Chapter 3 Accountign, Cash Flows

ACCOUNTING, CASH FLOWS, AND TAXES

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ISBN: 0-536-42875-1

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o matter how large and complex it is, a firm’s accounting system serves two basic purposes: • reporting the firm’s financial activities to its various stakeholders, and • providing information to assist the firm’s decision makers.

This chapter reviews material from basic accounting classes. We outline the basics of the accounting statements, without going into the details of how they are prepared. We describe important differences between accounting and economic information. Our focus in corporate financial management is on how to use and interpret this information, rather than on operating an accounting system and creating financial reports. Accounting statements are important, as actions by firms such as WorldCom, Enron, and Arthur Andersen, among others, have all too often demonstrated. Accounting statements are used to communicate with stakeholders outside the firm, such as stockholders, bondholders, and other creditors. They are used within the firm to help plan and organize its activities. Accounting statements are used to monitor employees in connection with such things as performance or even theft. And they are used by the Internal Revenue Service to determine the firm’s taxes. Finally, we review the federal income tax system. Because taxes affect value, they affect many of a firm’s decisions. At the most basic level, taxes are a significant cost of doing business. Throughout the book, we point out situations when taxes can affect decisions.

Corporate Financial Management, Third Edition, by Douglas R.Emery, John D.Finnerty, and John D.Stowe.Published by Prentice Hall.Copyright ©2007 by Pearson Education, Inc.

CHAPTER 3 ACCOUNTING, CASH FLOWS, AND TAXES

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FOCUS ON PRINCIPLES

• Two-Sided Transactions: Recognize that the accounting system always records two sides to every transaction, a debit and a credit, and there are real people or real firms on each side of the...