Solution Manual for Financial Reporting and Analysis, 6th Edition

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CHAPTER 1THE ECONOMIC AND INSTITUTIONAL SETTINGFOR FINANCIAL REPORTINGCHAPTER OVERVIEWFinancial statements contain information about a company, its economic health, and its products thathelp users in their decision making, and make it possible to monitor managers’ activities. Therein liesthe demand for financial statements. Specifically, equity investors, analysts, and brokers use financialstatements to form opinions about the value of a company as a basis for their investment decisions orrecommendations to others. Creditors use financial information to assess the company’s ability to makeits debt payments and comply with loan covenants. Auditors use financial statements to help designmore effective audits by identifying areas of potential reporting abuses. Other users that demandfinancial informationinclude managers, employees, suppliers, customers, and government and regulatoryagencies. Flexibility and consistency are both desired when preparing financial statements. The changingeconomic environment demands the revision of standards and best practices that will best serve these twodiverse results.Investors, creditors, and other interested parties demand financial statements because the informationis useful. What governs the supply of financial information? Two answers are mandatory reporting andthe advantages ofvoluntary disclosure. Most companies in the U.S. and other developed countries arerequired to produce, distribute, and file financial reports with a governmental agency—the Securities andExchange Commission (SEC) in the U.S.—so that interested parties can view the statements. Voluntaryfinancial information that goes beyond the minimum requirements can benefit the company, its managers,and its owners.Voluntary disclosurebenefits and costs are likely to affect accounting policies andreportingstrategies. Therefore, the flexibility and discretion inherent in financial reporting standardsprovidemanagers with opportunities to shape financial statements to achieve specific reporting goals.Users of this information that understand financial reporting, managers’ incentives, and accountingflexibility are better informed and more likely to be able to use financial statements to their advantage inthe decision-making process.The accountant’s and analyst’s job is more challenging when financial reporting measurement anddisclosure rules differ across countries. Those rules may underscore the reporting culture that may haveevolved to reflect firms’ underlying economic performance. The FASB and IASB are working together toconverge U.S. GAAP and IFRS.CHAPTER OUTLINEI.WORLDCOM’S CURIOUS ACCOUNTINGAThere are several “facts” to consider (stepping back in time to May 2002).1.The market price of WorldCom is $2.00 per share and declining.a.Stock analysts state that WorldCom is doing “surprisingly well despite tough timesthroughout the industry.”b.The company has $2.3 billion in cash, which translates into $20.50 book valueper share.2.The first-quarter results indicate sales of $8,120 million and $240 million in pre-taxoperating profits–a decline of 16% in sales and 40% in profits while other firms in theindustry are reporting even steeper sales and earnings decreases.3.The company has $104 billion in assets and $44 billion in debt.4.WorldCom’s “line costs” are holding steady at about 42% of sales while othercompanies are experiencing rising line costsas a percentage of sales.a.Does this suggest that WorldCom is adept at managing its excess capacity

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