Transcript 7_Financial_Reporting

Financial Reporting
Relevance to
Corporate Governance
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Financial Reports
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Chairman’s Report
Financial Statements
Income Statement
 Cash Flow Statement
 Statement of changes in Equity
 Balance Sheet
 Notes
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Notes to Accounts
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Accounting methods and policies used
Greater details of summarized figures
Statutory disclosures
Changes in accounting policies / impact
Details of off-balance sheet items, if any
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Qualities of Financial Statements
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Clear & understandable
Reliable & honest
No frauds
 No window dressing
 Properly audited
 Compliant with laws/ rules/ practice
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Functions of Fin Statements
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Information Function
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Stakeholders
Control Function
Board
 Owners
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Planning
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Management
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Investors’ Interest in
Financial Statements
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Instrument ratings
Shares
 Bonds
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Buy / sell / hold decisions
Pricing / valuation of the company
Acquisitions
 Mergers
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Key Issues
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Why would management want its financial
statements to be untrue?
Consequences of unreliable financial statements
Role & independence of external auditors
How can reliability be assured?
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No sudden collapse in near future
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Misleading Statements
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Deliberate false picture of the company
Improper accounting policies
Revenue and expense recognition
 Capital and revenue expenditure
 Income and liability distinction
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Creating complexities in financial statements
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Case 1:
Deliberate false picture
A Ltd wishes to show a higher profit. It can:
 overvalue its closing stock.
 Not make expense accruals
 Not make various provisions
 Bad
debts / legal obligations
 Investments revaluations
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Case 2:
Misuse of Accounting Policies
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Revenue recognition
Book revenue before earning it to increase profits
 Defer revenue to reduce profits
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Expense recognition
Defer expenses to increase profits
 Make unreal provisions to reduce profits
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Case 3:
Playing with debits
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Show a higher profit by
 Capitalizing
normal revenue expenses, treating them
as assets.
 Deferring start of depreciation or interest expensing.
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Show lower profits by expensing the capital
costs
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Case 4:
Playing with credits
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Show higher profits by treating liabilities as
incomes, e.g.
 An
advance from a client/taxes may be credited to
revenue.
 A loan may be channeled through a SPV and treated
as income
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Show lower profits by treating revenue as a
liability, e.g. Microsoft.
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Case 5:
Change in Accounting Policy
A company can alter its profit figures through
change in accounting policy and deliberately
omit to mention the change of policy in notes,
or omit to give the correct impact of the change.
Examples:
 Valuation Basis
 Depreciation Basis
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Case 6:
Complicating Fin Statements
A company can make its financial statements too
complex for an average investor to understand.
In particular, having different accounting
policies, closing dates and natures of business
offers tremendous scope for play in
consolidated financial statements.
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Responsibility for health of
Financial Statements
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The Board
Management (including internal auditor)
External Auditors
External Bodies
Regulators: KSE/SECP
 Accounting bodies: ICAP/ICMAP
 Trade associations
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The Board’s Role
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Importance of NEDs
Significance of INEDs
Audit Committee
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Management’s Role
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Management draws accounting policies, keep
accounts and prepares financial statements.
Management has most to gain or lose from the
defects of financial statements
Hence, management needs highest degree of
monitoring in this aspect.
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External Auditors’ Role
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Every one depends on external auditors’ report.
Independence of external auditors must be
assured:
Rotating them regularly
 Not giving them any other business
 Granting them full access to all records
 Limiting their relationship with management
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External Audit: Purpose
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Only purpose is to obtain an opinion.
External auditors is not supposed to fix the
financial statements.
Report:
Unqualified
 Qualified
 Disclaimer
 Adverse
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Audit Report: Scope
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Clarify basis of forming an opinion
Proper records have been kept
Financial statements:
are in accordance with the records
 reflect a true and fair view of the profit & position
 comply with the laws
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Errors and Frauds
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Difference is only of intent
Both result in:
Incorrect use of accounting policies,
 Omission of facts, or
 Misinterpretation of facts
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Basic responsibility to prevent and detect
errors/frauds lies with management, not external
auditor.
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Auditors’ Liability
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No liability to outsiders
Caparo Industries Case
 Bannerman Case
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Disclaimers now abound
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Professional Monitors of External
Auditors
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Accounting Standards from IFAC
Ethical Standards from ESB
Audit Standards from APB (UK)
Investigation & Discipline Board (UK)
Review Board (UK)
Public Company Accounting Oversight Board
(Sarbanes-Oxley Act) in USA
ICAP and SECP in Pakistan
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Guidelines to Audit firms
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Do not rely on one client for major part of
firm’s fee revenue.
No linkages with clients
Non-audit services should not be given (or at
least be restricted) to clients
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Non-Audit Work
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Taxation
Investigations (for acquisitions, etc.)
General consultancy on new projects
Systems development
Low-balling
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How to control non-audit work
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No restriction on audit firms – leaving it to their
professional judgment.
Total prohibition on non-audit work.
Partial prohibition on non-audit work, defined
either by nature of work, or level of approval.
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Rotation of External Auditors
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Rotation of audit firm – as prescribed by
Pakistan laws
Rotation of partners within the same firm.
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Different partners for different tasks
Appointment by open tender
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Objectives of Fixing
Financial Statements
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Managing Position
Managing Profits
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Managing Position
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To meet rules and regulations
To meet lenders’ covenants
To portray better picture to public
Keep assets or liabilities off balance sheet
 Window dressing
 Misclassification of items
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Earnings Management
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To keep share price stable, or rising
To meet market expectations
To maintain dividend payout pattern
Smoothening needs
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Hidden (misclassified) reserves
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Creative Accounting
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Standards do not cover every thing.
There is always more than one correct way of
handling things
Legitimate and dishonest intentions
Outright fraud: double set of books
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Directors Responsibilities
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To prepare accounts
To prepare directors’ report
Balanced and understandable assessment
 State of affairs; going concern
 Outline directors’
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To make legal disclosure
To present the above to shareholders
To file returns
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Voluntary Disclosures
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Future events or plans
Changes in administration or policy
Achievements
Concerns
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Role of Audit Committee
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To monitor the integrity of financial statements
To review internal controls & audit
To review risk management systems
To approve terms & remuneration of external
auditors
To ensure independence of external Auditors
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External Auditor &
Audit Committee
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Negotiations with external auditor
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Ensures independence
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Verifies suitability of the external auditor
Their resources, qualifications, independence, past record
Linkages, non-audit work
Rotation, former employees of audit firm
Audit firm’s performance, ethics
Discusses report / management letter with external
auditor
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Audit Cycle
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Audit plan / internal / external
Discussion of audit plan with auditors
Contact during audit
Review of findings, major issues
Oversee all correspondence with external
auditors
Representations letter
 Management letter
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Thank you
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