Course summary
15.511 Corporate Accounting
Summer 2004
Professor SP Kothari
Sloan School of Management
Massachusetts Institute of Technology
July 12, 2004
1
Course summary
Accounting – Mapping of actions and events into
financial statements
(Economic) Principles governing the accounting
mapping: Objectivity, conservatism, revenue
recognition, and matching
But the mapping is incomplete and asymmetric
(for good reasons, of course)
Hence, firms supplement financial information with
disclosures in
MD&A section
Footnotes
Management forecasts
Q&A at conference calls
2
Where do we go from each
topic from the course?
Financial statements and basic bookkeeping
Bookkeeping: Necessary evil!
Ability to interpret financial statement
information is essential for decision
making
Balance sheet
What are the assets and liabilities when buying
another firm?
Tangible, intangible, on- and off-balance sheet
What is the investment being made in a project,
department, firm, or a target? What appears on
paper is just a starting point.
3
Where do we go from each
topic from the course?
Financial statements and basic bookkeeping
Income statement
Assessing operating performance
Is it sustainable? Is it believable? Is the revenue
recognized optimistically? Conservatively?
Cash flow statement
Is the wedge between income and operating
cash flow worrisome?
Projections: What are the cash needs going
forward? For working capital and for fixed asset
investments? Where will the financing come from?
In an M&A context, valuation is on the basis of
cash flows
4
Where do we go from each
topic from the course?
Revenue recognition
Revenues is the engine that drives a firm
Revenue growth signals where the firm is
headed, so everyone focuses on it
Incentive to inflate it
Single biggest source of fraud and manipulation
High bang for the buck: Every dollar of invented revenue
increases pre-tax income by a dollar
Enhances revenue growth and all of the
operating efficiency ratios
Revenue recognition practices vary with industry,
so get to know the business
5
Where do we go from each
topic from the course?
Inventories
Lower of cost of market
Determinant of COGS
Combined with revenues, profitability depends on
COGS
Incentive to overstate inventory
Overstatement increases income and improves
the balance sheet
Reversal in the following period: Payback time!
6
Where do we go from each
topic from the course?
Depreciation
Accounting is quite mechanical!
No cash flow effect of changing accounting
Why do we care?
Depreciation cost is crucial from the standpoint of
making investment decisions
An important component of total cost, so serves as
one of the inputs into pricing and other decisions
7
Where do we go from each
topic from the course?
Liabilities
Fixed obligations
Increases the risk of residual claimholders,
shareholders
Present value calculations are needed to
determine long-term liabilities
On- and off-balance sheet liabilities
Pension liabilities
Enron, Freddie Mac and other spectacular
cases where off-balance sheet liabilities from
derivative positions have caused havoc
8
Where do we go
from here?
Course focused almost entirely on
analyzing a given set of actions and events
More interesting to think about
How to create opportunities? How to choose
from among alternative opportunities and
action choices?
How to finance the alternative action choices?
Market them? Operationalize them? Organize
them? Incentivize employees to take desirable
actions? …………
Obviously, too interesting to be a part of this course!
