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Chapter 4

Management and Organizational Studies 3360A/B Chapter Notes - Chapter 4: Statement Of Changes In Equity, Cash Flow Statement, Retained Earnings

Management and Organizational Studies
Course Code
MOS 3360A/B
Stacey Hann

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Chapter 4: Reporting Financial Performance
The income statement tells a story about a company’s performance within a specific
period of time
Business Models and Industries
Basic business model activities:
o Financing: obtaining cash funding, often by borrowing, issuing shares, or
retaining profits, and the repayment of debt and/or repurchase of shares
o Investing: using the funding to buy assets and invest in people, and divestitures
o Operating: using the assets to earn profits
With these activities comes various degrees of risk
Risk management involves identifying risk, deciding if and how to manage risks, and
monitoring risks
o E.g. educating employees, buying insurance, and installing safety equipment
Risk/return trade off states the most risk the more return you require
The same goes for opportunities, companies must decide which opportunities they want
to take and which ones they will forgo
Terminology of financial statements
Statement of financial position
Balance Sheet
Statement of comprehensive income
Statement of income
Statement of changes in equity
Statement of retained earnings
** Both refer to statement of cash flows and notes to the financial statements
Communicating Information about Performance
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o Evaluate the enterprises past performance and profitability
o Provide a basis for predicating future performance
o Help assess the risk of not achieving future net cash inflows
The income statement has the following limitations:
o Items that cannot be measured reliably are not reported in the income statement
E.g. contingent gains
o Income numbers are affected by the accounting methods that are used
E.g. choosing which type of depreciation method you will use
o Income measurement involves the use of estimates
The estimates won’t always be correct
o Financial reporting bias
Dependant on type of company (over-stating/under-stating)
Quality of Earnings/Information
Not all information is created equal
o Some is high quality and some poor quality
o E.g. information that is complete and unbiased is better than incomplete
information and biased
Accrual accounting requires estimates
o The income statement includes a mix of hard numbers (which are easily
measured with a reasonable level of certainty) and soft numbers (which are more
difficult to measure)
Quality of earnings refers to how solid the earnings numbers are
o If the quality is assessed as low, then the numbers are discounted
o If the quality is assessed as high, then the numbers are accepted as is
When analyzing the quality of earnings, two aspects are generally considered:
(a) Content, which includes:
The integrity of information, including whether it is unbiased and reflects
the underlying business fundamentals
The sustainability of the earnings
(b) Presentation
Means the earnings are presented in a clear, concise manner that makes
the information easy to use and understandable
Earnings management the process of targeting certain earnings levels or desired
earnings trends and then working backwards to determine what has to be done to ensure
that these targets are met
o Often used to increase income in the current year by reducing income in future
o But can also be used to decrease current earnings in order to increase future
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