Financial Accounting: In an Economic Context

CHAPTER 1

Financial Accounting and Its Economic Context

KEY POINTS

The following key points are emphasized in this chapter:

• The economic role of financial accounting statements.
• The four financial statements and the information each provides.
• The standard audit report, management letter, and footnotes to the financial statements.
• The two forms of investment—debt and equity—and how the information on the financial statements relates to them.
• The nature and importance of corporate governance and the role of financial statements.
• The current status of accounting standard setting—both in the U.S. and internationally.

Like schoolchildren who have practiced fire drills dozens of times, investors know exactly what to do when news leaks out that a company's financial records may not be in order. First, sell the stock; then, look around to see who else might get sucked up into the budding scandal, and drop them like a “hot potato.” Investors followed their “fire drill” to the letter when they learned that the financial records of New Century, one of the nation's leading lenders of high-risk loans, were misstated. Its stock price plummeted; it was forced to declare bankrupty; and one of the worst credit crises in U.S. history was underway.

The situation described above is all too common. Billions of dollars are lost each year by investors who base their investment decisions on misleading reported numbers. This text, beginning with this first chapter, explains how that could happen. It ...