Guideline for Financial Statements

Content

Where to get information.

Who is interested in those information.

Second Lecture: Shareholders Equity.

Third Lecture: Liabilities.

Lecture Four: Short-term Liabilities.

Lecture Five: Short-term liabilities.

Sixth Lecture: Internal control: Detecting and avoiding fraud.

Financial Statements

This text provides a detailed approach of financial accounting for advanced readers. The basics like the double-bookkeeping method according to the IFRS should be clear and are extended to topics like equity (diverse classes of shares), debt (primary bonds) and investments (FVTPL, FVOCI, etc.). All these accounting rules are stated and supported by several figures, graphics and pictures. Recommended for every middle-class company with a finance department or planning an expansion. Also underlying concepts of different market (movements) are stated and linked to the related IAS principles. Even though the IFRS is the international standard, the German GAAP or the US GAAP are slightly deviating from it, but due to the progressing globalization the IFRS approach is more and more accepted within the EU and soon even in Germany. But even now this text provides with enough information about the underlying structure and makes it much easier to understand the German or US methods.

Where to get information.

- Financial statements are a communication tool from the company to the shareholders.
- Always be critical about information used for important decisions.
- Who gives those information?
- What was his/her intention?
- Can you trust those information?
- Measurements of reliability.
- Audits: Companies have to change the audit company after several years; audit company is responsible for correctness, if the financial statements aren't correct their reputation will be damaged → incentive to do good work.
- Rating agencies.
- Analysts (be aware of their investor relation towards the company).

Who is interested in those information.

- Many stakeholder groups are interested in the financial statements of the company for several reasons.

- Company itself for decision making, e.g., the use of scarce resources or prediction of opportunity costs.

- Shareholders to evaluate the risk of giving money, determine whether to buy, hold or sell.

- Want to gather as much information through the balance sheet, income statement and cash flow statement to predict the future development of the share price.

- Creditors (VC companies, banks) care about the profits or losses to see whether they will receive their money soon or never.

- Closely before the announcement of the financial statement the volatility and volume of trading increases.

- Volatility: The shares are bought and sold high frequently.

Volume: The amount the shares are bought and sold is very high because some investors think the shares are over-priced and sell, the others think they are under-priced and buy.

Abbildung in dieser Leseprobe nicht enthalten

- Bond traders usually react later on the announcement of the financial statements because the announcements are after the closing of the bond market.

Abbildung in dieser Leseprobe nicht enthalten

- Employees want to know the financial situation of the company, so they can calculate with retirement benefits, employment opportunities and so on.

- Managers are given incentives to put as much effort as they can to increase the value of the company (bonuses on performance).

- Managers care about the performance of the company, displayed in the financial statements to see whether they receive high bonuses or not.

- Therefore most managers try to exceed the targeted goals only a little bit.

- No-one has incentive to go higher or lower.

Abbildung in dieser Leseprobe nicht enthalten

- If the goals aren't reached the bonuses decrease and the risk of forced dismissal increases.

- Suppliers to evaluate the ability of the company to pay the supplied goods and interest in a long-term relationship.

- Consumers have long term involvements (e.g. warranties) and need to know the continuance of the company.

- Figures reveal that the demand, search and claim for financial statements of a company is the highest close before and after bancruptcy.

Abbildung in dieser Leseprobe nicht enthalten

- Government for taxes and regulations.

- Public for CSR, risk of pollution will lead to protest against this company.

- Figure shows that the IRS downloaded many 10-K financial statements (big companies paying small taxes).

- The annual report.

- The annual report contains (i) corporate information, (ii) analysis and commentaries, (iii) other statements or disclosure, (iv) financial statements and (v) notes to the financial statements.

- Target is to provide every information needed for an external investor to make the optimal choice.

- Company vision, goals and strategy, financial statements, other compulsory disclosures.

Abbildung in dieser Leseprobe nicht enthalten

- Bigger companies have higher impact on markets, so disclosure is increased.

- Access: Get it as a shareholder or visit government websites providing all annual reports of every listed company in this country.

- I. Corporate Information.

- General information about the company (history, members of the board, key markets and products, statistics, awards, financial highlights).

=> Every information helps the reader understand the company // represents the company in the best way possible.

- General electrics printed a photo of the board of directors on the first page.

- II. Analysis and Commentaries.

- Normally is about 2-3 pages, gives a review and outlook to the future.

- Analysis though the eyes of the directors.

→ Most important to read if you want to invest into a company.

- Dynamics of the business, performance drivers and something like this is assessed.

- Major item is the Letter from the Chairman of the Board of Directors.

- Chairman is the representative of the board of directors.

- Is elected by the shareholders and in this letter he describes the company's performance, goals and targets, in other words: presents the company in the best and most trustful way.

- Most often the chairman is the CEO, but this has several advantages and disadvantages.

- Advantages: Strong, central leadership, increasing efficiency, CEO knows company best, so unity of both titles is the best option.

- Disadvantages: Lack of oversight, limitation of the independence of the board, conflict of interest between board and CEO.

- III. Other Statements or Disclosure.

- Disclosure varies from local law to local law, but normally contains

- Corporate Governance

- Reveals how the managers are controlled, who is responsible and accountable for what.

- Corporate Social Responsibility

- Environmental Impact Disclosures

- Phillip Morris, e.g., revealed its sustainability goals for the future.

- IV. Financial Statements.

- First there is a acknowledgment by the directors and managers about their responsibility.

- Then there is the audit report.

- Independent auditor company has to prove and evaluate the financial statements about their truthful representation.

- First section: Audited financial statements and company.

- Second section: Manager's and auditor's responsibility.

- Third section: How the audit was performed.

- Fourth section: Evaluation of the auditor.

- Unqualified opinion : No mistake that matters is in the financial statements.

- Qualified opinion : Auditor accept the financial statements except of some excerpt.

- Adverse opinion : Financial statements do not fairly represent the financial position.

- Then the financial statements are printed: Statement of comprehensive income, statement of financial position, statement of cash flows and the statement of changes in equity.

- Statement of comprehensive income.

- Revenue and gains minus expenses and losses equals net income.

- Net income minus other comprehensive income equals total comprehensive income.

- IAS 1: Income statement has to contain at least revenues, financing costs, tax expenses and share profits of associated companies because these four point reveals necessary information for important stakeholders.

- Tax expenses owed to the government.

- Financing costs owed to to lenders.

- Share profit of associated companies owed to shareholders.

- Statement of other comprehensive income contains revaluation adjustments, currency gains or losses, gains and losses on hedging instruments.

- Two kinds to notice expenses for the income statement.

- Expenses by function: All expenses belonging to one major point will be summed up to be clear (administration costs).

- Clear, well-structured, enables investors to find useful information very fast, but is related to effort and time.

- Expenses by nature: All expenses will be listed as they occur and only partly summed up (depreciation costs).

- Very easy to insert into the income statement and less expensive.

→ Only smaller companies are allowed to use this kind.

- Statement of Cash Flows.

- Divided into three activities to show outsiders in which areas the company is most profitable or maybe allow to predict future development.

- Two methods of cash accounting.

- Direct method: All cash transactions will be listed and compared.

Abbildung in dieser Leseprobe nicht enthalten

- Indirect method: Net income is adjusted by accruals (takes more effort).

- Statement of changes in equity.

Abbildung in dieser Leseprobe nicht enthalten

- Reconciles the movements in equity over the financial period.

- Extraordinary reasons for changes in equity.

- Accounting standards changed.

- Changes in estimates.

- Voluntarily changing the accounting policies (FIFO → Average).

- Errors (omissions and misstatements).

→ Revaluation adjustment in other comprehensive income.

- V. Notes to the financial statements.

- Summary of significant accounting policies, estimates, assumptions and other disclosure assumptions.

- Contains many information about single numbers and methods in the four financial standards.

- E.g., Split sales revenue to continents or related markets to show investors the strengths and potential weaknesses of the company.

- IAS 1 – International Accounting Standard No 1.

- General part : Annual report has to clearly identify the general information about the company (name, consolidated or not, duration of the financial period, currency used).

- Requirements .

- Going concern assumption: Assumption that the business will continue for the foreseeable future (otherwise accounting would be totally different).

- Accrual accounting: Not only cash, but also accruals should affect the income statement and appear in the journal entries.

- Materiality: Every fact has to be revealed which is likely to influence the decision making process of a (potential) investor (this means: small mistakes are allowed as long as they won't influence decision making process).

- Offsetting: Not allowed (summing up accounts receivable with accounts payable).

- Frequency of reporting: Every 52 weeks the annual report has to be published (exceptions e.g. if two companies merger and had different deadlines, so the latest one will be chosen).

- Comparative information: Always compare the previous numbers with the new ones (set them next to each other).

- Consistency of representation: If changed some method (FIFO → Average) re-calculate the numbers of previous years.

- Assets and liabilities will be listed by liquidity, the fastest in turning into cash will be first.

- Division into current and non-current assets and liabilities (current = won't stay longer than 12 months in the company).

- How to determine the success of a company?

- Normally in benchmarking // comparison to competitors.

- Another method is to look at previous targets and whether the company reaches them in this financial period or not.

- Reveals the competence of management, if the targets are reached because then they were set realistically.

- But: Maybe the company exceeded their goals only because of the under-performance of the last year, led to a down-correction of the targets of the next year.

Second Lecture: Shareholders Equity.

- Main Differences between a Corporation and a General Partnership.

- General partnership = proprietorship with more members.

- (1) Separate legal entity.

- Corporations are artificial persons existing apart from its owners.

→ Company can live longer than their founders.

- Has the right to buy, own and sell property (important for liability).

- Partnerships are no legal entities.

- (2) Transferability of Ownership.

- Every backer becomes an owner, not only the founders are ruling the company.

- Partnerships terminates if owners change (you have to found a new one).

- (3) Limited Liabilities.

- Shareholders of a corporation aren't liable for losses of the company (no personal obligations).

→ Very easy and efficient way to raise equity.

- Partnerships-owners are fully, personal liable for losses.

- (4) Separation of ownership and management.

- Board of Directors appoints managers and is elected by the shareholders.

- In a partnership the founder is the leader is the manager.

- (5) Taxation.

- Corporations are double-taxed; corporation tax on profits and income tax on dividends.

→ In some countries the double-taxed amount can be retrieved.

- Partnerships only pay income tax because every profit is the income of the founders.

[...]