Environment and Theoretical

Structure of Financial
Accounting
Zach Zhiguang Wang

Agenda

Information Produced by Public Companies

Three Roles of Accounting

Example: General Electric

General Accepted Accounting Principles

Auditors
Accounting Process

Information Produced by Public

Companies

Annual report to shareholders

SEC Form 10-K

SEC Form 10-Q

IPO Prospectus

Who are the users of

accounting information?

Investors and potential investors

Creditors
Other external users

General Electric

Chief Executive Officer

Number of Shares Outstanding

Jeff Immelt

10,057,380,000 shares (Year-end 2014)

Total borrowing (Loans and Bonds)

364,980 millions (Year-end 2014)

Existing Investors vs. Jeff Immelt

What do they want Jeff to do?

Maximize shareholder value

What might Jeff want to do?

Maximize his own benefit

Hide bad information from shareholders

The Stewardship Role of Accounting

Make Jeff report accounting information

Jeffs compensation tied to stock price and
accounting information

Potential Investors vs. Jeff Immelt

What do potential investors want to do?

Know the true value of GEs stock

What might Jeff want to do?

Maximize his own benefit

Future cash flows GE expects to generate

The riskiness of these cash flows

Hide bad information from shareholders

The Valuation Role of Accounting

Make Jeff report accounting information

Creditors vs. Jeff Immelt

What do creditors want Jeff to do?

Make safe investments and pay them back

What might Jeff want to do?

Maximize his own benefits

Make risky investments to build a larger company

Pay shareholders dividends (He owns $100M of GE)

The Debt Contracting Role of Accounting

Restrictions based on accounting numbers

Limit Jeffs ability to issue dividend (10% of earnings

and make investments (50% of cash flows)

Three Roles of Accounting

The Stewardship Role of Accounting

The Valuation Role of Accounting

The Debt Contracting Role of Accounting

GAAP (Generally Accepted

Accounting Principles)

What are the advantages of using GAAP

accounting?

Understandable to everyone
Comparability across time and between
companies
Independently audited

Auditors

Why are auditors important?

Companies who self-report have incentives

to puff, which reduces perceived reliability
Auditors give users confidence that the
accounting information meets GAAP

Auditor Report (GE 2014 10-k 124)

The consolidated financial statements present

fairly, in all material respects, the financial
position of General Electric in conformity
with U.S. generally accepted accounting
principles.

Accounting Process

Capture the economic implications of

transactions and events

Recognition

Measurement

Admit information to financial statements

The process of associating numerical amounts with
the elements of financial statements

Disclosure

The process of including additional pertinent

information in the financial statements and notes