Users of financial statements - PowerPoint by bib20662


									  Users of financial statements:

• 1. Credit and equity investors – focus of
     this course.
• 2. Government – regulatory bodies (public
     utility commissions, tax authorities (IRS
     and others.
• 3. General public, special interest groups
     and others. See shareholder proposals.
    Principal components of the
        financial statements.
• 1. Balance sheet
• 2. Income statement
• 3. Statement of comprehensive income the
      newest statement.
• 4. Statement of cash flows (formerly
      statement of changes in working capital).
• 5. Statement of stockholders’ equity.
• 6. Footnotes and supplementary data.
       Preparation of financial
• 1. Using generally accepted accounting
     principles (GAAP)
• 2. Uses accrual method of accounting – revenues
     are recognized when goods are delivered or
     when services are performed and expenses are
     recognized as services are used, rather than
     when cash is collected or paid.
• 3. Performance is measured using the matching
     principle – related revenues and costs are
     accounted for in the same period.
    Promulgation of accounting
• 1. Securities and Exchange Commission (the
• 2. The Financial Accounting Standards Board
      (FASB) successor to the Accounting
      Principles Board.
• 3. The emphasis in the past has been
      promulgation of standards by the private
      sector, though the SEC steps in on occasion.
• The SEC recognizes FASB statements as
    Qualitative characteristics of
      accounting information
• 1. Relevant – requires information that provides
  information useful in decision making. Enron.
• 2. Timeliness – less timely information is less
  relevant information.
• 3. Reliability –
   – A. Verifiability and representational faithfulness – has
     the financial data been properly measured and has it
     been properly described in the financial statements?
   – B. Neutrality – is the financial statement data biased?
     The data should be relevant and reliable. Standards
     should not be promulgated on the basis of perceived
     economic impact. (expensing of stock options)
• 4. Consistency – are the same accounting
  principles used over time (trends)?
• 5. Comparability – do similar companies
  use the same accounting principles?
• 6. Materiality – FASB statements
  frequently do not apply to immaterial items.
  Though occasionally a quantitative measure
  is used to define a materiality threshold,
  materiality is generally subject to
  management’s or the auditor’s judgment.
• Staff Accounting Bulletin 99 – requires the
  consideration of qualitative factors as well as
  quantitative measures of materiality.
• 1. Obscuring changes in earnings trends
  (Worldcom, Enron)
• 2. Hiding the failure to achieve analysts forecasts.
• 3. Changing a reported loss to income or vice
  versa. Channel stuffing (Sunbeam).
• 4. Obscuring changes in significant business
  segments. (Enron)
• 5. Increasing management compensation.
• 6. Affecting compliance with regulatory
  requirements, loan covenants, or other contracts.
• 7. Concealing unlawful acts.
     International Accounting
• 1. Promulgated by the International
  Organization of Securities Commissions.
• 2. Basle I and II
  Principal Financial Statements
• Balance Sheet – provides a snapshot of a
  corporation’s assets, liabilities and stockholders’
  equity at a given point in time. In the US, this is
  usually done quarterly and annually.
• Assets and liabilities are listed in descending order
  of liquidity, frequently with subtotals such as
  current assets and current liabilities.
• Primarily prepared based on historical cost, but
  there are exceptions. Think conservative.
  Marketable securities available for sale are carried
  at market value. Long-term assets may become
  impaired and written down, oil reserves may be
  written down. Recoveries aren’t written up.
• Income statement – presentation of
  revenues and expenses over some time
  period – usually quarterly or annually.
• The opportunity exists for game playing
  with the classification of items as
• Operating versus non-operating
• Recurring or nonrecurring
• Extraordinary –unusual and infrequent
• Revenue recognition
• Statement of Comprehensive Income
• Includes direct-to-equity adjustments:
• Cumulative translation adjustments – SFAS
  52 (Chapter 15)
• Minimum pension liability – SFAS 87
  (Chapter 12)
• Unrealized gains and losses on available-
  for-sale securities – SFAS 115 (Chapter 16)
• Deferred gains and losses on cash flow
  hedges – SFAS 133 (Chapter 16) (ENZN)
• Statement of cash flows:
• Classifies cash receipts and disbursements into
   – Operating
   – Investing – purchase or sale of PP&E, subsidiary or
     business segment, investments in other firms.
   – Financing – issuance or retirement of debt and equity
     securities, dividends paid.
   – Significant noncash investing and financing activities
     (capitalized leases) must be disclosed separately with
     the statement or in the footnotes.
   – Must disclose : interest paid and taxes paid
• Statement of stockholders’ equity – reports
  the amounts and changes in:
• Preferred stock
• Common stock
• Additional paid in capital
• Retained earnings
• Treasury stock
• ESOP adjustments
• Can be difficult to determine whether some
  securities are equity or debt.(trust preferred)
• Contains information about the accounting
  principles used, adoption of accounting principles,
  assumptions and estimates (fair values), additional
  information regarding fixed assets, inventories,
  income taxes, pension and post-employment
  benefits, terms of debt obligations, loss and gain
  contingencies, marketable securities, hedging,
  business risks, business segments, significant
  customers or vendors, related parties and other
     Supplementary schedules
• Usually audited though some may be
  unaudited. Examples are jobs in progress
  and present value of cash flows from oil and
  gas reserves.
           Contingent losses
• Losses are accrued if it is probable (more
  likely than not) that assets have been
  impaired or a liability incurred AND the
  amount of the loss can be reasonably
  estimated. The most likely amount should
  be accrued if the loss lies within a range. If
  there is no best estimate, the minimum
  amount in the range is reported.
• Footnote disclosure is required of
  (unrecognized) loss contingencies when it is
  reasonably possible (more than remote but
  less than probable). See SFAS 5.

• Contingencies tend to be subjective and
  involve judgment to measure and analyze.
• Examples: environmental remediation,
  litigation, expropriation, self-insurance,
  debt guarantees, repurchase agreements.
                  SOP 94-6
• Requires the disclosure of significant risks and
• Description of major business activities and
• Inclusion of a statement that the financial
  statements requires the use of estimates.
• Description of the uncertainty surrounding the use
  of significant estimates.
• Description of concentrations, for example,
  concentrations in customers, suppliers or markets.
       Management discussion and analysis
• Management is required to discuss:
    – Significant effects of currently known trends, events and uncertainties.
      May include forward-looking data.
    – Liquidity and capital resources – including transactions and event with
      material current of expected long-term liquidity implications.
    – Discussion of discontinued operations, extraordinary items, and other
      unusual or infrequent events with current or expected material effects on
      financial condition or results of operations.
    – Disclosure of a segment’s disproportionate need for cash flows or
      contribution to revenues and profits.
    – Impact of off-balance-sheet arrangements on liquidity and disclosure
      about contractual obligations and commercial commitments
    – Disclosures about trading activities including non-exchange traded
    – Effects of transactions with related parties including persons (such as
      former employees) that may not meet the technical definition of related
          Role of the auditor
• Responsible for seeing that the financial
  statements conform to GAAP
• Examines the company’s and accounting
  and internal control systems
• Audit is performed according to generally
  accepted auditing standards (GAAS).
• Provides “reasonable assurance”
• Free of material misstatements
• Examined on a test basis
• Opinion highlights “going concern”
• May highlight consistency problems
• See opinions on page 23 and 24

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