Reliance on Accounting Numbers
Earnings Management Pre-Sarbanes Oxley Scandals Backdating of Options Madoff
1
TW 5
Reliance on Accounting Numbers
Critically analyse reliance on financial information
What we will do this week
Understand the concept of “quality” accounting information Develop the skills to know when and how to adjust current earnings for i f income not expected to persist t t dt i t Understand issues the financial analyst faces when dealing with retroactively restated financial statements Understand how to deal with differences in accounting principles across countries
Lecture 5 - Reliance on Accounting Numbers
2
Sources of Accounting Distortions Accounting Standards – attributed to (1) political process of standardsetting, (2) accounting principles and assumptions, and (3) conservatism Estimation Errors – attributed to estimation errors inherent in accrual accounting Reliability R li bilit vs R l Relevance – attributed t over-emphasis on reliability at tt ib t d to h i li bilit t the loss of relevance Earnings Management – attributed to window-dressing of financial statements by managers to achieve personal benefits
Sources of Analysis Objectives y j
Comparatives Analysis – demand for financial comparisons across companies and/or across p time Income Measurement -- demand for (1) equity wealth changes and (2) measure of earning power. These h d f i Th correspond to two alternative income concepts: (1) Economic Income (or empirically, economic profit) (2) Permanent Income (or empirically, sustainable profit)
Chapter 6 discusses these measures in detail
Earnings Management – Frequent Source of Distortion
Three common strategies: Increasing Income – managers adjust accruals to increase reported income Big Bath – managers record huge write offs write-offs in one period to relieve other periods of expenses p Income Smoothing– managers decrease or increase reported income p to reduce its volatility
Earnings Management – Motivations
1
TW 5
Reliance on Accounting Numbers
Critically analyse reliance on financial information
What we will do this week
Understand the concept of “quality” accounting information Develop the skills to know when and how to adjust current earnings for i f income not expected to persist t t dt i t Understand issues the financial analyst faces when dealing with retroactively restated financial statements Understand how to deal with differences in accounting principles across countries
Lecture 5 - Reliance on Accounting Numbers
2
Sources of Accounting Distortions Accounting Standards – attributed to (1) political process of standardsetting, (2) accounting principles and assumptions, and (3) conservatism Estimation Errors – attributed to estimation errors inherent in accrual accounting Reliability R li bilit vs R l Relevance – attributed t over-emphasis on reliability at tt ib t d to h i li bilit t the loss of relevance Earnings Management – attributed to window-dressing of financial statements by managers to achieve personal benefits
Sources of Analysis Objectives y j
Comparatives Analysis – demand for financial comparisons across companies and/or across p time Income Measurement -- demand for (1) equity wealth changes and (2) measure of earning power. These h d f i Th correspond to two alternative income concepts: (1) Economic Income (or empirically, economic profit) (2) Permanent Income (or empirically, sustainable profit)
Chapter 6 discusses these measures in detail
Earnings Management – Frequent Source of Distortion
Three common strategies: Increasing Income – managers adjust accruals to increase reported income Big Bath – managers record huge write offs write-offs in one period to relieve other periods of expenses p Income Smoothing– managers decrease or increase reported income p to reduce its volatility
Earnings Management – Motivations