6 steps in performing accounting analysis?
1) Indentify accounting __________
2) Assess Accounting ______
3) Evaluate Accounting ______
4) Evaluate the quality of ________
5) Identify potential ____flags
6) undo accounting _______
- policies
- flexibility
- Strategy
4) disclosure
5) red
6) distortions
