Wednesday, October 05, 2011

Accounting Qualities

CFA Level 1 - Financial Statements

1) Primary qualities of useful accounting information:

- Relevance
Accounting information is relevant if it is capable of making a difference in a decision.

Relevant information has:
(a) Predictive value
(b) Feedback value
(c) Timeliness

- Reliability - Accounting information is reliable to the extent that users can depend on it to represent the economic conditions or events that it purports to represent. 

Reliable information has:

(a) Verifiability
(b) Representational faithfulness
(c) Neutrality

2) Secondary qualities of useful accounting information:

Comparability - Accounting information that has been measured and reported in a similar manner for different enterprises is considered comparable.
- Accounting information is consistent when an entity applies the same accounting treatment to similar accountable events from period to period.

Accounting Qualities and Useful Information for Analysts
Here is how these qualities provide analysts with useful information:

Relevance- Relevant information is crucial in making the correct investment decision.

Reliability - If the information is not reliable, then no investor can rely on it to make an investment decision.

Comparability - Comparability is a pervasive problem in financial analysis even though there have been great strides made over the years to bridge the gap.

Consistency - Accounting changes hinder the comparison of operation results between periods as the accounting used to measure those results differ. 

The following key SEC filings must be reported:

• S-1: Filed prior to sale of new securities
• 10-K: Annual filing similar to annual report; 40-F for Canadians; 20-F for other foreign issuers
• 10-Q: Quarterly unaudited statements
• 8-k: Disclose material events such as asset acquisition and disposition, changes in management or corporate governance
• DEF-14: Proxy statement
• 144: Issue of unregistered securities
• Beneficial and insider ownership of securities by company's officers and directors

Look Out!

Students should note that relevance and reliability tend to be opposite qualities. For example, an auditor may improve the quality of the audit but at the cost of timeliness. Relevance and reliability can also clash strongly in these ways: the market value of an investment can be highly relevant but may be accurate only to a certain extent. On the other hand, the historical cost, while reliable, may have little relevance. 
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