Financial statements remain the primary source of information for most investors and analysts. There are differences, however, in how accounting and financial analysis approach answering a number of key questions about the firm. We examine these differences in this chapter.

The first question that we examined related to the nature and the value of the assets owned by a firm. Categorizing assets into investments already made (assets in place) and investments yet to be made (growth assets), we argued that accounting statements provide a substantial amount of historical information about the former and very little about the latter. The focus on the original price of assets in place (book value) in accounting statements can lead to significant differences between the stated value of these assets and their market value. With growth assets, accounting rules result in low or no values for assets generated by internal research.

The second issue that we examined was the measurement of profitability. The two principles that seem to govern how profits are measured are accrual accounting - revenues and expenses are shown in the period where transactions occur rather than when the cash is received or paid - and the categorization of expenses into operating, financing and capital expenses. Operating and financing expenses are shown in income statements. Capital expenditures take the form of depreciation and amortization and are spread over several time periods. Accounting standards miscategorize operating leases and research and development expenses as operating expenses (when the former should be categorized as financing expenses and the latter as capital expenses).

In the last part of the chapter, we examine how financial statements deal with short-term liquidity risk and long-term default risk. While the emphasis in accounting statements is on examining the risk that firms may be unable to make payments that they have committed to make, there is very little focus on risk to equity investors.

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