Transcript 1st session: Organizational Architecture and Accounting
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa 01/05/2020
4
th
session: Corporate Governance and Financial accounting measures of performance
Performance Evaluation IMSc in Business Administration October-November 2007 Ricardo F Reis [email protected]
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa
Corporate Governance
Sarbanes-Oxley
“Five years under the thumb”
Auditing Profession
Financial Performance Measures
Earnings per Share
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 2/33
Sarbanes-Oxley
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa The
Sarbanes-Oxley Act of 2002
, also known as the
Public Company Accounting Reform and Investor Protection Act of 2002
and commonly called
SOX
or
Sarbox
; is a United States federal law signed into law on July 30, 2002 in response to a number of major corporate and accounting scandals including those affecting Enron , Tyco International , Peregrine Systems and WorldCom .
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 3/33
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa
TITLE I “Public Company Accounting Oversight Board (PCAOB)”
PCAOB to provide independent oversight of public accounting firms providing audit services ("auditors"). It also creates a central oversight board tasked with registering auditors, defining the specific processes and procedures for compliance audits, inspecting and policing conduct and quality control, and enforcing compliance with the specific mandates of SOX.
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 4/33
TITLE II “Auditors Independence”
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa Establishes standards for external auditor independence, to limit conflicts of interest. It also addresses new auditor approval requirements, audit partner rotation policy, conflict of interest issues and auditor reporting requirements. This title restricts auditing companies from doing other kinds of business apart from auditing with the same clients.
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 5/33
TITLE III “Corporate Responsibility”
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa This title mandates that senior executives take
individual responsibility for the accuracy and completeness of corporate financial reports
. It enumerates specific limits on the behaviours of corporate officers and describes specific forfeitures of benefits and civil penalties for non-compliance. For example, Section 302 implies that the company board (Chief Executive Officer, Chief Financial Officer) should certify and approve the integrity of their company financial reports quarterly. This helps establish accountability.
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 6/33
TITLE IV “Enhanced Financial Disclosures”
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa Title IV describes enhanced reporting requirements for financial transactions, including off-balance sheet transactions, pro forma figures and stock transactions of corporate officers. It requires internal controls for assuring the accuracy of financial reports and disclosures, and mandates both audits and reports on those controls. It also requires timely reporting of material changes in financial condition and specific enhanced reviews by the SEC or its agents of corporate reports.
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 7/33
TITLE V “Analyst Conflicts of Interest”
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa Title V defines the codes of conduct for securities analysts and requires disclosure of knowable conflicts of interest.
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 8/33
TITLE VI “Commission Resources and Authority”
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa Title VI defines the SEC’s authority to censure or bar securities professionals from practice and defines conditions under which a person can be barred from practicing as a broker, adviser or dealer.
Session 04 - 9/33 01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
TITLE VII Reports” “Studies and
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa Title VII is concerned with conducting research for enforcing actions against violations by the SEC registrants (companies) and auditors.
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 10/33
TITLE VIII “Corporate and Criminal Fraud Accountability”
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa Title VIII is also referred to as the “Corporate and Criminal Fraud Act of 2002.” It describes specific criminal penalties for fraud by manipulation, destruction or alteration of financial records or other interference with investigations, while providing certain protections for whistle-blowers.
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 11/33
TITLE IX “White Collar Crime Penalty Enhancement”
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa This section is also called the “White Collar Crime Penalty Enhancement Act of 2002.” This section increases the criminal penalties associated with white collar crimes and conspiracies. It recommends stronger sentencing guidelines and specifically adds failure to certify corporate financial reports as a criminal offence.
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 12/33
TITLE X Returns” “Corporate Tax
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa Title X consists of one section, which states that the Chief Executive Officer should sign the company tax return.
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 13/33
TITLE XI “Corporate Fraud Accountability”
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa Also known as “Corporate Fraud Accountability Act of 2002” . It identifies corporate fraud and records tampering as criminal offences and joins those offences to specific penalties. It also revises sentencing guidelines and strengthens their penalties. This enables the SEC to temporarily freeze large or unusual payments.
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 14/33
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa
The Certified Public Accountant and the Auditor’s Opinion
An audit is an examination of a company’s transactions and the resulting financial statements The auditor’s opinion describes the scope and results of the audit and a judgment that the financial statements prepared by management are accurate
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 15/33
Public Accounting Firms
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa The four largest public accounting firms are Deloitte Touche Tohmatsu Ernst & Young KPMG International PricewaterhouseCoopers 97% of the firms listed on the NYSE are clients of these four firms
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 16/33
Public Accounting Firms
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa Each firm has annual billings in excess of $1 billion All firms must follow generally accepted accounting principles (GAAP) The broad concepts and detailed practices of preparing and distributing financial statements
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 17/33
Sarbanes-Oxley Act
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa Established the Public Company Accounting Oversight Board to regulate public accounting and to set standards for audit procedures through the issuance of generally accepted auditing standards (GAAS) Prohibits public accounting firms from providing audit clients with certain non-audit services Requires rotation every 5 years of the lead audit or coordinating partner and the reviewing partner on an audit
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 18/33
Sarbanes-Oxley Act
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa Provides regulation of corporate governance Requiring boards to appoint an audit committee composed only of “independent” directors Requiring CEOs and chief financial officers (CFOs) to personally sign a statement certifying the appropriateness and fairness of their companies’ financial statements Increasing criminal penalties for knowingly misreporting financial information
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 19/33
Professional Ethics
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa Members of the AICPA must abide by a code of professional conduct The Institute of Management Accountants has a code of ethics for management accounts Auditors and management accountants have professional responsibilities concerning competence, confidentiality, integrity, and objectivity
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 20/33
Professional Ethics
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa Ethical standards are personal and depend on the values of the individual A successful manager must recognize the ethical dimensions of a situation and act with absolute integrity
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 21/33
Professional Ethics
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa Despite the criticism of accounting ethics, accountants were responsible for revealing the problems in many of the recent corporate scandals Companies often rely on accountants to safeguard the ethics of the company WorldCom and Enron whistle-blowers became two of the three 2002 Persons of the Year in Time magazine ( Cynthia Cooper of Worldcom and Sherron Watkins of Enron )
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 22/33
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 23/33
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa 01/05/2020
Financial accounting measures of performance
Computing Earnings per Share (EPS) Ricardo F Reis [email protected]
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa • • •
Computing Earnings per Share (EPS)
Earnings per share indicates the income earned by each share of
common stock
.
Reported at the end of the income statement Should report intermediate components as well.
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 25/33
EPS on Simple Capital Structure
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa Simple Capital Structure means that there is only common stock and there is no potential common stock (securities that can potentially be converted into common stock and dilute EPS).
Net Income EPS= Weighted Average Number of Shares
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 26/33
Preferred Stock Dividends
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa Preferred Stock Dividends are compensation not available for common stockholders, therefore they are subtracted from the Net Income.
Net Income – Preferred Dividends EPS= Weighted Average Number of Common Stock
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 27/33
Weighted Average Number od Shares Outstanding
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa Weighted by the fraction of the period they are outstanding
Find the equivalent number of whole shares outstanding for the year.
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 28/33
Stock Dividends and Stock Splits
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa When these happen computation of the average number of shares outstanding needs to be redone.
A stock dividend or split
does not change the shareholders’ total investment
.
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 29/33
Complex Capital Structure
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa Dilutive securities are securities that can be converted into common stock (through conversion or exercise) and will dilute earnings per share.
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 30/33
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa
Diluted EPS
Note that: Only dilutive securities are to be reported! Antidilutive are not considered.
EPS= Net income- Preferred dividends Weighted Average Shares Outstanding Impact of Convertibles Impact of Option, Warrants, and Other Dilutive Securities
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 31/33
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa
Diluted EPS – Convertible Securities
If-Converted Method
1.
2.
Conversion of the convertible securities as soon as possible (beginning of period or issuance) Elimination of related interest, net of tax.
Logic is that if the convertible securities were converted, then they didn’t produce any interest and net income has to be filtered of this.
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 32/33
Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa
Diluted EPS – Options and Warrants
Treasury Stock Method
1.
2.
Exercise of options or warrants as soon as possible (beginning of period or issuance) Proceeds from the exercise are used to purchase common stock.
01/05/2020 Performance Evaluation Ricardo F Reis [email protected]
Session 04 - 33/33