Discuss the following.

What is financial information?

What financial information should be provided to users of financial

statements?

Why is financial information important to users?

Who establishes the rules for how financial information is presented? In

the U.S.? In the rest of the world?

Is U.S. GAAP rules based or principles based? What is the

dierence? How was that dierence reflected in what happened at
Enron?

How flexible is U.S. GAAP in allowing accounting managers choices on

how to record accounting transactions? Is this good or bad? For
example, being able to choose LIFO vs FIFO inventories.

Financial Information is the organized and raw financial numbers, words, and other financial
data organized and presented in a way as to be useful in decision-making. Just as the
professor stated that information is data used in making decisions, financial
information is the organized and processed data which is used in making decisions.
Quality of financial information is one of the crucial assumptions in financial decision
making leading to improvement of businesses and the economy. Financial information
of the businesses is primarily conveyed to users through financial statements. Hence, it
is responsibility of Generally Accepted Accounting Principles (GAAP) to ensure that
these financial statements fulfill certain qualitative characteristics. There are
fundamental qualitative characteristics (relevance and faithful representation), and
enhancing qualitative characteristics (comparability, timeliness, verifiability and
understandability). Relevance is important because it means that financial information is
capable of making a dierence in decision. While faithful representation implies that
numbers and descriptions are factual. The role of comparability is accomplished when
companies are able to compare their financial statements with consistency. The
financial information contained in financial statements should be verifiable so that if
independent auditors or analysts observe them using the same methods, they could
obtain similar results. Moreover, for the financial information to be relevant, it must be
available to those in decision making positions in a timely manner- that is, before it
loses its capacity to influence decisions. Finally, understandability implies that
information presented in a clear and concise way so that is available for interpretation
and comprehension of reasonably informed users.

Users need credible and materially relevant financial information. Users who need to measure
financial position of a company should be provided with Balance Sheet, so that the user
can know the resources of a firm (its assets) and the claims on those resources
(liabilities and shareholders equity) as of a specific date. Give examples of users who
need could need this information.

Users who need to measure operating performance of a company should be provided with it
Income Statement so that the users can assess the profitability of a firm for a period of
time. Give examples of users who need could need this information. Users who need to
know information about cash inflows and outflows for a specific period should be
provided with statement of cash flows. Similarly, users who need to know changes in
owners equity for a specific period should be provided with Statement of Owners
Equity. Give examples who need this information.

The financial information is important to users because it helps them make decisions, and
accordingly, depending upon the type of decision they are required to make, they need

dierent financial statements. We can broadly categorize these users into External and
Internal Users. Internal users include department managers, finance directors,
production supervisors, and company ocers. For example, financial statements may
be important to board of directors to assess whether the managers performance
deserve a bonus due to companys profitability. The financial information is important
to the employees when they want to assess the companys pension plans, the union
contracts to negotiate wage increase in presence of profitable companys financial
figures. External users such as creditors which includes suppliers and banks use
financial statements to measure and evaluate the risk of extending credit to the
company. For example, the creditors of United Airlines would like to know what is
happening to a companys most liquid resource. Accordingly, they would look at the
statement of cash flows. Existing and potential creditors would like to know whether the
company can pay its bill as they come due. They would also like to know whether the
company has sucient working capital to be able to pay short-term bills. Another party
which closely examines financial statements are suppliers which extend credit to their
clients to build business relationships. They would like to know whether they can
extend credit sales to a particular client based on its ability to pay for goods shipped.
External users such investors and potential shareholders would like to compare
companies and decide which shares to buy, hold or sell. For example, Investors
interested in shares of General Electric may look at income statement and assess
whether the earning are satisfactory or not. Similarly, potential investors struck in
between choice of which shares to buy may decide based on size, profitability, their
preferences for risk, returns, dividend yield, and liquidity. Equity traders carry out
fundamental analysis on the financial statements to identify misplaced securities in
order to make a profit.

Although In US, SEC has has ultimate legal authority to determine and set
accounting principles, it has delegated this responsibility to FASB, a private-sector
organization, which establishes the new accounting rules. FASB is an independent
group with 7 full-time member and a large sta. While IASB establishes the accounting
rules for the rest of the world. it formulates new accounting standards and work
towards promoting there acceptance world-wide, and work across dierent countries to
achieve greater convergence of financial reporting standards, procedure, and
regulations. it consist of member representations from various businesses and
accounting organizations around the world.

US GAAP is a rule-based set of accounting standards. Accounting scandals such as

Enrons, have ignited the debate over the pros and cons of a more detailed,
rules-based US GAAP, and a more general principles-based IFRS. Compared to
US GAAP, IFRS allows more latitude to companies, oering dierent accounting
treatments for similar business transactions - thus reflecting the natural diversity
the IASBs membership. On the other hand, US GAAP is more narrowly defined
set of accounting standards that oer more detailed and implementation
guidance such that similar business truncations tend to result in consistent
accounting treatment. However, managers and executives at Enron have
exploited the use of narrowly defined US GAAP to use the ambiguities to satisfy
the letter of the standards while at the same time overstep the spirit of the
standards. Enron create o-balance sheet special purpose vehicles, and would
then help it borrow money by co-signing its loans.

Using that borrowed cash, Enron would then enter into arrangements to sell commodities
to itself by buying from these special purpose self-created entities. Enron was
recording this as cash inflow instead of recording it as loan (a financing inflow).
Thus the operating inflows were inflated and financing cash flow was impaired.

Hence the investor were cheated of billions of dollars. The US GAAP did not
allow Special Purpose Entities consolidation. Enron then used SPE consolidated
financial statements to conceal it real business condition.