Consider the following: While accrual accounting information is imperfect, ignoring it and making cash flows the basis of all analysis and business decisions is like throwing the baby out with the bath water.
Required:
a. Do you agree or disagree with this statement? Explain.
b. How does accrual accounting provide superior information to cash flows?
c. What are the imperfections of accrual accounting? Is it possible for accrual accounting to depict economic reality? Explain.
d. What is the prudent approach to analysis using accrual accounting information?
The following is an excerpt from a quarterly earnings announcement by American Express:
American Express Reports Record Quarterly Net Income of $648 Million
|
QUARTER ENDED
SEPTEMBER 30
|
|
($ millions except per share amounts)
|
20X9
|
20X8
|
Percentage
Inc./(Dec.)
|
|
Net income
|
$648
|
$574
|
13.00%
|
|
Net revenues
|
$4,879
|
$4,342
|
12.40%
|
|
Per share net income (Basic)
|
$1.45
|
$1.27
|
14.20%
|
|
Average common shares outstanding
|
446
|
451.6
|
-1.20%
|
|
Return on average equity
|
25.30%
|
23.90%
|
|
|
NINE MONTHS ENDED
SEPTEMBER 30
|
|
($ millions except per share amounts)
|
20X9
|
20X8
|
Percentage
Inc./(Dec.)
|
|
Net income
|
$1,869
|
$1,611
|
16.00%
|
|
Net revenues
|
$14,211
|
$12,662
|
12.20%
|
|
Per share net income (Basic)
|
$4.18
|
$3.53
|
18.40%
|
|
Average common shares outstanding
|
447
|
456.2
|
-2.00%
|
|
Return on average equity
|
25.30%
|
23.90%
|
|
Due to a change in accounting rules, the company is required to capitalize software costs rather than expense them as they occur. For the third quarter of 20X9, this amounted to a pre-tax benefit of $68 million (net of amortization). Also, the securitization of credit card receivables produced a gain of $55 million ($36 million after tax) in the current quarter.
Required:
Evaluate and comment on both (a)the earnings quality and (b)the relative performance of American Express in the most recent quarter relative to the same quarter of the prior fiscal year.