Chapter Two - Wiley

More documents

Recommendations

Info

8956d_ch02.qxd 7/17/03 2:40 PM Page 54 mac34 Mac34: kec_420: 54 CHAPTER 2 A Further Look at Financial Statements determined by standard-setting bodies in consultation with the accounting profession and the business community. The Securities and Exchange Commission (SEC) is the agency of the U.S. government that oversees U.S. financial markets and accounting standard-setting bodies. The primary accounting standard-setting body in the United States is the Financial Accounting Standards Board (FASB). The FASB’s overriding criterion is that the accounting rules should generate the most useful financial information for making business decisions. To be useful, information should possess these qualitative characteristics: relevance, reliability, comparability, and consistency. Business Insight INVESTOR PERSPECTIVE In the aftermath of Enron, much attention has turned toward the Securities and Exchange Commission (SEC). In 2000, companies filed 98,000 reports with the SEC, 14,000 of which were annual reports. But budget shortfalls and staffing limitations meant that the SEC was able to review only 2,280 of these annual reports. As a result of SEC reviews, companies are often required to improve the disclosures in their annual report. Enron’s report had not been reviewed since 1997. STUDY OBJECTIVE 2 Discuss the qualitative characteristics of accounting information. RELEVANCE Information of any sort is relevant if it would influence a decision. Accounting information is relevant if it would make a difference in a business decision. For example, when Best Buy issues financial statements, the information in the statements is considered relevant because it provides a basis for forecasting Best Buy’s future earnings. Accounting information is also relevant to business decisions because it confirms or corrects prior expectations. Thus, Best Buy’s financial statements help predict future events and provide feedback about prior expectations for the financial health of the company. In addition, for accounting information to be relevant it must be timely. That is, it must be available to decision makers before it loses its capacity to influence decisions. In order to increase the timeliness of financial reports, the SEC recently required that companies provide their annual report to investors within 60 days of their year-end. They had previously been allowed up to 90 days. RELIABILITY Reliability of information means that the information can be depended on. To be reliable, accounting information must be verifiable—we must be able to prove that it is free of error. Also, the information must be a faithful representation of what it purports to be—it must be factual. If Best Buy’s income statement reports sales of $20 billion when it actually had sales of $10 billion, then the statement is not a faithful representation of Best Buy’s financial performance. Finally, accounting information must be neutral—it cannot be selected, prepared, or presented to favor one set of interested users over another. As noted in <strong>Chapter</strong> 1, to ensure reliability, certified public accountants audit financial statements.
8956d_ch02.qxd 7/17/03 2:40 PM Page 55 mac34 Mac34: kec_420: Characteristics of Useful Information 55 COMPARABILITY Let’s say that you and a friend kept track of your height each year as you were growing up. If you measured your height in feet and your friend measured hers in meters, it would be difficult to compare your heights. A conversion would be necessary. In accounting, comparability results when different companies use the same accounting principles. At one level, U.S. accounting standards are fairly comparable because they are based on certain basic principles and assumptions. These principles and assumptions allow for some variation in methods, however. For example, there are a variety of ways to report inventory. Often these different methods result in different amounts of net income. To make comparison across companies easier, each company must disclose the accounting methods used. From the disclosures, the external user can determine whether the financial information is comparable and try to make adjustments. Unfortunately, converting the accounting numbers of companies that use different methods is not as easy as converting your height from feet to meters. One factor that can affect the ability to compare two companies is their choice of accounting or fiscal year-end. Most companies choose December 31 as their fiscal year-end, although an increasing number of companies are choosing dates other than December 31. In the notes to its financial statements, Best Buy states that its accounting year-end is the Saturday nearest the end of February. This can create two problems for analysis. First, if Best Buy’s competitors use a different year-end, then when you compare them, you are not comparing performance over the same period of time or financial position at the same point in time. Also, by not picking a particular date, the number of weeks in Best Buy’s fiscal year will change. For example, its fiscal years 2000 and 1999 had 52 weeks, but fiscal year 2001 had 53 weeks. International Note Accounting standards vary from country to country. Most countries have their own standardssetting body. This can complicate comparison of companies from different countries, such as German corporation Adidas and U.S. corporation Nike. One group, the International Accounting Standards Board (IASB), has been organized to try to reduce the differences in accounting practices and standards across countries. Helpful Hint An accounting time period that is one year long is called a fiscal year. Business Insight MANAGEMENT PERSPECTIVE Why do companies choose the particular year-ends that they do? For example, why doesn’t every company use December 31 as the accounting year-end? Many companies choose to end their accounting year when inventory or operations are at a low. This is advantageous because compiling accounting information requires much time and effort by managers, so they would rather do it when they aren’t as busy operating the business. Also, inventory is easier and less costly to count when it is low. Some companies whose year-ends differ from December 31 are Delta Air Lines, June 30; Walt Disney Productions, September 30; Kmart Corp., January 31; and Dunkin’ Donuts, Inc., October 31. CONSISTENCY Users of accounting information often track a company’s financial results over a series of years. To compare Best Buy’s net income over several years, you’d need to know that it used the same accounting principles from year to year; otherwise, you might be “comparing apples to oranges.” Consistency means that a company uses the same accounting principles and methods from year to year. Thus, if a company selects one inventory accounting method in the first year of operations, it is expected to continue to use that same method in succeeding years. When financial information has been reported on a consistent basis, the financial statements permit meaningful analysis of trends within a company.
Page 1 and 2: 8956d_ch02_051 8/20/03 12:54 PM Pag
Page 3: 8956d_ch02_053 7/21/03 6:56 AM Page
Page 7 and 8: 8956d_ch02_057 10/14/03 11:06 AM Pa
Page 9 and 10: 8956d_ch02.qxd 7/17/03 2:40 PM Page
Page 15 and 16: 8956d_ch02_065 7/21/03 6:57 AM Page
Page 27 and 28: 8956d_ch02_077 9/26/03 3:33 PM Page
Page 29 and 30: 8956d_ch02_079 11/11/03 8:38 AM Pag

Chapter Two - Wiley

Create successful ePaper yourself

Delete template?

Save as template?