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The accounting practice attempts to summarize the transactions of multinational corporations In a few pages of text and figures. This article examines the extent to which such accounting can reflect economic reality and considers the relevant extraneous Issues of reviewing a company's financial statements.
Accounting analysis is the process of evaluating the extent to which a company's accounting reflects economic reality. Every day, financial statements are reviewed by directors, shareholders, analysts, employees, and governments. The quality of the decisions made by these stakeholders is dependent on both the quality of financial information available to them and their understanding of the limitations of financial statements. Stakeholders need to be more aware of the accounting choices companies make and how these choices impact companies' financial information. The purpose of this article is to provide a framework for an accounting "checkup" that may be used by stakeholders to access this important aspect of a company's governance. We highlight both the general limitations of financial statements and some specific issues that provide warning signs of overly flexible accounting.
Regulators all over the world have become more aggressive towards misleading accounting in the wake of many accounting scandals. This means that directors must be more vigilant in ensuring they don't mislead investors. It also means that investors are becoming more aware of the limitations of accounting. This article draws from the experiences of companies that have been investigated by regulators to illustrate the dangers of taking financial statements at face value.
Accounting analysis and the quality of financial information
Arthur Levitt, former chairman of the securities and Exchange Commission (sec), stressed the importance of high-quality information in a speech given in 1999: "Quality information is the lifeblood of strong, vibrant markets. Without it, investor confidence erodes. Liquidity dries up. Fair and efficient markets simply cease to exist."1
Traditionally, financial statements have been a very important source of information. Mr. Levitt went on to voice concerns over their quality. He observed "a gradual, but perceptible, erosion in the quality of financial reporting. The motivation to satisfy Wall Street earnings expectations was beginning to override long established precepts of financial reporting and ethical restraint. A culture of gamesmanship over the numbers was not only emerging, but weaving itself into the...