Financial Disclosures PDF

CH. 2. FINANCIAL DISCLOSURES TEXT BOOK PAGES 62-72 Intermediate Accounting I Dr. Charles Kang 2-1 Required Disclosures Additional information, relevant but not as relevant in other financial statements, eg. cash flow statement Financial Reports contai...

CH. 2. FINANCIAL DISCLOSURES TEXT BOOK PAGES 62-72 Intermediate Accounting I Dr. Charles Kang 2-1 Required Disclosures Additional information, relevant but not as relevant in other financial statements, eg. cash flow statement Financial Reports contain more than just numbers and tables!! required dislosures/ voluntary disclosures Required Disclosure Notes o Summary of significant accounting policies o Subsequent events o Noteworthy events and transactions Additional Required Sections of the Financial Statements less important but still required o Management Report / Management Discussion & Analysis o Auditors’ Report o Disclosure on Compensation on Directors & Executives 2-2  Example: CNOOC Financial Report 2015 Required Disclosure Notes There are 4 pages of financial statement only --> other information is in the notes —> 78 pages of additional information disclosures Explain the data presented in the financial statements themselves, or provide additional information – Provide information not directly related to any specific elements in the financial statements. Two types of disclosure notes 1. Required disclosure notes 2. Other common disclosure notes 2-3 Required Disclosure Notes 1. Summary of significant accounting policies 2. Descriptions of subsequent events 3. Noteworthy events and transactions 2-4  Example: Singapore Airlines Eg. Inventory policy, LIFO/ FIFO? Investors wish to compare apples to apples —> use accounting policies in a consistent manner 2-5  Required Disclosure Notes 2. Descriptions of subsequent events Subsequent events = Significant events between the date of the financial statements and the date the statement is issued after the end of the financial year Periodicity (assumption we make to organise financial report) For some companies, their financial statement period is the same as the calendar year 1st Jan - 31 Dec 1Jan2023 31Dec2023 1 Mar 2024 The company starts to prepare the financial reports. It takes a while for them to prepare + audit from certified auditors 2-6 Required Disclosure Notes 2. subsequent events that should be disclosed in a note Rule of Thumb: Any event in the subsequent period that has material effects on operations: – Debt refinancing or debt restructuring – New developments associated with litigation – New development that affects operations (for example, a natural disaster) and its estimated impact on income – Changes in the status of a proposed merger or acquisition 2-7 Post financial year-end events Determine the appropriate treatment for each of the following events in the 2013 financial statements of Northwest Distribution Corporation. The financial year end for this company is Dec. 31. Northwest issues 2013 Financial Statements on March 10, 2014 1 Jan 2013 31 Dec 2013 Mar 10 2014 2-8 Post financial year-end events 1) On Jan. 22, 2014, the company negotiated a major merger with Blandon industries. The merger will be completed by the middle of 2014. – Details of the merger should be disclosed in a note to the financial statements. 2-9 Post financial year-end events The date: its a subsequent period 2) On Feb. 3, 2014, Northwest negotiated a $10 million long-term note with the National Credit Bank. The amount of the note is material. > 5% of the net income – Details of the issuance of the new debt should be described in a note to the financial statements. 2-10 Post financial year-end events 3) On Feb 25, 2014, a flood destroyed one of the company’s manufacturing plants, causing $6 million of uninsured damage. The damage amounts to 10% of net income. – The event should be described in a note to the financial statements along with the amount of uninsured damage. 2-11  Required Disclosure Notes 3. Noteworthy events and transactions family ties? went to the same school, attend the same company before 1) Related third-party transactions some ties between the two companies ▪ Transactions with owners, management, families of owners or management, affiliated companies, and other parties that can significantly influence or be influenced by the company. ▪ These transactions frequently use favorable terms of trade, violating the arm’s length principle. there are some distance we can assume the company are not that close XYZ ABC TRUMP IVANCA TRUMP arms length 1% loan. 10% loan for 20 Million 2-12  Required Disclosure Notes 3. Noteworthy events and transactions 1) Related third-party transactions ▪ Example: Connected lending An interest rate for lending to family members of a founder-CEO is often significantly less than the market interest rate for an independent third party with similar credit risk. This lending transfers income (wealth) from the company to the family members of the founder- CEO, to the detriment of the interests of other shareholders. 2-13 Required Disclosure Notes 3. Noteworthy events and transactions 1) Related third-party transactions ▪ The following should be disclosed in a note: The nature of the relationship, a description of the transaction, and any dollar amounts involved, etc. 2-14 Required Disclosure Notes 3. Noteworthy events and transactions 2) Frauds and Errors = error intentional/ unintentional restatement, correct the problem ▪ Misstatements in the financial statements if you try to make estimate, you are more likely to make mistakes ▪ Frauds: intentional misstatements in a financial statement to obtain an unjust or illegal advantage ▪ Errors: unintentional misstatements in a financial statement 2-15  Required Disclosure Notes Investors view misstatements (especially the fraudulent ones) very negatively intentional manipulation? Research shows that following revelation of misstatements: ▪ the stock price goes down sharply (Palmrose et al. 2004) ▪ and investors’ trust in the company’s future disclosure goes down (Chen et al.2014) SOX auditors = fired, lose all the jobs CEO = go to jail ▪ Companies often fire managers and auditors to regain investor trust (Hennes et al. 2008, Chen et al.2014, Chakravarthy et al. 2014) restatement 2-16  Management Reports (required disclosure) Financial statements contain a comprehensive discussion and analysis of the company’s operations by the management (termed as the MD&A ‘Management Discussion and Analysis / Operating and Financial Overview / Management Report, and etc.) Let’s look at the CNOOC 2015 and find their Management Discussion and Analysis (MD & A) section 2-17 Auditor’s Report (required disclosure) very important part of the financial report, without it the firm cannot issue the financial statement Some of you will become public auditors Auditors audit the financial statements and give assurance about their validity verifiability auditor report = short report give several type of opinions (positive) auditors find no issue = nth to qualify Unqualifed Opinion (positive report) 99% – report means auditors found no problems Emphasis on Matter—Going Concern, uncertain lawsuit outcome (negative) reach out to the management first, eg. disagreement of accounting policies (but the firm is going the another way) Qualified Opinion – some disagreement with management not ncessarily a negative report as well Disclaimer – the scope of audit is limited eg. the company has operations in other countries —> dangerous to fly and check (not going to the physical location) Adverse Opinion – statement is not dependable eg. See example in CNOOC 2-18 Compensation of Directors and Executives (Required disclosure) Pubic companies are required to disclose the compensation Lets the investors know about management incentives but only regarding details of the disclosures but all countries have disclosure requirement (eg. how are the directors paid) Different countries have different requirements 2-19 Other Common Disclosure Notes Details about elements of financial statements voluntary disclosures, not required by IFRS – Earnings per share calculations – Property, plant, and equipment – Fair values of financial instruments – Debts, leases, provisions, inventory, etc. 2-20