Rounded Dollar Valuation.

Computations are made easier by rounding off all amounts in the statements to the nearest $1,000 ($100 for a small company). While procedural in nature, this step is important in that it calls attention to the generalized nature of many of the results of data developed by analysis, for analysis involves reducing a mass of information to a generalized figure. The greater the extent of this gen­eralization the greater the danger of using one figure, such as a rate of return on total assets, to evaluate a company and its activities. How­ever, since it is generalized information, it also represents useful information. Its usefulness, according to communication theory, derives from the human inability to comprehend in a significant manner a de­tailed mass of data. By reducing the mass to simple measures, by ex­pressing dollar amounts in thousands of dollars, or by developing one measure which summarizes the significance of a number of separate measures, effectivecommunication of accounting information is im­proved. The communication process is improved in that the generalized information provides a means for the message receiver—the reader of the accounting report—to understand in meaningful terms the data transmitted.

Reclassification of Amounts. If analyzed data are to be compared, a uniform classification system should be used for all amounts compared. For example, if depreciation has been computed on the assump­tion of an average 20-year life, this policy should be followed consis­tently; and if the current year's depreciation has been computed on a 10-year instead of the 20-year life, the excess depreciation should be reclassified as part of the asset, for purposes of comparison.

In developing a uniform classification system, all offsets—where liabil­ities are reduced by assets so that only the net liability is reported, or vice versa—should be removed and all assets and liabilities re­vealed., In the same way, all reductions in liabilities and assets which have occurred should be recorded. Thus, treasury stock should not be treated as an asset but as a reduction in the stockholders' equity, because it is a reduction in an equity and not an asset. Also, bond discount should be deducted from the liability.

In many instances, information will not be available to allow a satis­factory reclassification or even to knowwhether reclassification is appro­priate. If the statements have been certified by a certified public ac­countant as a fair presentation of the accounting facts, it is appropriate to assume that for a particular company no material inconsistencies exist in the classification of amounts from period to period.

Classification for Different Purposes. For particular analyses, different classifications of amounts may be appropriate. That is, since the purpose of analysis is to reveal information, and since information enables a de­cision maker to correct past actions or improve future decisions, only by analyzing reports in terms of different managerial objectives can the maximum amount of accounting information be transmitted. It follows, then, that analyses to develop information useful for different purposes will require different aggregations of the basic data. For example, the ratio of variable expenses to sales normally must be preceded by a re-classification of expenses into the categories of variable and fixed items, and this involves regroupings and rearrangements of the basic data.

Appropriate Ratios, Comparisons, Trends, and Relationships. The selec­tion of the statistical measures, ratios, comparisons, trends, and relation­ships to be computed in analyzing statements and supporting data depends upon the specific purpose of the analysis. It isimpossible to list all of the comparisons which may be made. Different situations and different purposes may require any number of different analyses. In general, the analyst should determine in detail the purpose for which the information is to be used before selecting the types of ratios and comparisons to be made.

Analysis for credit and investment purposes:

Typical analyses used in determining whether to loan or invest money in a company include:

1. Balance-sheet ratios.

2. Income-statement ratios.

3. Cross statement ratios.

4. Percentage statements.

5. Comparative statements.

Summary

The analysis of accounting reports is undertaken to achieve an under­standing of a company and its activities. It is an involved process and the detailed study of this topic falls in the area of advanced accounting where statistical and mathematical methods and external, as well as in­ternal, data are used. But this introduction to the subject provides a basic understanding of the process. It is based on theassumption that masses of data are often best understood when reduced to one significant figure. Consequently, a number of financial ratios may be used to reveal information in accounting reports. However, effective •analysis of ac­counting reports can seldom be reduced to a process of computing 8 or 10 ratios. The more informative analyses depend upon the use that is to be made of the information. Broadly, accounting report analysis may develop information for either management or investors.

Effective analysis requires that the data available be unambiguously defined. Non-comparable data should be adjusted. If broad interpreta­tions are to be made, data may be rounded off and reclassified to disclose only the significant information needed.

Selected ratios, comparisons, trends, and relationships which may be developed to reveal information to investors are:

1. Balance-sheet ratios:

Current ratio

Acid-test ratio

Shareholders'-equity ratio

Book value per share of stock

2. Income-statement ratios:

Operating ratio

Number of times fixed charges earned

Net income to sales ratio

3. Cross-statement ratios:

Inventory turnover

Number of days' sales in receivables

Return on investment

4. Percentage statements

5. Comparative statements over time

For management purposes, analyses are usually more precise. Three conventional techniques used for these purposes are:

1. Analysis of rate of return on investment

2. Volume sensitivity analysis

3. Analysis of changes in income over time

Date: 2016-01-14; view: 710