Lecture 3

Question 1

What is the importance of accounting analysis

Answer 1

• Accounting analysis practises govern the types of disclosure made in the financial statement
• Understanding accounting allows business analyst to effectively use financial information disclosed by companies

Question 2

Name sources of noise and biases

Answer 2

• financial reports are prepared using accrual accounting rather than cash accounting
• applying accounting principles is the responsibility of management who has superior knowledge of a firm’s business
• incentives exist for managers to distort accounting numbers in their favor

Question 3

Name 3 sources of noise and bias in accounting data

Answer 3

1. Noise from accounting rules
2. forecast errors
3. manager’s accounting choices

Question 4

Name the 6 steps in performing accounting analysis

Answer 4

Step 1: identify principal accounting policies
Step 2: assess accounting flexibility
Step 3: evaluate accounting strategy
Step 4: evaluate the quality of disclosure
Step 5: Identify potential red flags
Step 6: Undo accounting distortions

Question 5

Name three accounting analysis pitfalls

Answer 5

1. conservative accounting may also be misleading: historical cost, accounting for intangible assets
2. not all unusual accounting practises are questionable
3. common standards do NOT equal common practises