systematic bias Flashcards
Flashcard 1: Purpose of Accounting Analysis
Q: What is the purpose of accounting analysis?
A: Evaluate how well accounting reflects underlying business economics and adjust financial statements to mitigate distortions
Flashcard 2: Financial Ratios and Accounting Distortions
Q: Why might financial ratios be misleading?
A: Accounting distortions can cause financial ratios to misrepresent a firm’s actual economic condition.
Flashcard 3: Accounting and Economic Reality
Q: What factors influence reported financial accounting amounts?
A: Financial Accounting Amounts = f(Economics, Measurement Error, Bias)
Flashcard 4: Reasons Accounting Might Not Reflect Economic Reality
Q: Why might accounting fail to capture economic reality?
A: Due to measurement error, systematic bias, or discretionary bias by management.
Flashcard 5: Measurement Error in Accounting
Q: What causes measurement errors in financial statements?
A: Estimates required for collectability of accounts receivable, depreciation, and postretirement liabilities.
Flashcard 6: Impact of Measurement Error
Q: How does measurement error affect financial reporting?
A: Good faith estimates may be too high or low, but they are expected to cancel out over time.
Flashcard 7: Measurement Error in Asset Valuation
Q: Which type of firm has the least measurement error in asset valuation?
A: Mutual funds, as their assets are based on fair market values.
Flashcard 8: Bias in Accounting System
Q: What are the qualitative characteristics of useful financial information?
A: Relevance and representational faithfulness, balanced through a mixed attribute model.
Flashcard 9: Conservative vs. Aggressive Bias in Accounting
Q: What are examples of conservative and aggressive accounting bias?
A:
Conservative bias: Understating assets and earnings (e.g., R&D accounting in US GAAP)
Aggressive bias: Overstating assets and earnings (e.g., contingent liability omission)
Flashcard 10: Definition of an Asset (FASB)
Q: What defines an asset under FASB?
A: Probable future economic benefits obtained or controlled due to past transactions or events.
Flashcard 11: R&D Accounting Under GAAP
Q: How does GAAP treat R&D expenses?
A: Internally generated R&D is expensed, while externally purchased R&D (e.g., patents) is capitalized.
Flashcard 12: R&D Accounting Under IFRS
Q: How does IFRS classify R&D costs?
A: Research phase expenses are expensed, while development phase costs are capitalized.
Flashcard 13: Financial Statement Bias from Expensing R&D
Q: How does expensing R&D affect financial statements?
A:
Balance Sheet: Understates assets and equity
Income Statement: Overstates expenses, understates earnings
Cash Flow Statement: Understates CFO, overstates CFI
Flashcard 14: Aggressive Bias - Omission of Contingent Liabilities
Q: When are contingent liabilities omitted?
A: If future obligations are not sufficiently probable or not reasonably estimable.
Flashcard 15: Examples of Omitted Contingent Liabilities
Q: What are common examples of contingent liabilities?
A: Ongoing litigations and potential environmental cleanup costs.
Flashcard 16: Earnings Quality Analysis
Q: What is the role of the income statement in earnings quality analysis?
A: Reports revenues, expenses, and net income, highlighting quality through accounting policies and estimates.
Flashcard 17: Definition of Revenue (FASB)
Q: How does FASB define revenue?
A: Inflows or enhancements of assets from delivering goods, rendering services, or core operations.
Flashcard 18: New Revenue Recognition Standard (ASC 606)
Q: What are the five steps to recognizing revenue under ASC 606?
A: Performance obligation-based revenue recognition framework.
Identify the contract with a customer.
Identify the performance obligations in the contract.
Determine the transaction price.
Allocate the transaction price to the performance obligations.
Recognize revenue when (or as) the entity satisfies a performance obligation
Flashcard 21: Quantitative Revenue Analysis - Days Sales Outstanding (DSO)
Q: How is Days Sales Outstanding (DSO) calculated?
A: DSO = (365 × Average Accounts Receivable) / Sales
Flashcard 22: Interpreting an Increase in DSO
Q: What could cause an increase in DSO?
A:
More lenient credit policies
Declining credit quality
Flashcard 23: Deferred Revenue Analysis
Q: What does a decreasing deferred revenue-to-sales ratio suggest?
A:
More aggressive revenue recognition
Customers unwilling to prepay
Capacity improvements
Flashcard 24: Key Takeaways from Accounting Analysis
Q: What are the key insights from accounting analysis?
A:
Measurement errors arise from estimation uncertainty.
Systematic bias results from the mixed-attributes model.
Revenue quality assessment requires both qualitative and quantitative analysis.
