Recognize the people involved in the accounting communication process (regulators, managers, directors, auditors, information intermediaries, and users), their roles in the process, and the guidance they receive from legal and professional standards.
Management of the reporting company must decide on the appropriate format (categories) and level of detail to present in its financial reports. Independent audits increase the credibility of the information. Directors monitor managers' compliance with reporting standards and hire the auditor. Financial statement announcements from public companies usually are first transmitted to users through electronic information services. The SEC staff reviews public financial reports for compliance with legal and professional standards, investigates irregularities, and punishes violators. Analysts play a major role in making financial statement and other information available to average investors through their stock recommendations and earnings forecasts.
Identify the steps in the accounting communication process, including the issuance of press releases, annual reports, quarterly reports, and SEC filings as well as the role of electronic information services in this process.
Earnings are first made public in press releases. Companies follow these announcements with annual and quarterly reports containing statements, notes, and additional information. Public companies must file additional reports with the SEC, including the 10-K, 10-Q, and 8-K, which contain more details about the company. Electronic information services are the key source of dissemination of this information to sophisticated users.
Recognize and apply the different financial statement and disclosure formats used by companies in practice.
Most statements are classified and include subtotals that are relevant to analysis. On the balance sheet, the most important distinctions are between current and noncurrent assets and liabilities. On the income and cash flow statements, the distinction between operating and nonoperating items are most important. The notes to the statements provide descriptions of the accounting rules applied, add more information about items disclosed on the statements, and present information about economic events not included in the statements.
Analyze a company's performance based on return on equity and its components.
ROE measures how well management used the stockholders' investment during the period. Its three determinants, net profit margin, asset turnover, and financial leverage, indicate why ROE differs from prior levels or the ROEs of competitors. They also suggest strategies to improve ROE in future periods.
In Chapter 6, we will begin our in-depth discussion of individual items presented in financial statements. We will start with two of the most liquid assets, cash and accounts receivable, and transactions that involve revenues and certain selling expenses. Accuracy in revenue recognition and the related recognition of cost of goods sold (discussed in Chapter 7) are the most important determinants of the accuracy—and, thus, the usefulness—of financial statements. We will also introduce concepts related to the management and control of cash and receivables, a critical business function. A detailed understanding of these topics is crucial to future managers, accountants, and financial analysts.
