FINANCIAL ACCOUNTING IN AN

Financial Accoun�ng in an Economic Context 9e Jamie Prat (Solu�ons Manual All Chapters, 100% Original Verified, A+ Grade) Part: 1 : Page 1-573 Part: 2 : Page 574-722 1 / 4

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CHAPTER 1

FINANCIAL ACCOUNTING IN AN

ECONOMIC CONTEXT

ISSUES FOR DISCUSSION

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Security analysts and stockholders: These users would use financial statements to try to estimate the future earnings and cash flow potential of the company, which would be used to project a value for the company’s stock.Bank loan officers: These users would use the financial statements to determine the ability of a company to repay loans to the bank.A company’s customers and suppliers: These users would use financial statements to determine whether to extend credit to the company (suppliers) or whether to rely upon the company to be a supplier (customers). Both suppliers and customers would also use the financial statements to monitor the company’s profit margins.Public utilities: This group would use the financial statements to determine the company’s growth rate and how that might impact upon the company’s utility needs. Also, they would evaluate the company’s ability to pay its bills.Labor unions: These groups would use the financial statements to monitor the profitability of the company to help determine the amount of pay raises and benefits that it will negotiate for from the company.A company’s managers: The company’s managers will use the financial statements to assess the overall financial health of the company. This could impact the managers in a number of ways: raises, promotion opportunities, performance of other departments, etc.

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The board of directors serves various functions for a company. One is to represent and protect the interests of the stockholders who are not on the board. Another is to provide oversight and input to management. The managers are involved in running the business on a day to day basis whereas the board is more focused on the bigger, long term picture. A weak board may not ask probing questions of management but instead may take everything at face value and believe anything that management says to them. A healthy management team would want a strong board that delivers valuable input. A management team that wants a weak board of directors may be trying to hide something (management fraud).Auditors are concerned with management fraud because, if there is a problem, in many cases the auditors will be sued by the stockholders on the basis that the auditors should have detected the fraud.

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The function of the audit committee is to provide a channel whereby the auditors report their findings and concerns, if any, to the board of directors. Typically there are outside members of the board that are on the audit committee so that if the auditors have concerns about management’s financial statements or activities, then the auditors have a way to speak directly to the board of directors.

The auditors are in a sensitive position because the financial statements and activities that they are auditing are prepared by the same people who hire and pay the auditors. Therefore, they may be reluctant to jeopardize their relationship with the company by being too negative.

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Banks make loans to customers and depend on those customers to repay the loans (called the “principal”) plus interest for the banks to earn a profit. If customers are not able to pay the interest, the banks cannot make a profit; further, if the customers are not able to repay the principal the banks will show a loss that reduces the equity on the balance sheet. Banks look at a number of factors, both “macro” and “micro” in nature. Banks will look at the overall strength of the economy and the likelihood for future growth; these are the macro issues a bank considers. Banks will also examine the specifics of a company’s individual performance within the economy; these micro issues often are seen in the financial statements of companies. Issues such as the amount of debt, the level of profits, the amount of cash on hand and the amount of cash generated by the business, and the quality and size of the assets can all be seen from the financial reporting system. Banks require borrowers to submit financial statements to show these performance measures. During the 2008-2009 recession and related credit crunch, banks were concerned about the macro issues shown in general economic data, as well as the micro issues shown in companies’ individual financial reports. The reluctance of banks to lend has been cited as one of the reasons for the length of the economic downturn.

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Sales for Home Depot increased during the time period because of the slow rebound of the economy after the worst of the “Great Recession”. As conditions improved, home owners and to a lesser extent home builders purchased more materials from Home Depot to improve and construct houses. Profits increased because the bump in sales was not offset with an equal increase in expenses, probably due to some economies of scale experienced by the large hardware retailer. Assets increased as the company boosted inventory in stores to meet the higher sales, as well as the company increasing its total number of stores. Equity remained flat because the company rewarded its owners by paying out dividends equal to its profits. Finally, the cash balance slightly increased due to the fact that the improved operations (from the stronger economy) generated more cash than what was needed to invest in new stores and pay out to the providers of capital.

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Creditors would impose these types of restrictions on United Continental so that the creditors would be protected for their loans. These types of restrictions are fairly common and act as a trip wire to warn the creditors that business may not be going well. The cash restriction would force United Continental to have enough cash to pay the interest on the debt and the minimum cash flow coverage assures that the airline’s operations are functioning well enough to generate sufficient cash flow to meet obligations..

These restrictions act as trip wires in that as soon as a restriction is violated the creditors can call the debt and force the company to pay back the loans. What is more typical is for the loans to be 3 / 4

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restructured. This usually means higher interest rates and fees to do the restructuring. These all put the creditors in a better position to protect their loans.

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Companies would usually engage in this type of behavior to try to improve their stock price. By showing higher revenues or lower expenses investors are more likely to reward the company with a higher stock price. Companies that have negative cash flow are under a lot of pressure to maintain a high stock price since selling stock is the only way to fund the business. This type of incentive can lead to questionable behavior.

The ethical implications are significant because if investors lose faith in the financial statements that are reported this would severely impact the stock market. A strong driver to a robust economy is access to capital (stock markets). If this source is reduced because investors don’t believe the numbers that are reported, a very bad impact on the overall economy would result.

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This is the normal statement that an auditor would make about a company whose books it had audited and found no significant problems. This would be part of what is called a “non-qualified opinion”. If there was a particular item that the auditors did not agree with they would issue a “qualified opinion” – they would agree with everything except the qualified item that would be identified.

“In our opinion”, shows that the statement represents the auditor’s opinion and not a fact; “fairly, in all material respects” means that the auditors can not say that every single number is exactly accurate to the penny but that the numbers are generally accurate. This reflects the concept of materiality; the auditors believe that all material items have been presented accurately. Finally, “in conformity with accounting principles generally accepted in the United States of America” means that the financial statements have been compiled in a way that meets all of the accounting principles that are called GAAP in the U.S but not necessarily in conformance with international standards.

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Corporate governance describes the relationship among the stakeholders of a company, mainly : the shareholders, the Board of Directors, management and the company’s auditors. Corporate governance mechanisms encourage management and the Board of Directors to act in the best interest of the shareholders and to provide the shareholders with accurate and timely financial information. The Sarbanes-Oxley Act was passed to upgrade the financial transparency of corporate operations, requiring increased financial disclosures and management responsibilities for the intergrity of the financial statements. Improved information provided to shareholders and other providers of capital

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