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Terms in this set (21)
What are consensus estimates?
A figure based on the combined estimates of the analysts covering a public company - often made for a quarter, fiscal year, and next fiscal year
What is accounting analysis?
An evaluation of the degree to which a firm's accounting captures the underlying economic reality
What happens if a company exceeds its consensus estimate?
Rewarded with an increase in stock price
What happens when a company falls short of a consensus estimate?
Share price will take a hit
What incentives might motivate management to adopt aggressive accounting policies or estimates, or to commit accounting fraud?
- External pressures (competitors, consensus estimates)
- Internal pressures (compensation, past performance, smooth earnings)
How might management rationalize the decision to use aggressive accounting or to commit accounting fraud?
- "just this one time"
- won't get compensation, or may get fired otherwise
What are the three elements of the fraud triangle?
*These three factors need to be present at the same time in order for accounting fraud to be considered fraud
Without resorting to fraud, what are some of the ways that management can improve earnings to meet analyst expectations while still being in compliance with GAAP?
1. Cookie Jars - When over-estimated expenses, holding some of these expenses in a cookie jar, and then using them on a "rainy day" when profits are super high. Allows the company to smooth out their earnings.
2. One time events - No historical data - tempting to overstate expenses
3. Planning on big purchases to occur during periods where income is high
*often the goal is to smooth out earnings
What is financial analysis?
Assessment of a firm's performance in the context of:
1. its strategy
2. the economic environment
3. what its competitors are doing
How can you perform financial analysis?
- Cash Flow analysis
What are the elements of a cash flow analysis?
1. assess firm's liquidity position
2. assess firm's ability to generate cash flows from operations
3. how closely correlated are reported net income and cash flows from operations?
What are the five main elements of accounting analysis?
1. Identification of key accounting policies and estimates
2. Evaluation of management's accounting flexibility
3. Evaluation of quality of disclosure
4. Areas of concern (red flags, and flexibility)
5. Analysis of restatement of accounting numbers
Red Flags - Slide 1
- unusual audit report
- long-term trend of consistently and precisely meeting analysis expectations
- changes in accounting policies, estimates, or application of existing policies
- lots of related party transactions
- numerous commitments and contingencies
(P&E, AR, REC)
Red Flags - Slide 2
- Bonuses and stock option plans tied to financial statement measures
- large 4th quarter adjustments
- over-emphasis on non-GAAP metrics
Red Flags - Slide 3
Assets + Partnership
1. Unusual increase in intangible assets or creating of a new or unusual asset account
2. Use of financing mechanisms like R&D, and special purpose entities
Red Flags - Slide 4
1. Growth in trade payables that are out of line with past experience or longer than normal credit terms
2. large increase in ST or LT borrowings
3. Build up of cookie jar reserves
Red Flags - Slide 5
1. Slowdown of inventory turnover rates or unusual increase relative to sales
2. Revenues and profit growing at different rates or moving in opposite directions
3. cogs not disclosed
4. reduction of managed costs relative to sales (ads, r&d)
Red Flags - Slide 6
1. Acquisitions with no purpose
2. R&D writeoffs on acquisition
3. One-time sources of income/one-time writeoffs (gain on sale of investments or capital assets, frequent use of restructuring charges)
4. frequent use of "other" to describe material elements of financial statements
5. increasing gap between accounting and tax profits
AROO - G
Red Flags - Slide 7
1. cash flow from operations not growing at the same rate as net income
2. negative or volatile cash flow from operations
3. positive cash flow from investing activities
Common Areas of Accounting Abuse
1. Revenue Recognition (falsification or revenues and incorrect timing)
2. capitalization versus expensing
3. depreciation expense
4. off-balance sheet financing (leasing, spe's)
5. business combinations and goodwill (valuation of assets purchased, impairment testing of goodwill)
6. contingent liabilities
7. stock options
8. pro-forma reporting (non-gaap measures)
Formula for Inventory Turnover
Sales / Inventory - the higher the better
THIS SET IS OFTEN IN FOLDERS WITH...
Chapter 12 -Accounting for NFPOs
Chapter 8 & 9 - Special Topics in Accounting
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