How to Read a Financial Report: Wringing Vital Signs Out of the Numbers

Chapter 20. ACCOUNTING METHODS AND MASSAGING THE NUMBERS

Chapter Preamble

The accounting methods used to record the activities of a business and to prepare its financial statements should conform to authoritative financial accounting standards. The shareowners and creditors who read the financial reports of a business are entitled to assume that its financial statements comply with established accounting standards, and that there are no serious violations of these standards. The primary purpose of audits of financial reports by an independent certified public accountant (CPA) is to ensure that proper accounting methods have been used by the business. (Chapter 21 discusses audits of financial reports.)

As you may have gathered from the chapter's title, the numbers reported in its financial statements depend on which accounting methods the business uses and whether the numbers have been massaged, or manipulated by its managers. For that matter, the financial statements may be fraudulent and provide bogus numbers for sales revenue and expenses. Or a business may discover later that financial statements it has issued have serious errors. In this latter situation, the business issues a restatement of its original financial statements in order to set the record straight, which I discuss at the end of the chapter.

Financial statements have the appearance of accuracy and finality, don't they? In financial statements you see a lot of numbers that are well organized and lined up in neat columns. ...