Answer to Question #17509 in Finance for Bushina

Question

For managerial purposes, i.e., making decisions regarding the firm's operations, the standard financial statements as prepared by accountants under Generally Accepted Accounting Principles (GAAP) are often modified and used to create alternative data and metrics that provide a somewhat different picture of a firm's operations. Related to these modifications, which of the following statements is CORRECT?

The standard statements make adjustments to reflect the effects of inflation on asset values, and these adjustments are normally carried into any adjustment that managers make to the standard statements.

The standard statements focus on accounting income for the entire corporation, not cash flows, and the two can be quite different during any given accounting period. However, for valuation purposes we need to discount cash flows, not accounting income. Moreover, since many firms have a number of separate divisions, and since division managers should be compensated on their divisions’ performance, not that of the entire firm, information that focuses on the divisions is needed. These factors have led to the development of information that is focused on cash flows and the operations of individual units.

The standard statements provide useful information on the firm’s individual operating units, but management needs more information on the firm’s overall operations than the standard statements provide.

The standard statements focus on cash flows, but managers are less concerned with cash flows than with accounting income as defined by GAAP.

The best feature of standard statements is that, if they are prepared under GAAP, the data are always consistent from firm to firm. Thus, under GAAP, there is no room for accountants to “adjust” the results to make earnings look better.