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Financial Statements An Overview

Map. or. Maze. Financial Statements An Overview. Financial Statements An Overview. Map. or. Maze. Auditor’s Report. MD&A. Notes. Statement of Cash Flows. Income Statement. Statement of Shareholders’ Equity. Balance Sheet. Our Objective:.

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Financial Statements An Overview

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  1. Map or Maze Financial StatementsAn Overview (C) 2007 Prentice Hall, Inc.

  2. Financial StatementsAn Overview Map or Maze Auditor’s Report MD&A Notes Statement of Cash Flows Income Statement Statement of Shareholders’ Equity Balance Sheet (C) 2007 Prentice Hall, Inc.

  3. Our Objective: To ensure that financial statements serve as a map, not a maze The better one can read and understand the financial statements, the more useful they are as a MAP to intelligent decision-making (C) 2007 Prentice Hall, Inc.

  4. Volume of Information:The Annual Report • Introduction (period covered; board of directors; change in capital; dividends distributed in the last 3 years; major shareholders; business industry) • Activities • Investments • Production of Goods and Services • Financial Structure • Financial Statements • Administrative • Proposed Profit Distribution (C) 2007 Prentice Hall, Inc.

  5. Financial Statements Prepared according to generally accepted accounting principles (GAAP) Present financial information that is understandable by users AND relevant and reliable for decision making (C) 2007 Prentice Hall, Inc.

  6. GAAP • Global: Two major accounting standards: • IFRS (IASB) • US GAAP (FASB) • TURKEY • Capital Markets Board Standards • TAS (TMSK) (C) 2007 Prentice Hall, Inc.

  7. Classification of Accounting Systems (C) 2007 Prentice Hall, Inc.

  8. Development of International Accounting Standards • International Financial Reporting Standards (IFRS-IASB) • 14 member committee of auditors, accountants, academics and financial statement users • Developed International Accounting Standards (IAS) to help investors cope with financial analysis in global capital markets • Currently in use by European Union, Australia, South Africa … (C) 2007 Prentice Hall, Inc.

  9. Where to Find a Company’s Financial Statements: • Istanbul Stock Exchange web site http://www.imkb.gov.tr/bilanco/mtablodonem.htm • Annual report • Website of the company (C) 2007 Prentice Hall, Inc.

  10. The Four Basic Financial Statements • Balance Sheet • Income Statement or Earnings Statement • Statement of Stockholders’ Equity • Statement of Cash Flows (C) 2007 Prentice Hall, Inc.

  11. Financial Statement Notes • An INTEGRAL part of the statements • Provide summary of accounting policies • Present detail about particular accounts (e.g. inventory, investments, etc.) • Include other information (e.g. leasing arrangements, pending legal proceedings, income taxes, etc.) (C) 2007 Prentice Hall, Inc.

  12. Financial Statement Notes(cont.) some supplementary information such as: • Information on foreign currency translations for firms operating in foreign countries • Information by segment for firms with several lines of business (C) 2007 Prentice Hall, Inc.

  13. Auditor’s Report Unqualified Qualified Adverse opinion Disclaimer of opinion (C) 2007 Prentice Hall, Inc.

  14. Auditor’s Report (cont.) • Unqualified (what you want!) • Statements present information in conformity with GAAP (C) 2007 Prentice Hall, Inc.

  15. (C) 2007 Prentice Hall, Inc.

  16. Auditor’s Report (cont.) • Unqualified (what you want!) • Statements present information in conformity with GAAP • Qualified • Reports other than an unqualified opinion due to various circumstances • Typically use word “except for” (C) 2007 Prentice Hall, Inc.

  17. (C) 2007 Prentice Hall, Inc.

  18. Auditor’s Report (cont.) • Adverse opinion (not what you want!) • Financial statements have not been presented fairly in accordance with GAAP (C) 2007 Prentice Hall, Inc.

  19. Auditor’s Report (cont.) • Disclaimer of opinion isissued when • auditor can’t evaluate the fairness of the statements and expresses no opinion • there is material scope limitation of the audit • there is lack of independence by the auditor • remember, the auditor is hired by the firm being audited, so there is always the possibility of conflict of interest (C) 2007 Prentice Hall, Inc.

  20. Auditor’s Report (cont.) • Unqualified opinion with explanatory language is warranted when there is • a consistency departure due to a change in accounting principle • uncertainty caused by future events such as contract disputes and lawsuits • an event (or events) that the auditor wishesto describe because they maypresent business risk and/or going-concernproblems (C) 2007 Prentice Hall, Inc.

  21. (C) 2007 Prentice Hall, Inc.

  22. Why use financial statements? Savvy use of financial statements allows user to assess: • Financial position of the company • Success of its operations • Policies and strategies of management • Insight into future performance (C) 2007 Prentice Hall, Inc.

  23. Questions one might ask: • Would an investment generate attractive returns? • What is the degree of risk inherent in the investment? • Should existing investing holdings be liquidated? (C) 2007 Prentice Hall, Inc.

  24. Questions one might ask(cont.) • Will cash flows be sufficient to service interest and principal payments on debt? • Does company provide a good opportunity for employment? (C) 2007 Prentice Hall, Inc.

  25. Questions one might ask (cont.) • How well does this company compete in its operating environment? • Is this firm a good prospect as a customer? (C) 2007 Prentice Hall, Inc.

  26. Missing and Hard-to-Find Information • Employee relations with management • Morale/efficiency of employees • Reputation/public perceptions of firm Not available in the financial statements: (C) 2007 Prentice Hall, Inc.

  27. Missing andHard-to-Find Information(cont.) • Effectiveness of management team/provisions for succession • Potential exposure to regulatory changes QUALITIES THAT IMPACT OPERATING SUCCESS BUT ARE DIFFICULT TO QUANTIFY (C) 2007 Prentice Hall, Inc.

  28. Missing and Hard-to-Find Information (cont.) • Affects public perception of firm and can impact financial performance • Proven correlation between financial returns and reputation • A recent example of adverse publicity is Enron for denying their involvement in any wrongdoing Publicity in the Media (C) 2007 Prentice Hall, Inc.

  29. Complexities-1 • Accounting choices and estimates • Management judgment- accrual basis of accounting • Complex merger&acquisition transactions • Goodwill • Consolidation • Use and accounting for derivatives • Foreign Operations (C) 2007 Prentice Hall, Inc.

  30. Complexities-2 • Complexity of GAAP (i.e. IFRS) • Frequent change in GAAP (C) 2007 Prentice Hall, Inc.

  31. Quality of Financial Reporting (Earnings) • Persistence (Sustainability) • Predictability (ability of past earnings to predict future earnings) • Closeness to cash (C) 2007 Prentice Hall, Inc.

  32. Earnings Management • A survey study carried out in 1998. Based • On 253 response of senior auditors. Identified • 515 attempts of earnings management. • Nelson, Elliot and Tarpley (2003), How are • Earnings Managed?, Accounting Horizons (C) 2007 Prentice Hall, Inc.

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