1. Objectives and Approaches of Users

1(a). Investors' and creditors' objectives and approaches

Leading view

1. The fundamental objectives of investors, creditors, and their advisors (the users) differ depending on whether they are evaluating debt or equity securities. Major, recurring objectives of include:

* Investors form opinions about the absolute and relative value of companies and their equity securities

* Creditors assess the ability of a company to meet its obligations related to current or future debt or other financial instruments through timely payment of principal and interest or, as a last resort, through transfer of a collateralized asset.

2. The objective of external reporting is to provide information that is useful to present and potential investors and creditors in deciding whether or not to commit, or continue to commit, resources to a particular company.

3. The users are a diverse group, as illustrated in Exhibit 1(a)-1. Because of that diversity, users employ different approaches to accomplishing their objectives. The particular approach used depends on the (a) users' objectives, (b) instrument being evaluated, (c) company's industry and circumstances, and (d) users' personal preference.

4. Some of the approaches that investors use to assess a company's value include:

* apply a multiple to the company's current or projected earnings, core cash flows, or adjusted reported equity

* project the company's future cash flows and residual value and discount at a risk-adjusted cost of capital

* adding to or subtracting from the value of future core earnings or cash flows the estimated values of non-operating resources or obligations

* total the values of the company's major assets and subtract the value of the company's debt

* identify recent favorable or unfavorable developments the market price does not yet reflect

* identify probable short-term price changes through indicators involving financial measurements, such as the momentum in the company's earnings

* combinations of the above.

5. Some of the approaches that creditors use to assess a company's ability to meet its obligations include:

* compare the company's current or projected earnings to current or projected fixed charges

* compare the company's current or future cash flows to current or future debt service requirements

* assess the company's ability to raise cash from the sale of assets

* assess the company's ability to raise capital

* assess the company's ability to meet lending agreement covenants

* combinations of the above.

1(b). Types of information that investors and creditors use and the relative usefulness of that information

1. Users have diverse needs for information. The information that a user needs depends on the (a) user's approach to achieving his or her objectives, (b) instrument being evaluated, (c) company's industry and circumstances, and (d) user's personal preference. Exhibit 1(b)-1 discusses how those factors can impact the information that users need.

2. Despite the diversity of users' needs for information, many users, particularly those who predict a company's earnings or cash flows, when evaluating many securities and many companies in many situations, have common needs for company-specific information. The types of that information is identified and discussed in Section 13, "Nonfinancial Business Information". The relative usefulness of a particular piece of information depends on the factors listed in (1) above.

1(c). Investors' and creditors' use of information to achieve their objectives

Note: The following describes how investors and creditors use each of the major types of information listed in Section 13, "Nonfinancial Business Information". Not all investors and creditors use all of the information listed. Further, our descriptions of how investors and creditors use information is no doubt incomplete.

The segment's business, methods of conducting the business, and its relationship with others

(i) Users use information about the company's operating activities to understand the relationship between those activities and the company's financial results, which in turn helps users predict the financial impact of trends

(ii) Users also use information about the company's operating activities to identify opportunities and risks that could result from those activities and to spot companies that may be impacted by trends

(iii) Users use information about the company's resource providers, customers, competitors and potential competitors to identify opportunities and risks that could result from those parties and spot companies that may be impacted by trends

(iv) Users use information about major shareholder, director, and management interests, relationships, and incentives to identify conflicts of interests, and assess whether shareholders', directors', and management's interests are consistent with those of the user.

Financial statements and related notes

(i) Users use financial statements to understand the relationship between the company's financial results and its physical activities, which in turn helps users predict the financial impact of trends

(ii) Users use financial statements to determine the company's historical core earnings or cash flows as a basis for predicting future earnings or cash flows

(iii) Users also compare the company's financial statements over time to identify key trends that are impacting the company

(iv) Users also comparing the company's financial statements to those of other companies to identify the company's strengths and weaknesses, and identify the opportunities and risks that may result from those strengths and weaknesses

(v) Users also analyze the company's financial statements to assess the company's ability to pay its debts when due and to identify the types of assets that may be available to secure debt.

Key nonfinancial statistics

(i) Users analyze nonfinancial data to understand and quantify the company's activities. Users then relate those activities to the company's financial results, which helps users predict the financial impact of trends

(ii) Users also compare the company's nonfinancial data over time to identify key trends that are impacting the company

(iii) Users also compare the company's nonfinancial data to those of other companies to identify the company's strengths and weaknesses, and identify the opportunities and risks that may result from those strengths and weaknesses

(iv) Users also analyze nonfinancial data related to the company's assets to identify the assets that may be available to secure debt.

Explanations of relationships and changes among financial and nonfinancial statistics between periods

(i) Users use explanations of changes among financial and nonfinancial statistics to understand what happened that caused financial and operating data to change between periods, which in turn helps the user assess whether relationships, trends, and changes will continue in the future.

Identity and possible effect of key trends

(i) Users use information about the identity and possible effects of key trends to project nonfinancial and financial results.

Major goals, strategy, factors that are critical to successfully implementing the strategy, and major plans

(i) Users use information about mission to understand management's overall goals for the company, and to identify opportunities and risks from the company's potential activities

(ii) Users use information about the company's strategy to predict the company's future direction and to identify opportunities and risks

(iii) Users analyze factors that are critical to successfully implementing the company's strategy to assess the likelihood that the strategy will succeed and to identify opportunities and risks

(iv) Users use information about the company's major plans to predict the company's future direction and assess the opportunities and risks of its future activities.

Opportunities and risks

(i) Users use information about opportunities and risks to predict nonfinancial and financial performance and to assess the uncertainty of that performance. The uncertainty of that performance is a key component in the approach used by many investors and creditors.

Measures of leading indicators, such as backlog

(i) Users use leading indicators to predict operating and financial performance.

Projected financial and nonfinancial information (the types and periods are dependent on the users' objective and approach).

(i) Users use projected nonfinancial information to project financial information

(ii) Users use projected financial information as a key component in their approach to achieve their objective.

Exhibit 1(a)-1

Diversity of Investors, Creditors, and Their Advisors

The investors, creditors, and their advisors who use external reporting (the users) are a diverse group. Various dimensions capture that diversity. Examples of those dimensions include: (i) their employers and roles, (iii) their backgrounds, (iv) the type of instruments they are evaluating, (v) the types of entities they are evaluating, and (vi) their timeframes. The following examples within each of those dimensions illustrate the diversity within the user group:

Employers and Roles

Users are employed by diverse organizations, examples of which follow:

1. Broker-dealer firms - sell-side analysts; brokers; dealers

2. Investment banking firms - sell-side analysts; underwriters; investment bankers

3. Pension funds, mutual funds, and insurance companies - buy-side analysts, fund managers

4. Banks and finance and leasing companies- analysts; loan officers; loan committee members

5. Performance bonding companies - analysts; bonding officers, approval committee members

6. Rating agencies - analysts; rating committee members

7. Companies - credit analysts; credit committee members; strategic planners, purchasing agents.

And users serve various roles within those organizations, such as:

1. Analyze industries, companies, instruments and situations, and recommend actions to others (analysts and strategic planners)

2. Decide which securities to buy and sell (fund managers, investment bankers)

3. Generate business (brokers, underwriters, loan officers, bonding officers)

4. Decide whether to extend credit (loan committee members, approval committee members, credit committee members)

5. Rate the credit worthiness of a particular security (rating committee members)

6. Decide whether to do business with a vendor (purchasing agents).

Backgrounds

Users have diverse backgrounds reflecting the diverse nature of the skills required. Examples of those backgrounds include economists, operating management, financial management, strategic planners, consultants, analysts, public accountants. mathematicians and statisticians, and no formal experience.

Type of Investments

In recent years, there has been an explosion in the number and types of financial instruments with which users are associated. A few examples of the major classes of those instruments follow:

1. Debt

2. Equity

3. Options

4. Forward contracts

5. Swaps

6. Guarantees and commitments

7. Derivative instruments

8. Convertible instruments

9. Marketable and nonmarketable instruments

10. Short-term, medium-term, and long-term instruments

11. Secured and unsecured instruments.

Types of Entities Under Evaluation

Users evaluate securities from every type of entity in every circumstance. The following list illustrates the diversity of those entities and circumstances.

1. Entities in every industry (not-for-profit and governmental are outside the scope of the Committee's work)

2. Small and large

3. Public and private

4. Start-up and established

5. Successful and unsuccessful

6. Domestic, foreign, and international

7. Single segment and conglomerates

8. Corporations, partnerships, joint ventures

9. Regulated and nonregulated

10. Subsidiaries and parent companies.

Timeframes

Users have very diverse timeframes for their analysis of the future. The users' timeframe often depends on the instrument under evaluation, and the users' objective and approach. For example, some creditors assess whether a company can meet its obligations over only a few days or months, whereas others are concerned with many years. As another example, some investors assess a company's long-term potential, whereas others seek to determine whether the company's stock price will rise or fall over the next few months.

Exhibit 1(b)-1

Diversity of Users' Needs for Information

Users have diverse needs for information. The information that a user needs depends on the (a) user's approach to achieving his or her objectives, (b) instrument being evaluated, (c) company's industry and circumstances, and (d) user's personal preference. The following discusses how those factors can impact the information that users need.

Approach

The approach used by investors and creditors sometimes impact their needs for information.

For example, contrast the information needs of investors who follow the earnings momentum approach as a means of predicting short-term stock price changes with those of an investor following the fundamental approach as a means of determining the longer-term value of a company's stock. The first investor probably has extensive needs for information that helps predict near-term earnings. Yet, he probably needs little about the expected long-term impact of key trends. In contrast, investors following the fundamental approach are probably less preoccupied with predicting near- term earnings, but need far more information about the long- term impact of key trends.

As another example, consider investors who total the values of the company's major assets and subtract the value of the company's debt as a means of valuing companies. Those investors need information about the identity and values of individual assets and liabilities. In contrast, investors who value companies by applying a multiple to projected earnings may need relatively little information about those values.

Nature of Instrument

The nature of the financial instrument under analysis often impacts users' needs for information.

For example, contrast the information needs of a bank which is evaluating a potential loan to an excellent credit risk and a potential investor of that same company's stock. Under any scenario, the company's cash flows are more than sufficient to pay its debts when due. Under those conditions, the bank may require no more than recent audited financial statements, and may use those statements only to verify certain key financial ratios. Because of the large cushion of excess cash flows, the bank may not need financial projections. Further, the bank may need little information about risks if it judges those risks to be minimal in relation the excess cash flows. Finally, the bank may need no information about the company's opportunities. In contrast, the investor may need more extensive information. The investor may need sufficient information to project the company's earnings, and detailed information about both its risks and opportunities to judge the uncertainties of those earnings.

As another example, contrast the information needs of short- term and long-term creditors. For example, consider a creditor who may buy a company's 60 day commercial paper, and a second creditor who is considering a new issue of the same company's 10 year secured bonds. Although both creditors must assess the risk of the company not being able to pay its debts when due, the first creditor's needs for information is less than the second. The first creditor can probably make a decision based on a fairly brief review of recent financial statements, and some inquiry of the company's experience with issuing commercial paper in the past. In contrast, the second creditor needs to understand longer-term trends that may affect the company and assess what the impact of those trends may be. Unlike the first creditor, the second needs to evaluate the adequacy of the company's security interest.

The Company's Industry and Circumstances

The following examples illustrates how the company's industry and circumstances can impact the users' needs for information.

The company's circumstances can impact the extent to which investors need historical information about the company. In most cases, historical financial and nonfinancial business information over a ten year period provides a foundation on which the users can evaluate the future. However, in the cases of some companies, recent circumstances have changed so much that historical information is not as helpful in predicting the future. Those cases often involve start-up companies; cases in which changes in technology has redefined the market, product, or production process; companies emerging from dramatic restructuring, such as bankruptcy; and companies with new management.

A company's circumstances can also impact the extent to which the user needs information about the value of certain assets. In many cases, the historical cost of assets provides useful information and users have little need for the values of those assets. However, in some cases, the value of a company is based on the value of a few key assets or classes of assets. Examples include some natural resource companies for which the values of proved reserves or deposits drives the value of the company. In those cases users will need information that helps them value the key assets.

A degree of a company's success and financial strength can also impact users' needs for information. For example, creditors evaluating a company that is highly profitable, growing, financially strong, and has excellent prospects may need only limited information. That information could be limited to financial statements with little analysis and no projections of the future because the risk of the company not being able to meet its obligations when due is remote. On the other hand, creditors evaluating a company that marginally profitable, stable, highly leveraged, with average prospects may need more extensive information.

Personal Preferences

Another factor impacting the users' needs for information are the users' personal preference. Two users may be evaluating the same security using the same approach, and yet have different needs for information because they assess facts differently, emphasize different matters, or have different timeframes for their analysis.

For example, one investor may use historical data for the last ten years, to observe how a company reacted in periods of recession and expansion. Another investor uses historical data for only the last three years because new management greatly changed the company's operations at that time.

In another case, one investor projects future income by using operating data as much as possible. That investor projects future sales in units and separately estimates selling prices, costs and expenses that the company will incur to support that volume. That investor uses operating data for several historical and future periods. In contrast, another investor projects future income using only the data in financial statements, and based on discussions with management. That investor rarely uses operating data.

In a third case, one investor holds securities for about one year on average. Another investor holds securities for about seven years on average. The first investor is primarily concerned with events that will affect the company within the next one to two years. In contrast, the second investor needs information about the expected longer-term impact key trends.