Transcript Financial Reporting

Financial Reporting
Relevance to
Corporate Governance
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Financial Reports
 Chairman’s Report
 Financial Statements
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Income Statement
Cash Flow Statement
Statement of changes in Equity
Balance Sheet
Notes
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Qualities of Financial
Statements
 Clear & understandable
 Reliable & honest
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No frauds
No window dressing
Properly audited
Compliant with laws/ rules/ practice
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Functions of Fin Statements
 Information Function
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Stakeholders
 Control Function
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Board
Owners
 Planning
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Management
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Investors’ Interest in
Financial Statements
 Instrument ratings
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Shares
Bonds
 Buy / sell / hold decisions
 Pricing / valuation of the company
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Acquisitions
Mergers
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Key Issues
 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
 Deliberate false picture of the company
 Improper accounting policies
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Revenue and expense recognition
Capital and revenue expenditure
Income and liability distinction
 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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 Book false gains through sale-purchase
back.
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Case 2:
Misuse of Accounting Policies
 Revenue recognition
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Book revenue before earning it to increase
profits
Defer revenue to reduce profits
 Expense recognition
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Defer expenses to increase profits
Make unreal provisions to reduce profits
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Case 3:
Playing with debits
 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
 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
 The Board
 Management
 External Auditors
 External Bodies
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Regulators: KSE/SECP
Accounting bodies: ICAP/ICMAP
Trade associations
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The Board’s Role
 Importance of NEDs
 Significance of INEDs
 Audit Committee
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Management’s Role
 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
 Every one depends on external auditors’
report.
 Independence of external auditors must
be assured:
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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
 Only purpose is to obtain an opinion.
 External auditors is not supposed to fix
the financial statements.
 Report:
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Unqualified
Qualified
Disclaimer
Adverse
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Audit Report: Scope
 Clarify basis of forming an opinion
 Proper records have been kept
 Financial statements:
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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
 Difference is only of intent
 Both result in:
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Incorrect use of accounting policies,
Omission of facts, or
Misinterpretation of facts
 Basic responsibility to prevent and detect
errors/frauds lies with management, not
external auditor.
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Auditors’ Liability
 No liability to outsiders
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Caparo Industries Case
Bannerman Case
 Disclaimers now abound
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Professional Monitors of
External Auditors
 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
 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
 Taxation
 Investigations (for acquisitions, etc.)
 General consultancy on new projects
 Systems development
 Low-balling
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How to control non-audit work
 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
 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
 Managing Position
 Managing Profits
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Managing Position
 To meet rules and regulations
 To meet lenders’ covenants
 To portray better picture to public
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Keep assets or liabilities off balance sheet
Window dressing
Misclassification of items
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Earnings Management
 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
 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
 To prepare accounts
 To prepare directors’ report
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Balanced and understandable assessment
State of affairs; going concern
Outline directors’ expectations
 To make legal disclosure
 To present the above to shareholders
 To file returns
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Voluntary Disclosures
 Future events or plans
 Changes in administration or policy
 Achievements
 Concerns
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Role of Audit Committee
 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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Audit Committee Issues
 Composition
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All NEDs
Majority INEDs
Chairman of the company not a member
 Duration
 Frequency of meetings
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Nature of Audit Committee
 It is not an executive body.
 It does not draw up accounting policy; its
role is only to review and oversee.
 It does not perform internal or external
audit.
 It reports to the Board, not management.
 It issues advice to management, not
directives.
 Committee can go to shareholders
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Internal Audit
 If formal internal audit department exists,
it reports to Audit Committee.
 If no formal internal audit department
exists, Audit Committee can recommend
establishment of one, or suggest other
measures.
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External Auditor &
Audit Committee
 Negotiations with external auditor
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Verifies suitability of the external auditor
Their resources, qualifications, independence, past
record
 Ensures independence
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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
 Audit plan / internal / external
 Discussion of audit plan with auditors
 Contact during audit
 Review of findings, major issues
 Oversee all correspondence with
external auditors
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Representations letter
Management letter
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AC and whistleblowing
 In absence of any other formal avenue,
Audit Committee may handle
whistleblowing cases.
 Set up process of handling these cases.
 Set up mechanism for investigation and
follow up.
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Thank you
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