Some financial statement users maintain that despite its intrinsic intellectual appeal, uniformity in accounting seems unworkable in a complex modern society that relies, at least in part, on economic market forces.
Required:
a. Discuss at least three disadvantages of national or international accounting uniformity.
b. Explain whether uniformity in accounting necessarily implies comparability.
(CFA Adapted)
EXERCISE 2–1 Uniformity in Accounting
EXERCISE 2–3 Timeliness of Financial Statements
Some financial statement users criticize the timeliness of annual financial statements.
Required:
a. Explain why summary information in the income statement is not new information when the annual report is issued.
b. Describe the types of information in the income statement that are new information to financial statement users when the annual report is issued.
EXERCISE 2–4 Reliability of Quarterly Reports
The SEC requires companies to submit statutory financial reports on both a quarterly and an annual basis. The quarterly report is called the 10-Q.
Required:
What are two factors about quarterly financial reports that can be misleading if the analyst does not consider them when performing analysis of quarterly reports?
EXERCISE 2–6 Mechanisms to Monitor Financial Reporting
Managers are responsible for ensuring fair and accurate financial reporting. Managers also have inside information that can aid their estimates of future outcomes. Yet managers face incentives to strategically report information in their best interests.
Required:
Assume a manager of a publicly traded company is intending to recognize revenues in an inappropriate and fraudulent manner. Explain the penalty(ies) that can be imposed on a manager by the monitoring and enforcement mechanisms in place to restrict such activity.
EXERCISE 2–5 Information in SEC Reports
The SEC requires various statutory reports from companies with publicly traded securities.
Required:
Identify which SEC report is the best place to find the following information.
a. Management’s discussion of the financial results for the fiscal year.
b. Terms of the CEO’s compensation and the total compensation paid to the CEO in the prior fiscal year.
c. Who is on the board of directors and are they from within or outside of the company?
d. How much are the directors paid for their services?
e. Results of operations and financial position of the company at the end of the second quarter.
f. Why a firm changed its auditors.
g. Details for the upcoming initial public offering of stock.
EXERCISE 2–2 Announcements of good news or bad news earnings for the recently completed fiscal quarter usu- ally create fairly small abnormal stock price changes on the day of the announcement.
Required:
a. Discuss how stock price changes over the preceding days or weeks help explain this phenomenon.
b. Discuss the types of information that the market might have received in advance of the earnings announcement.
c. How does the relatively small price reaction at the time of the earnings announcement relate to the price changes that are observed in the days or weeks prior to the announcement?
Earnings
Announcements and Market Reactions
Incentives for Voluntary Disclosure There are various motivations for managers to make voluntary disclosures. Identify whether you
believe managers are likely to release the following information in the form of voluntary dis- closure (examine each case independently):
a. A company plans to sell an underperforming division for a substantial loss in the second quarter of next year.
b. A company is experiencing disappointing sales and, as a result, expects to report disappointing earnings at the end of this quarter.
c. A company plans to report especially strong earnings this quarter.
d. Management believes the consensus forecast of analysts is slightly higher than managers’ forecasts.
e. Management strongly believes the company is undervalued at its current stock price.
EXERCISE 2–7
Analyst Forecasts versus Financial Statements Analysts produce forecasts of accounting earnings along with other forward-looking information.
This information has strengths and weaknesses versus financial statement information.
Required:
a. Discuss whether you believe analysts’ forecasts are more relevant for business decision making than financial statement information.
b. Discuss whether you believe analysts’ forecasts are more reliable than financial statement information.
EXERCISE 2–11 Accrual Accounting versus Cash Flows a. Identify at least two reasons why an accrual accounting income statement is more useful for analyzing business
performance than a cash flow based income statement.
b. Describe what would be reported on the asset side of a cash flow based balance sheet versus the asset side of an accrual accounting balance sheet.
c. A strength of accrual accounting is its relevance for decision making. The strength of cash flow information is its reliability. Explain what makes accrual accounting more relevant and cash flows more reliable.
EXERCISE 2–10 Historical Cost versus Fair Value
Financial statements are inexorably moving to a model where all assets and liabilities will be mea- sured on the basis of fair value rather than historical cost.
Required:
a. Discuss the conceptual differences between historical cost and fair value.
b. Discuss the merits and demerits of the two alternative measurement models.
c. What types of assets (or liabilities) more readily lend themselves to fair value measurements? Can we visualize a scenario where all assets are measured using fair value?
d. What are the likely effects of adopting the fair value model on reported income?
EXERCISE 2–9 Financial Statement Information versus Analysts’ Forecasts Financial statements are a major source of information about a company. Forecasts, reports, and
recommendations from analysts are popular alternative sources of information.
Required:
a. Discuss the strengths of financial statement information for business decision makers.
b. Discuss the strengths of analyst forecast information for business decision makers.
c. Discuss how the two information sources in (a) and (b) are interrelated.
EXERCISE 2–8