week 1 financial reporting overview chp 1

Question 1

Financial statements are used as

Answer 1

-analytical tool
-management report card
-an early warning signal
-basis for prediction
-measure of accountability

Question 2

statement readers must :

Answer 2

-understand current financial reporting standards
-recognize that management can shape the financial information communicated to outside parties
-distinguish between financial statement information that is highly reliable and judgmental

Question 3

quality of information

Answer 3

degree to which the financial statements are grounded in facts and sound judgements and thus are free from distortion

Question 4

financial statements 2 purposes:

Answer 4

a. provide a way for company management to transfer information about business activities to people outside the company which helps solve information asymmetry
b. improves contract efficiency

Question 5

information asymmetry

Answer 5

management has access to more and better information about the business than do people outside the company

Question 6

stewardship

Answer 6

company’s resources belong to investors and creditors, but managers are “stewards” of those resources and are thus responsible for ensuring their efficient use and protecting them from adversity.

Question 7

The supply of financial statement information is guided by

Answer 7

the costs of producing and disseminating it and the benefits it will provide to the company.

Question 8

shareholders and investors use financial statements

Answer 8

-use fundamental analysis to identify mispriced securities

Question 9

efficient markets hypothesis

Answer 9

a stocks current market price reflects the knowledge and expectations of all investors

Question 10

managers and performers

Answer 10

-use financial statements that arises from contracts(executive compensation agreements ) that are linked to financial statement variables

Question 11

employees demand financial statement information for :

Answer 11

-to learn about the company’s performance and its impact on employee profit sharing and stock ownership plans
-monitor the health of company sponsored pension plans and to gauge the likelihood that promised benefits will be provided on retirement
-to know about union contract that may link negotiated wage increases to the company’s financial performance
- to help employees assess their company’s current and potential future profitability and solvency

Question 12

Lenders & suppliers use financial statements to:

Answer 12

-help decide the loan amount , interest rate, the security (collateral)
-suppliers use it to determine whether the customers will pay for the goods shipped

Question 13

loan agreements contain :

Answer 13

• contractual provisions = covenants that require the borrower to maintain minimum levels of working capital , debt to assets (accounting variables that

Question 14

customers use financial statements :

Answer 14

-needs to know whether the seller has the financial strength to deliver a high quality product on an agreed upon schedule , provide support and provide replacement parts

Question 15

government and regulatory

Answer 15

allows the sec to monitor security laws and to ensure that investors have a level playing field with timely access to financial statement information
-regulatory intervention -> antitrust litigation , protection form foreign imports , government loan guarantees ,price controls

Question 16

rate of return

Answer 16

profit / asset book value

Question 17

disclosure costs from informative financial disclosures

Answer 17

a. information collection ,processing , dissemination costs
b. competitive disadvantage costs
c. litigation costs-sh ,creditors initiate court actions
d. political costs

Question 18

fundamental analysis approach

Answer 18

estimates the value of a stock by assessing the amount,timing, and uncertainty of future cash flows

Question 19

creditors form opinions about credit risk by

Answer 19

comparing required principal and interest payments to estimates of the company’s current and future cash flows

Question 20

financial flexibility

Answer 20

ability to raise additional cash by selling assets , issuing stock or borrowing more

Question 21

covenants

Answer 21

strict conditions like restricting a company from paying dividends ,selling assets , buying other companies, forming joint ventures or borrowing

Question 22

fraud risk factors

Answer 22

rapid growth , unusual profitability ,ineffective board of directors , audit committee oversight

Question 23

decision usefulness

Answer 23

primary characteristics:
a. Relevance
b. faithful representation
c. comparability
d. verifiability- independent measures should get similar results when using the same yardstick
e. timeliness-fresh information available
f. understandability

Question 24

relevance

Answer 24

definition: info is capable of making a difference in a decision
components:
a. predictive value - improves forecast
b. confirmatory value - confirms or alters the decision makers earlier beliefs
c. materiality-capable of making a diffrence

Question 25

faithful representation

Answer 25

components:
a. completeness
b. neutrality
c. free from material error