Asked by Nacole Watkins on May 16, 2024
Verified
Briefly discuss how a firm's P/E ratio is related to the firm's choice of accounting methods.
P/E Ratio
The price-to-earnings ratio, a measure of a company's current share price relative to its per-share earnings.
Accounting Methods
Systems and rules used for measuring, tracking, and recording a company’s financial transactions, often influencing how income and expenses are reported.
- Comprehend how the choice of accounting methods can affect a firm's Price-to-Earnings (P/E) ratio.
Verified Answer
VT
Vibha ThaparMay 23, 2024
Final Answer :
Firms that use conservative accounting methods (i.e.,those that tend to recognize expenses sooner rather than later or recognize revenues later rather than sooner)will report lower earnings than would otherwise be the case.The lower earnings means that these firms will tend to have higher P/E ratios than might otherwise be the case.Conversely,firms that use aggressive accounting methods (i.e.,those that tend to recognize expenses later rather than sooner and revenues sooner rather than later)tend to report higher earnings than would otherwise be the case.The higher earnings means that these firms will tend to have lower P/E ratios than might otherwise be the case.An interesting issue is the extent to which investors in the market adjust for such accounting method differences when setting the market prices of otherwise similar firms.
Learning Objectives
- Comprehend how the choice of accounting methods can affect a firm's Price-to-Earnings (P/E) ratio.
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