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Chapter 6. Investigation: Verifying the ... > Healthy Suspicions: How Much Trust C...

Healthy Suspicions: How Much Trust Can You Place in the Report?

The fact that there remain conflicts of interest cannot be ignored; the accounting industry will only reform itself when reform is imposed by corporate leaders. However, that does not necessarily mean that the audited statement cannot be trusted. Some changes imposed through Sarbanes-Oxley and by revised listing standards on the part of the NYSE have helped to remove the conflict between management and audit work; even though conflicts remain a problem for the accounting industry, audited financial statements continue to be dependable, at least as a starting point in fundamental analysis. Even so, serious investors also need to recognize that as long as accounting firms continue providing audit and nonaudit work for the same clients, their work has to be viewed as less than objective. Consequently, the level of trust cannot be the same as it was prior to the large-scale corporate scandals.

Fortunately, we can use trends to test the reliability of financial statements. It is very difficult to hide manipulation or to change accounting assumptions without distorting established trends. The problem for most investors is one of how much analytical work to perform. In other words, if we begin with the premise that the audited financial statement is essentially accurate and correct, we can then apply fundamental tests to arrive at comparative value judgments. However, we already know that we need to investigate core earnings, because those adjustments can be substantial. In order to analyze two or more corporations, or two or more periods for a single corporation, we need to first make core earnings adjustments.


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