qualities of info.ppt

Copyright 2003 Prentice Hall Publishing

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Qualities of Accounting InformationQualities of Accounting Information


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Objectives of Financial ReportingObjectives of Financial Reporting Financial reporting must provide information

that is useful to investors & creditors & other users in making rational investment, credit, and similar decisions.

The information must be comprehensible to those who have a reasonable understanding of business and economic activities & are willing to study the information with reasonable diligence


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Nature Of Accounting NumbersNature Of Accounting Numbers Accounting Numbers= Economic Substance (based on judgments &

estimates) leads to+ “Measurement Error”+ (due to management intervention) leads to

“Bias”


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Securities and Exchange Commission has the legal authority to set the accounting rules for companies that are publicly traded.

The SEC has delegated that responsibility to the accounting profession.

Currently, the Financial Accounting Standards Board is the standards-setting body.

Who Sets the Rules?Who Sets the Rules?


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GAAP (not a clothes store)GAAP (not a clothes store) Generally Accepted Accounting

Principles (GAAP) are the rules that most companies follow in preparing their financial reports.

GAAP are not exact rules: professional judgment is needed.

Statements of Financial Accounting Concepts provide the basis and guidance for establishing accounting standards.


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Role of Internal AuditorRole of Internal Auditor

Assessing the efficiency, effectiveness & economy of management performance

Making constructive suggestions to continuously improve performance

Monitoring the quality, integrity, and reliability of the financial reporting process


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Role of External AuditorRole of External Auditor

Management is primarily responsible for the fair presentation of financial statements in conformity with GAAP,

The external auditor’s report attests to the fairness of management presentations and/or assertions.


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The Auditor’s ReportThe Auditor’s Report

“We have audited the accompanying balance sheet of XYZ as of December 31, 2004 & the related income and cash flow statements….. These financial statements are the responsibility of the company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.


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The Auditor’s Report (cont’d)The Auditor’s Report (cont’d)

“We concluded our audits in accordance with GAAP. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement due to error or fraud. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.


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The Auditor’s Report (cont’d)The Auditor’s Report (cont’d) “An audit also includes examining, on a test

basis, evidence supporting the amounts and disclosures in the financial statements. AN audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.

“In our opinion, the financial statements present fairly, in all material respects….in conformity with GAAP.”


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Certification Obligations for Certification Obligations for CEOs and CFOsCEOs and CFOs Criminal certifications

Corporate officers who knowingly violate the certification requirements are subject to fines of up to $1 million and up to 10 years imprisonment or both

Corporate officers who willfully violate the certification requirements are subject to fines of up to $5 million and up to 20 years imprisonment, or both


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Certification Obligations for CEOs Certification Obligations for CEOs and CFOs and CFOs – Civil Certifications– Civil Certifications They have personally reviewed the report Based on their knowledge, the report does

not contain any material misstatement that would render the financials misleading

Based on their knowledge, the financial information in the report fairly presents in all material respects the financial conditions, results of operations, and cash flow of the company


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Certification Obligations for CEOs Certification Obligations for CEOs and CFOs and CFOs – Civil Certifications– Civil Certifications Responsible for designing, maintaining, and

evaluating the company’s internal controls, they have evaluated the controls within 90 days prior to the report, and they have presented their conclusions about the effectiveness of those controls in the report

Disclosed to the auditors and the audit committee any material weaknesses in the controls and any fraud, whether material or not, that involves management or other employees who have a significant role in the company’s internal controls


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Certification Obligations for CEOs Certification Obligations for CEOs and CFOs and CFOs – Civil Certifications – Civil Certifications

Indicated in their report whether there have been significant changes in the company’s internal controls since the filing of the last report


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Statements of Financial Statements of Financial Accounting ConceptsAccounting Concepts

Objectives of accounting information

Qualitative characteristics of accounting information

Elements of financial statements

Recognition and measurement in financial statements

GAAPGAAP


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Objectives Objectives QualitiesQualities The financial information is viewed to be relevant if

it makes a difference to decisions by decision makers to and helps users to assess past performance, predict future performance, confirm or correct expectations provide feedback on earlier expectations

» specific to a business entity,

» timely,

» simplified and condensed,

» focus on earnings,

» all within a cost-benefit framework.


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Objectives Objectives Qualities Qualities

Timeliness : means providing financial information to decision makers when they need such information & before the information loses its capacity & capability to influence decisions.

Online, real-time electronic financial reports are tools to improve the timeliness of financial information


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Objectives Objectives Qualities Qualities Financial information is reliable when

investors & creditors consider the information to reflect economic conditions or events that it claims to represent. Reliability, which includes the notions of verifiability, neutrality, and representational faithfulness, is a measure of the integrity and objectivity of financial reports

Reliability provides assurance for users that the information is accurate & useful


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Objectives Objectives Qualities Qualities Verifiability : is the extent to which different

individuals using the same measurement material arrive at the same amount or conclusion.

Example, Cash is considered a verifiable financial item because different individuals can count the reported cash and reach the same conclusion about the ending balance of cash.


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Objectives Objectives Qualities Qualities An amount or a disclosure is considered to

be material if it influences or makes a difference to a decision maker.

Materiality affects the quality, integrity, and reliability of financial statements because management uses its judgment to decide what may be material to users of financial statements.


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Objectives Objectives Qualities Qualities High-quality financial information must be

transparent in the sense it provides the complete reporting and disclosure of transactions, which portray the financial conditions & operational results of the firm.

Transparency enables financial statements users to obtain the right information and ensure that financial information is factual & objective


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Objectives Objectives Qualities Qualities Representational faithfulness means the

degree of correspondence between the reported accounting numbers and the resources or events those numbers claim to represent.

Means the extent to which the audited financial statements reflect the economic reality & economic resources & obligations of the company.


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To provide useful information for decision-making. Comparable: (consistent)

»from year to year for one company,

»across companies for a single year, »to industry averages,»estimates.


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Matching Concept Dual Aspect Accrual Concept Accounting Period Concept Historical Cost Recognition (realization) Concept


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Additional Concepts/ConstraintsAdditional Concepts/Constraints

Cost/benefit Business Entity Monetary Going Concern Full disclosure Conservatism


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The Expectation GapThe Expectation Gap Between the needs of the users & the

priorities of financial statement preparers. Investors & creditors do not receive the

information they need to make prudent economic decisions due to (1) deficiencies in the auditing & reporting standards(2) lack of motivation to fully comply with these standards and (3) lack of financial literacy and training.


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Users of Financial StatementsUsers of Financial Statements

TransactionActivity

TransactionActivity

DecisionsDecisions

InformationUsers

InformationUsers

FinancialStatementsFinancial

StatementsAccounting

SystemAccounting

System

BankersInvestorsVendorsGovernmentManagement

BankersInvestorsVendorsGovernmentManagement

Loan ApprovalFinancial InvestmentCredit ApprovalOperational & Financial Decisions

Loan ApprovalFinancial InvestmentCredit ApprovalOperational & Financial Decisions

Balance SheetIncome StatementStatement of Owner EquityStatement of Cash Flows

Balance SheetIncome StatementStatement of Owner EquityStatement of Cash Flows


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Perceived Problems of Current Perceived Problems of Current Financial Reporting-Financial Reporting-

Publicly traded companies are pressured to report earnings that meet analysts’ forecasts & expectations rather than focusing their efforts on continuously improving both quality & quantity of earnings, primarily because (1) missing the earnings expectations can cost a significant amount of SR. in the market capitalization, and (2) the top management team receives substantial bonuses based on earnings and stock prices


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Declining Quality of Corporate Earnings Publicly traded companies must focus on the

integrity, quality, and effectiveness of the interim financial reporting process, because of the ineffectiveness of processes & internal controls surrounding the preparation of such reports.


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Perceived Problems of Current Perceived Problems of Current Financial Reporting-Financial Reporting-Deficiencies in Reporting Certain Types

of Information. Published financial statements do not

properly explain the implications of extraordinary, unusual, nonrecurring charges or disclose off-balance sheet assets or liabilities


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Reporting Systems that Obfuscate Ratherthan Enlighten. Current reporting models do not properly

measure and recognize the value of intangible assets such as strategic goals, employees training & turnover, R&D expenditures, new product development, brand value, product quality market share, customer satisfaction & retention, intellectual capital, etc…


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Unsuitable Reporting Models The global economy has transformed from an

industry-based economy to a knowledge economy, and with the internet-based technology, to a digital economy.

Current financial models are more appropriate for a manufacturing economy than a knowledge or digital economy, primarily because they are based on historical cost.


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Omission of Intangible Constructs The current financial reporting problem is

based on the historical cost that ignores intangible & non-financial measures

Thus, accounting systems that are primarily based on tangible constructs are inadequate & ineffective in measuring, recognizing, & disclosing all business economic events that create shareholders value


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Perceived Problems of Current Perceived Problems of Current Financial Reporting- Financial Reporting-

Predomination of Backward-LookingInformation Corporations have traditionally prepared &

disseminated historical financial statements to investors & creditors for their prospective economic decisions.

A new financial reporting system must focus on presenting futuristic, relevant information on a continuous basis rather than historical information on a periodic basis


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Excessive & Improper Use of FinancialDerivatives Derivatives have been used for a variety of

purposes including risk management, financial schemes, and speculative activities.

The nature of risks associated with derivatives & how corporations use them are not well understood by many users of financial statements. (e.g. Enron)


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Perceived Problems of Current Perceived Problems of Current Financial Reporting-Financial Reporting-The Human Factor The simple fact is that an internal focus

on value alone cannot boost a company’s share price in and of itself — the details of how decisions are made and why certain activities are receiving emphasis need to be explained to investors.


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Financial Statements do not outline the

firm’s growth strategy, industry’s dynamics

current & anticipated regulations, and

competition. Today, companies are under intense

pressure to focus on creating and preserving shareholder value.


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Perceived Problems of Current Perceived Problems of Current Financial Reporting- Financial Reporting- Shareholder value emphasizes cash flows, both

current and projected, to assess a company’s future performance. The current reporting model, with its rigorous and often complex disclosure requirements, fails to capture the information needed to reasonably judge how a company is spending its cash and what implications that deployment of cash has for future potential.

In today’s world, the value of an idea can represent the entire potential of an organization, yet the idea will in no way be reflected on a balance sheet


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Absence of Reporting “Value-Creation” Information For almost any company, the ultimate achievement

barometer is to be first to discover — and capitalize on — an idea whose time has come. Innovation and creativity are critically important to all companies as new ideas produce new products and services, which are key to remaining competitive and to fueling value growth.


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Absence of Reporting “Value-Creation”Information For companies seeking to maximize long-

term value growth, a recognizable brand can be the key to standing out in a crowd. This will be especially important in the future, when consumers will be faced with an even greater sea of choices due to technological advances.


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Perceived Problems of Current Perceived Problems of Current Financial Reporting- Financial Reporting- Absence of Reporting “Value-Creation”

Information Creating value for shareholders begins

with creating value for customers. Satisfied customers are more likely to be loyal and this offers a critical edge for both expanding existing relationships and establishing new ones.


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Absence of Reporting “Value-Creation”

Information From product development to distribution,

from controls to customer service, the integration of all aspects of a company’s

supply chain is critical to maximizing efficiency and, hence, long-term value creation.


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Absence of Reporting “Value-Creation” Information Companies cannot achieve their goals without the

right people in the right positions at every level. At a time when the workforce is more mobile than ever, recruiting and retaining the best people is perhaps the biggest challenge facing all companies. To assure continuity and hold down the high costs of replacing and training new workers, companies must make investing in their "people equity" a priority.


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profits could be ‘earned’ not just by selling more or producing for less, but also by engaging in a variety of non-productive activities:

exploiting accounting conventions, engaging in financial entrepreneurship, and reducing discretionary expenditures such as :

R&D, promotion, distribution, quality improvement, applications engineering, human resources, and customer relations – all of which, of course, are vital to a company’s long-term performance. The immediate effect of such

reductions is to boost reported profitability, but at the expense of sacrificing the company’s long-term competitive position.


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Relevant InformationRelevant Information Market share Capital expenditures Market growth Regulatory environment Earnings Cash flow by business segment Competitive landscape Revenue by product type Quality of management


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Relevant InformationRelevant Information Customer churn rate Pricing strategy Growth strategy Significant operating costs by category Sales and marketing strategy Number of customers by type Cost per gross additional customer Strategic alliances Research & development activities Breadth of product offerings Brand equity

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