Financial statements are based on generally accepted accounting principles (GAAP) and audited by CPA firm.?

Question

So do investors need to worry about the validity of those statements? Explain your answer.

Answer 1

You do need to worry about the validity of those statements.  They do follow GAAP, and are much more reliable since Enron, but there are some things that you need to know.

Firms do not need to put future obligations to pension funds on their balance sheets, yet they can claim funds in the pension fund as an asset.

Real estate is another area that is not reported accurately.  GAAP rules require that buildings be depreciated, when the reality is that the price is usually going up.  A company like Sears Holding (SHLD) has an immense amount of real estate that is probably worth more than their stock.

Liabilities can also be left off of balance sheets and put into the footnotes.

Answer 2

YES! if financial statements are false, then an investor is investing based on false information. This is illegal in the accounting practice.