The Analysis and Use of Financial Statements, 3rd Edition, Gerald I. White, Ashwinpaul C. Sondhi, Dov Fried

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Chapter 1 - Solutions
Overview: Problem Length {S} [M] 1.{S}(i) Problem #s 1 to 23 24

Short-term lenders are concerned primarily with liquidity. Accounting standards would focus primarily on near-term cash flows and might include cash flow forecasting. Performance reporting would likely emphasize cash-based measures.

(ii) Long-term equity investors are primarily concerned with the earning power of the firm. Income measurement would be the focus of standards for such users. (iii)Tax authorities are concerned with the generation of tax revenue. Accounting standards might limit the ability of firms to shift income from one period to another and place strict controls on the recognition and timing (accrual) of both revenues and deductible expenditures. (iv) Corporate managers seek to control their reported earnings, to cast the best possible light on their stewardship. Accounting standards set by managers would be highly flexible, with little supplementary information and footnote disclosure. 2.{S}The matching principle states that revenues should be matched with the expenses that generate them. As the revenues and related expenditures may be incurred in different accounting periods, accrual accounting is required to recognize them in the same period. 3.{S}The going concern assumption states that the enterprise will continue operating in a normal fashion. This assumption permits financial statements to record assets and liabilities based on the cash flows that they will generate as the firm operates. If this assumption were absent, all assets and liabilities would have to be evaluated on a liquidation basis. Accrual accounting could not be used, as the assumption that expenditures would produce future revenues could no longer be made. 1-1

4.{S}Public companies must provide current investors with detailed financial statements, mandated by the FASB and the SEC. Because of SEC filing requirements, annual and quarterly financial data are publicly available to potential investors as well. Private companies may not prepare audited financial data. When audited financial statements are prepared, they will lack some disclosures (e.g., earnings per share) and certain SEC-mandated data (such as the management discussion and analysis). In addition, these statements may not be made available to potential investors. 5.{S}All public companies in the United States are required to issue financial statements whose form and content are determined by the FASB after much public debate. The SEC oversees this process and supplements these standards with additional disclosure requirements. As U. S. GAAP have an investor and user orientation, they require detailed disclosures. Financial statements issued by non-U.S. firms follow local (in some cases, IASB) accounting standards, with less disclosure. Local standards reflect legal and political requirements and often do not have the same investor protection objective as in the United States. Foreign firms generally do not provide quarterly reports; semi-annual reporting is the norm. 6.{S}The FASB sets accounting standards for all audited financial statements prepared under U.S. GAAP. The SEC has jurisdiction over all public companies. Given the overlapping jurisdiction, the SEC generally relies on the FASB to set standards but supplements those standards with additional disclosure requirements deemed necessary to inform and protect investors in public companies. 7.{S}The balance sheet includes only those economic events that qualify as assets and liabilities. As accounting standards define, in effect, assets and liabilities they determine which economic events are accounted for and which are ignored. Events ignored (such as many contracts) are excluded from the process of preparing financial statements. The recognition rules also influence managers' decisions regarding the form of contractual agreements used to acquire assets and incur liabilities, thereby affecting the preparation of financial...
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