Transcript Introduction to Financial Statement Analysis

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Some Sage Advice . . .

This short stories that follow have
nothing to do with earnings quality or
earnings management.

However they may prove useful to you in
the future.

So, here are three lessons from large
corporations to help you survive change
Source: The Internet, of course – Where Else!
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CORPORATE LESSON
A crow was sitting on a tree, doing nothing all day.
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A small rabbit saw the crow, and asked him,
"Can I also sit like you and do nothing all day
long?”
The crow answered: "Sure, why not.”
So, the rabbit sat on the ground below the
crow, and rested.
All of a sudden, a fox appeared,
Jumped on the rabbit... and ate it.
CORPORATE LESSON 1
The moral of the story . . .
To be sitting and
doing nothing you
must be sitting
very, very high up.
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A turkey was chatting with a bull.
"I would love to be able to get to the top of that tree,"
sighed the turkey, "but I haven't got the energy.”
"Well, why don't you nibble on some of my droppings?"
replied the bull. They're packed with nutrients."
The turkey pecked at a lump of dung and found that it
actually gave him enough strength to reach the first
branch of the tree.
The next day, after eating more dung, he reached the
second branch.
Finally after a fortnight, there he was proudly perched at the
top of the tree
Soon he was spotted by a farmer
Who promptly shot the turkey out of the tree.
CORPORATE LESSON 2
The moral of the story . . .
Bullshit might get
you to the top. But
it won’t keep you
there
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A little bird was flying south for the winter.
It was so cold, the bird froze and fell to the ground in
a large field.
While it was lying there, a
cow came by
and dropped some dung
on it.
As the frozen bird lay there in the pile of cow dung, it began to
realise how warm it was. The dung was actually thawing him out!
He lay there all warm and happy, and soon began to sing for joy.
P
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A passing cat heard the bird singing and came to investigate.
Following the sound, the cat discovered the bird under the pile of
cow dung, and promptly dug him out and ate him!
CORPORATE LESSON 3
The morals of this story are:

Not everyone who drops
shit on you is your enemy.

Not everyone who gets you
out of shit is your friend.

And, when you’re in deep
shit, keep your mouth shut.
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Time Period Principle
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Discrete (separate) accounting
periods.
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Life of the Firm
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First . . . Let’s
at the Income Statement
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Uses of the Income Statement

Evaluate the past performance of the
enterprise.
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Provide a basis for predicting future
performance.

Help assess the risk or uncertainty of
achieving future cash flows.
Intermediate Accounting
Kieso, Weygandt, and Warfield
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The Statement’s Limitations

Items that cannot be measured reliably
are not reported in the income
statement.

Income numbers are affected by the
accounting methods employed.
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Income measurement involves judgment.
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The Quality of Earnings
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A Multidimensional Concept

Decisions made by standard setters

Choices made by management about
which accounting methods to use from
the set of alternatives

Judgments and estimates made by
management to implement the chosen
alternatives.
Walter R. Teets
Issues in Accounting Education November 2002
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The Quality of Earnings

“Management may be giving way to
manipulation; integrity may be losing out
to illusion.”
Arthur Levitt
The Numbers Game
Remarks to NYU Center for Law and Business,
September 28, 1998
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The “Numbers Game”
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Accounting Hocus-Pocus
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“Big Bath” Charges
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Creative Acquisition Accounting
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Miscellaneous “Cookie Jar Reserves”
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Materiality
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Revenue Recognition
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The Power of a Speech

The “Numbers Game” speech provided
the impetus for:
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SAB 99, Materiality (August 12, 1999)
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SAB 100, Restructuring and Impairment
Charges (November 24, 1999)
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SAB 101, Revenue Recognition (December
3, 1999)
James R. Duncan
Twenty Pressures to Manage Earnings
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Do we have a problem?
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12% of CFOs had managed their
earnings at the request of their superiors.
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55% were asked but refused to do so.
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60% of CFOs have felt pressure to
manage earnings.
James R. Duncan
Twenty Pressures to Manage Earnings
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The Quality of Earnings
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Earnings Management
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Practices by which “earnings reports
reflect the desires of management rather
than the underlying financial
performance of the company.”
Arthur Levitt
The Numbers Game
Remarks to NYU Center for Law and Business,
September 28, 1998
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Earnings Management

“Earnings management can be defined
as the active manipulation of accounting
information to create an altered
impression of the firm’s financial
performance, as measured by its
earnings.”
Theresa Libby and Robert Mathieu
Playing by the Rules
CMA Management July/August 2001
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Earnings Management

Earnings management is often defined
as the planned timing of revenues,
expenses, gains, and losses to smooth
out bumps in earnings.

In most cases earnings management is
used to increase income in the current
year at the expense of income in future
years.
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Earnings Management

Earnings management has a negative
effect on the quality of earnings if it
distorts the information in a way that is
less useful for predicting future earnings
and cash flows.
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