Question

Please write 6 steps (in order) in performing accounting analysis.

Answer 1

The six steps in performing accounting analysis are as follows-

1. Identify principal accounting policies- It is an imperative step in order to measure critical business factors and key risks that affect a business. For example, key success factors in manufacturing industry are product innovation and R&D. Accouting analysis is performed to evaluate the extent to which a firm's accounting captures the underling reality.

2. Assess Accounting Flexibility- The managers are given littlie flexibility in choosing accounting policies and estimates. Accounting analysis will have to be performed from a viewpoint as to how the flexibility resulted in information content.

3. Evaluate accounting strategy- When managers take accounting flexibility, they can use it to the advantage of hiding the information or portraying a clear picture. Accounting strategy can be evaluated by comparing the policies/strategy with another company in same industry. Other things to be noted includes, do management have incentives to fabricate, history of accounting adjustments etc.

4. Evaluate Quality of disclosure- Auditor needs to evaluate if there is adequate disclosure, Is there an appropriate explanation of accounting policies and assumptions, how forthcoming is the management about bad news, does the comoany explain its current performance, etc.

5. Analysis of red flags- Red flags are basically unusual/problematic pointing to questionable accounting. Some example which auditor should take into consideration includes- qualified audit reports, unexpected large asset write-offs, unexplained transaction that inflate profit, Unexplained accounting changes in case of poor performance, unusual increase in inventories when compared to sales and any other alarming instances.

6. Undo any accounting distortions- In order to fix the accounting distortions, there will be a need to restate the reported numbers. It can be fixed by journal entry or altering ratios.