Changes in accounting techniques that decrease reported profits will necessarily decrease the value of a firm.

Question

Quizplus · Accepted Answer

Changing the appearance of cash flows without actually changing the cash flows (say, by changing accounting techniques) doesn’t change the value of a company. For example, in the 1990s, FASB proposed a change to the accounting rules requiring companies to record an expense for the value of options when issued. It was claimed by many that the entire venture capital industry would be decimated because young start-up companies provide much of their compensation through options and thus would then show low or negative profits. Despite dire predictions, the stock prices of companies didn’t change when the new accounting rules were implemented, because the market had already reflected the cost of the options in its valuations of these companies.

Changes in Accounting Techniques That Decrease Reported Profits Will Necessarily