Overview of accounting analysis
HOMEWORK 3: DISCUSSION QUESTIONS
1. A finance student states, “I don’t understand why anyone pays any attention to accounting earnings numbers, given that a ‘clean’ number like cash from operations is readily available.” Do you agree? Why or why not?
I disagree with the finance student, because net income forecasts future cash flow and is informative.
a. Net income forecasts future cash flow better than current cash flow, and does so by recording transactions associated with cash consequences when the transactions occur, rather than when the cash is received or paid. To compute net income, the effects of economic transactions are recorded on the basis of expected, not necessarily actual, cash receipts and payments.
b. Net income is informative when corporate managers have better information than outside investors. Corporate managers use accrual rather than cash accounting to prepare financial reporting and determine net income. Since accrual accounting helps managers to record past events and forecast future events, net income gives superior information.
2. Fred argues: “The standards that I like most are the ones that eliminate all management discretion in reporting - that way I get uniform numbers across all companies and don’t have to worry about doing accounting analysis”. Do you agree? Why or why not?
I disagree with Fred, because the elimination of delegation of reporting to management will create chaos and misinterpretation of financial statements. Corporate managers know how to apply and judge business transactions using the accrual accounting framework. They have inside information and make appropriate judgments to convey that information to investors and forecast future performance. If this discretion is eliminated, managers will be unable to make use of inside information in reported financial statements.
However, since investors view profits as a measure of a manager’s performance, some managers have an incentive to use their accounting
1. A finance student states, “I don’t understand why anyone pays any attention to accounting earnings numbers, given that a ‘clean’ number like cash from operations is readily available.” Do you agree? Why or why not?
I disagree with the finance student, because net income forecasts future cash flow and is informative.
a. Net income forecasts future cash flow better than current cash flow, and does so by recording transactions associated with cash consequences when the transactions occur, rather than when the cash is received or paid. To compute net income, the effects of economic transactions are recorded on the basis of expected, not necessarily actual, cash receipts and payments.
b. Net income is informative when corporate managers have better information than outside investors. Corporate managers use accrual rather than cash accounting to prepare financial reporting and determine net income. Since accrual accounting helps managers to record past events and forecast future events, net income gives superior information.
2. Fred argues: “The standards that I like most are the ones that eliminate all management discretion in reporting - that way I get uniform numbers across all companies and don’t have to worry about doing accounting analysis”. Do you agree? Why or why not?
I disagree with Fred, because the elimination of delegation of reporting to management will create chaos and misinterpretation of financial statements. Corporate managers know how to apply and judge business transactions using the accrual accounting framework. They have inside information and make appropriate judgments to convey that information to investors and forecast future performance. If this discretion is eliminated, managers will be unable to make use of inside information in reported financial statements.
However, since investors view profits as a measure of a manager’s performance, some managers have an incentive to use their accounting