Book 2: Chapter 16 Flashcards
What is financial reporting?
It’s the way companies show their financial performance to investors, creditors and other interested parties by preparing and presenting financial statements
What is the role of financial statement analysis?
To use the information in a company’s financial statements, along with other relevant information, to make economic decisions (eg whether to invest in the company’s securities or recommend them to investors, whether to extend trade or bank credit to the company)
What do analysts use financial statement data for?
To evaluate a company’s past performance and current financial position in order to form options about the company’s ability to earn profits and generate cash flow in future
What is the role of the statement of financial condition/statement of financial position/balance sheet?
To report the firm’s financial position at a point in time
What does the balance sheet consist of?
Assets, liabilities and owners’ equity (=shareholders’ equity, shareholders’ funds/net assets)
Define assets on a balance sheet
The resources controlled by the firm
Define liabilities on a balance sheet
Amounts owed to lenders and other creditors
Define owners’ equity on a balance sheet
The residual interest in the net assets of an entity that remains after deducting its liabilities from its assets
What is the fundamental accounting equation that must hold in a balance sheet
Assets = liabilities + owners’ equity
Define the capital structure of a company
The proportions of liabilities and equity used to finance a company
What is the role of the income statement/statement of comprehensive income/statement of operations/profit and loss statement?
This reports all changes in equity other than shareholder transactions (eg issuing stock/repurchasing stock/paying dividends) and reports on the financial performance of the firm over a period of time
Which elements make up the income statement?
Revenues, expenses, gains and losses
Define revenues
Inflows from delivering or producing goods, rendering services or other activities that constitute the entity’s ongoing major or central operations
Define expenses
Outflows from delivering or producing goods or services that constitute the entity’s ongoing major or central operations
Define other income on the income statement
This includes gains that may or may not arise in the ordinary course of business
What do you get when you combine the income statement with “other comprehensive income”
A single statement of comprehensive income, alternatively the two can be presented separately
Define the statement of changes in equity
This reports the amounts and sources of changes in equity investors’ investment in the firm over a period of time
Define the statement of cash flows
This reports the company’s cash receipts and payments
Which cash flows are in the statement of cash flows?
Operating cash flows, investing cash flows and financing cash flows
Define operating cash flows
These include the cash effects of transactions that involve the normal business of the firm
Define investing cash flows
The cash flows resulting from the acquisition or sale of property, plant and equipment, of a subsidiary or segment, or securities, and of investments in other firms
Define financing cash flows
Those resulting from issuance or retirement of the firm’s debt and equity securities and include dividends paid to stockholders
What are footnotes?
Financial statement notes, they include disclosures that provide further details about the information summarised in financial statements
What do footnotes achieve?
They allow users to improve their assessments of the amount, timing and uncertainty of the estimates reported in the financial statements
What 3 roles do footnotes perform?
1) discuss the basis of presentation (eg fiscal period covered by the statements and the inclusion of consolidated entities)
2) provide info about accounting methods, assumptions and estimates used by management
3) provide additional info (eg on business acquisitions, disposals, legal actions, employee benefit plans, contingencies and commitments, significant customers, sales related to parties, issuance of stock options and segments of the firm)
What is management’s commentary also known as?
Management’s report, operating and financial review, management’s discussion and analysis (MD&A)
This is one of the most useful sections of the annual report!
What does IFRS guidance recommend that’s included in the MD&A?
The nature of the business, management’s objectives, the company;’s past performance, the performance measures used, the company’s key relationships, resources and risks
Are all parts of the MD&A section audited?
No, some may not be
What does the SEC require that the MD&A section covers?
Trends
Identify significant events and uncertainties that effect the firm’s liquidity, K resources, and results of operations
Effects of inflation and changing prices if material
Impact of off-balance sheet obligations and contractual obligations such as purchase commitments
Accounting policies that require significant judgement by management
Forward-looking expenditures or divestitures
What is an audit?
An independent review of an entity’s financial statements
What do public accountants do?
They conduct audits and examine the financial reports and supporting records
What is the objective of an audit?
To enable the auditor to provide an opinion on the fairness and reliability of financial statements
Who is responsible for ensuring that the company’s financial statements conform to the applicable accounting standards?
The independent certified public accounting firm employed by the board of directors
What does the auditor look into?
The company’s accounting and internal control systems, confirms assets and liabilities, generally tried to determine that there are no material errors in the financial statements
What does the standard’s auditor’s opinion contain?
1) the auditor has performed an independent review
2) generally accepted auditing standards were followed, so providing reasonable assurance that the financial statements contain no material errors
3) the auditor is satisfied that the statements were prepared in accordance with accepted accounting principles and that the principles chosen and estimates made are reasonable
* plus an additional explanation when accounting methods have not been used consistently between periods
What is an unqualified/unmodified/clean opinion?
This indicates that the auditor believes the statements are free from material omissions and errors
What is a qualified opinion?
If the statements make any exceptions to the accounting principles. The auditor will explain these exceptions in the audit report
What is an adverse opinion?
It’s expressed when the statements are not presented fairly or are materially non conforming with accounting standards
When is a disclaimer of opinion issued by the auditor?
When they’re unable to express an opinion (eg in the case of a scope limitation)
What is an opinion other than an unqualified opinion sometimes referred to as?
A modified opinion
When will the auditor also include an explanatory paragraph?
When a material loss is probable but the amount cant be reasonably estimated
What kind of things can the uncertainties expressed in the auditor’s explanatory paragraph relate to?
1) the “going concern assumption” (the assumption that the firm will continue to operate for the foreseeable future)
2) the valuation or realisation of assets
3) litigation
What might the explanatory paragraph made by the auditor signal?
Serious problems, this might call for close examination by the analyst
What are internal controls?
The processes by which the company ensures that it presents accurate financial statements
Who is responsible for internal controls?
Management of the company
True or false; for public ally traded firms in the US the auditor must express an opinion on the firm’s internal controls?
True
Where can the auditor provide their opinion on the firm’s internal controls?
Separately or as the fourth element of the standard opinion
What is in the “Key Audit Matters” (international reports) or “Critical Audit Matters” (US) section in the audit report?
Accounting choices that are of greatest significance to users of financial statements. Including accounting choices that require significant management judgements and estimates, how significant transactions during a period were accounted for, or choices the auditor finds especially challenging or subjective and which therefore have a significant likelihood of being misstated
Other than annual financial statements, what else should an analyst examine?
A company’s quarterly or semiannual reports
What do quarterly and semiannual reports typically update?
The major financial statements and footnotes but they’re not necessarily audited
Where are SEC (Securities and Exchange Commission) filings available from?
EDGAR (electronic data gathering, analysis and retrieval system)
What do SEC filings include?
Form 8-K, Form 10-K and Form 10-Q
What is a form 8-K?
What a company must fiel to report events like acquisitions, disposals of major assets, changes in management or changes in corporate governance
What is a Form 10-K?
A company’s annual financial statements
What is a Form 10-Q?
A company’s quarterly financial statements
What are proxy statements?
Statements issued to shareholders when there are matters that require a shareholder vote, they’re also filed with the SEC and available from EDGAR
Proxy statements can be a good source of information about what?
The election of (and qualifications of) board members, compensation, management qualifications and the issue of stock options
Who writes corporate reports and press releases?
Management
What are corporate reports and press releases often viewed as?
Public relations or sales materials
True or false, all of the material in a corporate report/press release is independently reviewed by outside auditors?
False- not all of it
Where can you often find corporate reports/press releases?
The company website
What do firms often provide before the financial statements are released?
Earnings guidance, once an earnings announcement is made a conference call may be held whereby senior management is available to answer questions
Where can you find information about economic conditions, the company’s industry and its competitors?
Trade journals, statistical reporting services and government agencies
Describe the 6 steps in the financial statement analysis framework
1) state the objective and context- determine what questions the analysis seeks to answer, the form in which this information needs to be presented, and what resources and how much time is available to perform the analysis
2) gather data- acquire the company’s financial statements and other relevant data on its industry and the economy, ask questions to management, suppliers and customers and visit company sites
3) process the data- make appropriate adjustments to the financial statements, calculate ratios, prepare exhibits such as graphs and common-size balance sheets
4) analyse and interpret the data- use the data to answer the questions in step 1, decide what conclusions or recommendations the information supports
5) report the conclusions or recommendations- prepare a report and communicate it to its intended audience, ensure this report and its dissemination comply with the code and standards that relate to investment analysis and recommendations
6) update the analysis- repeat these steps periodically and change the conclusions or recommendations when necessary
