5 - ACCOUNTING & AUDITING Flashcards
Information Asymmetry
B/c the insider know more about the company than outsiders.
“The Whole market virtually collapses if the extent of information asymmetry is serious.”
EG: Some stocks are over valued, some are under valued .
Undervalued firms: Reluctant to issue shares at a low price.
Overvalued firms: NEW issuance of shares - signal market the firm is overvalued.
What is Information Disclosure? & Why?
- Sunshine
- To effectively Monitor Manager - Outsiders need information
- Outside investors need information to evaluate securities value
EG: Hang Seng & Dah Sing - No disclosure makes ppl assume the worst.
Types of Information Disclosure
- Mandatory
EG: Prospectus (when Stock Offer) / Annual Reports / Intrim / CG Reports - Voluntary Disclosure - Disclosure above the mandated minimum
EG: Management Forecast / Conference Calls / Press releases / Internet Sites
Information to users : Annual Report
- ARs are regulated
EG: GAPP / IFRS - Accounting Standards regulate reporting choices available to mgmt
EG: How Management Choose to present the firm’s financial statements. - Regulation reduce processing cost
EG: Commonly accepted language Managers can use to communicate with investors.
Accuracy of Financial Reports?
- Important for efficiency of capital markets. / Proper Evaluation of Securities
- To allow the BOD to analyze & evaluate strategies, business model & evaluate Risk.
- For structuring compensation packages. Awarding performance based compensation knowing the predetermined targets.
The Audit Committee’s Objective are?
Ensure Accuracy of Financial Reports.
- By setting parameters for Quality
- For Transparency
- For Control
- Hire External Auditors for Misstatement
Audit Committee’s responsibilities
HOMOON
- Hire & Monitor External Auditor
- Oversee Financial Reporting & Disclosure
- Monitor the choice of accounting principles
- Oversee internal audit Function
- Oversee regulatory compliance
- Monitor Risks
Required of Audit Committee (SOX)
- ALL committee members are independent
- ALL Members are Financially literate
- One Member it’s be a financial Expert
What is Accounting Quality?
Quality - The degree to which accounting figures precisely REFLECT changes in financial Position / Earnings / Cashflows.
- Transparency - the degree to which the company provides supplemental information to explain accounts reported in F/S & filings
- Internal Control - The process & procedures that ensure transactions are accurately recorded. / That financial statements are properly produced/ Company assets are protected from theft / fraud.
Evidence for Accounting Quality?
Companies like to make small manipulations. More likely to report small increase than small decrease in earnings.
> Companies with “low- accounting Quality” experience better short term performance. Long term performance suffers.
What correlates to Financial Fraud?
- Few outside directors
- Low director ownership
- Busy Boards
- Fewer accounting meetings
- Fewer financial experts on audit committees
What may cause Financial restatements?
- Human Error
- Aggressive Accounting
- Fraud
What is External Auditor’s role?
: Assess the validity & reliability of publicly reported financial information.
- Spot unintentional errors when possible
- Management wrong judgement may occur
- Managers may intentionally misrepresent F/S ) manipulate earnings to gain more bonus
Limitation to External Audit?
- Sampling base
- Collusion / By pass controls
- Management’s Authority
Process to External Audit?
- Audit preparation to determine the scope of the audit & identify areas requiring special attention.
- Review Mgmt estimates & disclosure by company. By sampling key accounts, test mgmt’s assumptions and independently verify estimates.
- Fraud evaluation by evaluating fraud opportunities, examining incentive for fraud & apply “professional skepticism”
- Assess internal controls: Examine design of IC, identify Weakness and focus on key accounts and unusual tranx
- Conclude by reviewing with Audit Committee.
- Express an opinion.
