External users require high-quality financial information to enable them to assess the likelihood of
making a reasonable return with an acceptable level of risk. It is important that the quality of the
financial statements provide useful and reliable information to assess the prospects of future cash
flows or future earnings.
The users want the information to accurately represent what has happened during the past period.
Distorting the real situation is not a faithful representation of the actual situation. The result is the
external users are not able to make appropriate decisions as to whether to increase, decrease or
maintain their level of participation with the reporting entity in their capacity as investor, creditor,
supplier and/or customer.
References
Short Answer Difficulty: Easy Learning Objective: 01-04 Analyze and
interpret financial statements to assess
the impact of different accounting
methods on key financial statements
ratios.
21.
Award: 10.00 points
Explain ways that management can mispresent the financial situation of a company.
Management can represent the financial situation of a company by
• using an accounting method that does not match the actual situation,
• managing earnings by increasing profits by recognizing revenue earlier than usual or delaying the
recognition of an expense to a later period,
• not following GAAP for certain transactions or
• reporting fictious transactions.
Note: Students may be able to provide other methods not listed above.
References
Short Answer Difficulty: Medium Learning Objective: 01-04 Analyze and
interpret financial statements to assess
the impact of different accounting
methods on key financial statements
ratios.
22.
Award: 10.00 points
Provide the procedures used to analyze a company's financial statements to determine its future
prospects.
Procedures to analyze a company's financial statements:
Perform common-size analysis and interpret the results.
Review the accounting policies and estimates used by the company to ensure that they are
appropriate.
Adjust the financial statements, as necessary, to use appropriate accounting policies and estimates.
Calculate the ratios for one or more periods.
Compare the ratios to relevant benchmarks.
Interpret the results of the analysis to determine whether they are better, worse or the same as the
benchmark.
Decide whether to increase, decrease or maintain the level of participation with the reporting entity.
References
Short Answer Difficulty: Easy Learning Objective: 01-04 Analyze and
interpret financial statements to assess
the impact of different accounting
methods on key financial statements
ratios.