Overview of Accounting Analysis

Question 1

Assess degree of distortion

Answer 1

analyst will need to identify areas where this is accounting flexibility and evaluate the appropriateness of firm’s accounting choices

Question 2

Institutional framework:

Answer 2

> Corporate law require companies to produce financial statements allowing owners to monitor income statement, balance sheet, cash flow statement
Income statement and balance sheet based on accrual accounting

Question 3

Accounting standards

Answer 3

> Uniform acc standards attempt to reduce managements ability to record similar economic transaction in dissimalr ways

Question 4

External auditing

Answer 4

> Ensure managers use acc rules and conventions consistently over time

Question 5

Legal libility

Answer 5

Threat of law suits have the beneficial effect of improving the accuracy of disclosures

Question 6

Factors influencing acc quality

Answer 6

> Noise and bias introduced by rigidity in acc rules
Random forecast errors: provisions or bad debts
Systematic reporting choices made by manager to achieve specific objectives

Question 7

Doing acc analysis

Answer 7

1. Identify key accounting policies and estimates that the firm uses to measure its critical factors/risks
2. Assess acc flexibility
3. Evaluate acc strategy (how firms acc policies compare to industry norm)
4. Evaluate disclosure quality (firm provide adequate disclosures to assess firms business strategy?)
5. Identify potential red flags (questionable accounting quality)
6. Undo acc distortions (if reported numbers are misleading, analyst attempt to restate the reported numbers to reduce distortions)