Financial Reporting Environment

In: Business and Management

Submitted By Elaine830
Words 340
Pages 2
Information presented in financial statements is of critical importance to external decision mak- ers. Financial statements affect the prices paid for equity securities and interest rates attached to debt securities. To the extent that financial performance and condition are accurately com- municated to business decision makers, debt and equity securities are more accurately priced. By extension, financial reporting plays a crucial role in efficient resource allocation within and across economies. Accounting information contributes to the efficient operation of securities markets, labor markets, commodity markets, and other markets. To illustrate, imagine the consequences of a breakdown in the integrity of financial report- ing. The Enron scandal provides a case in point. At the beginning of 2001, Enron was one of the most innovative and respected companies in the United States. With revenues of over $100 billion and total company value of over $60 billion, it was the fifth largest U.S. corporation based on market value. In October 200 I, the company released its third quarter earnings report to the public. Although operating earnings were higher than in previous years, the income state- ment contained a $1 billion "special charge." Financial analysts began investigating the cause of this charge and discovered that it was linked to related-party transactions and questionable accounting practices. Once it became clear to the capital markets that Enron had not faithfully and accurately reported its financial condition and performance, people became unwilling to purchase its securities. The value of its debt and equity securities dropped precipitously and the company was unable to obtain the cash needed for operating activities. By the end of 2001, Enron was bankrupt' The Enron case illustrates the importance of reliable financial reporting. Accountants recognize the…...

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