ACCT1511 Lecture Notes - Lecture 10: Financial Statement, Contingent Liability, Historical Cost
5.2 – Financial Statement Analysis & Accounting Policy
Choice
Limitations of Ratio Analysis:
• Lack of disclosure by companies
• Accounting policy choice
Estimates (e.g. depreciation & revenue recognition)
Assets traditionally valued at historical cost (is fair value a better choice?)
• Off alane sheet’ financing
Operating leases, guarantees, contingent liabilities
Classification issues (e.g. hybrid securities – equity vs liability)
Accounting policy – choice made in advance about:
• What accounting methods will be used
• What information will be disclosed in financial statements
• How accounting estimates will be determined
• What events or transactions will be recognized
Examples of Accounting Method Choice (in Australia):
• Inventory (weighted average or FIFO)
• Depreciation methods (straight-line, reducing-balance, units-of-production)
• R&D (capitalization, expensing)
Examples of Accounting Estimates:
• Allowance for doubtful debts
• Useful lives of plant & equipment to calculate depreciation
• Useful lives of intangible assets subject to amortization
• Provision for warranty liability
• Provision for employee entitlements
Accounting Recognition Decisions:
• Write-down of inventory obsolescence
• Capitalization of cost of asset betterments
• Recognition of intangible assets (brand names, trademarks)
• Recognition of liabilities for contingencies that are probable & measured reliably
• Recognition of revenue on partially completed sales (e.g. under long-term contracts)
Accounting choices made by managers may be conservative (pessimistic) or aggressive
(optimistic)
Why do choices exist?
• To cater for diverse companies (e.g. construction)
• Accounting policy choices must be within:
Accounting standards (GAAP/AASB/IFRS)
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Document Summary
5. 2 financial statement analysis & accounting policy. Limitations of ratio analysis: lack of disclosure by companies, accounting policy choice. Assets traditionally valued at historical cost (is fair value a better choice?) (cid:858)off (cid:271)alan(cid:272)e sheet" financing. Classification issues (e. g. hybrid securities equity vs liability) Accounting policy choice made in advance about: what accounting methods will be used, what information will be disclosed in financial statements, how accounting estimates will be determined, what events or transactions will be recognized. Examples of accounting method choice (in australia): depreciation methods (straight-line, reducing-balance, units-of-production, r&d (capitalization, expensing) Examples of accounting estimates: allowance for doubtful debts, useful lives of plant & equipment to calculate depreciation, useful lives of intangible assets subject to amortization, provision for warranty liability, provision for employee entitlements. Accounting choices made by managers may be conservative (pessimistic) or aggressive (optimistic) Why do choices exist: to cater for diverse companies (e. g. construction, accounting policy choices must be within:
