Financial

Reporting
Relevance to
Corporate Governance

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 Financial Reports
 Directors' Report
 The first section of final report is a narrative often in
the form of letter from the chairman to its
shareholders giving three important pieces of
information.
 Firstly, comments on the company performance.
 Secondly, an assessment of what lies in the
immediate future.
 Thirdly, a statement about the company’s
policies, principles and strategies developed to
meet the challenges of the future.

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 Financial Reports
Financial Statements
The second section of the report comprises of
four financial statements , namely
 Balance Sheet

 Income Statement

 Statement showing a moving of Equity

 Cash Flow Statement

 Notes: To be considered important as accounts themselves
as they provide an insight into the company’s accounting
policies and manner of treating various financial items

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 Notes to Accounts
 Accounting methods and policies used
i.e (i. GAAP ii. IFRS) GAAP (generally accepted accounting
principles) is a collection of commonly-followed accounting rules and
standards for financial reporting. (IFRS: (International
( Financial
Reporting Standards) is designed to provide a global framework for how
public companies prepare and disclose their financial statements.
 Greater details of summarized figures
 Statutory disclosures (Details of directors and
managers salary; Break up of share ownerships)
 Changes in accounting policies / impact
 Details of off-balance sheet items, if any
 (Legal Liability)

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 Qualities of Financial
Statements
 Clear & understandable
 Reliable & honest
 No frauds
 No window dressing

 Properly audited

 Compliant with laws/ rules/ practice

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 Functions of Fin
Statements
 Information Function
 Stakeholders
 Control Function
 Owners (What should to reinvest again?)
 Planning
 Management

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 Investors’ Interest in
Financial Statements
 Instrument ratings
 Shares
 Bonds

 Buy / sell / hold decisions

 Pricing / valuation of the company
 Acquisitions
 Mergers

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 Financial Statements
 1. Balance sheet
 Assets = Equity + Long term Liabilities
 Assets are sometimes defined as resources or things of value
that are owned by a company e.g cash, accounts receivable,
inventory, investments, land, buildings, and equipment.
 Equity: In accounting, equity (or owner's equity) is the
difference between the value of the assets and the value of the
liabilities of something owned.
 Long term Liabilities: Long-term liabilities are financial
obligations of a company that become due more than one year.
In accounting, they form a section of the balance sheet that
lists liabilities not due within the next 12 months including
debentures, loans, deferred tax liabilities and pension
obligations.
 Balance sheet
 Fixed, Current, Tangible, Intangible Assets
 Fixed Assets e.g land, buildings, and equipment.
 Current Assets : Cash and other assets that are expected to
be converted to cash within a year: e.g Cash, including foreign
currency, Accounts receivable, Inventory
 Tangible Assets: e.g such as machinery, buildings
and land, and current assets, such as inventory.
 Intangible Assets: eg Nonphysical assets, such as patents,
trademarks, copyrights, goodwill and brand recognition,
 Investments: e.g stocks, bonds, mutual funds,
interest-bearing accounts, land, derivatives, real estate,
artwork, old comic books, jewelry -- anything an investor
believes will produce income (usually in the form of
interest or rents) or become worth more.

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 Balance sheet
 Working Capital (the capital of a business which
is used in its day-to-day trading operations, calculated
as the current assets minus the current liabilities)
 Current liabilities:
 Accounts payable. These are the trade payables due to suppliers,
usually as evidenced by supplier invoices.
 Sales taxes payable. ...
 Payroll taxes payable. ...
 Income taxes payable. ...
 Interest payable. ...
 Bank account overdrafts. ...
 Accrued expenses. ...
 Customer deposits.

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 Long term liabilities: Long-term
liabilities are financial obligations of a
company that become due more than
one year. e.g. Bond

 Bonds/Debentures ( Debentures: a long-

term security yielding a fixed rate of
interest, issued by a company and
secured against assets.)
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Financial Statements

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Financial Statements

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 Financial Statements
 2. Income /Profit & Loss Statements
 Trading Part ( Sales, direct expenses,
gross profit)
 Profit & Loss Part (Gross operating
profits)
 Profit & Loss appropriation part
 ( In this part, net profit for the year, deduction of
applicable tax and reached toward Profit after tax)
 ( Moreover, recommendation of proposed dividend,
payment of interim dividend)

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 Financial Statements
 3. Cash Flow Statement
 Financing
 Investing

 Operating

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Financial Statements

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 Key Issues
 Why would management want its
financial statements to be untrue?
 Consequences of unreliable financial
statements
 Role & independence of external
auditors
 How can reliability be assured?
 No sudden collapse in near future

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 Misleading Statements
 Deliberate false picture of the
company
 Improper accounting policies
 Revenue and expense recognition
 Capital and revenue expenditure

 Income and liability distinction

 Creating complexities in financial

statements

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 Case 1:
Deliberate false picture
A Ltd wishes to show a higher profit. It
can:
 overvalue its closing stock.

 Not make expense accruals

 Not make various provisions

 Bad debts / legal obligations
 Investments revaluations

 Book false gains through sale-purchase

back.
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 Case 2:
Misuse of Accounting
Policies
 Revenue recognition
 Book revenue before earning it to
increase profits
 Defer revenue to reduce profits

 Expense recognition
 Defer expenses to increase profits
 Make unreal provisions to reduce
profits

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 Case 3:
Playing with debits
 Show a higher profit by
 Capitalizing normal revenue expenses,
treating them as assets.
 Deferring start of depreciation or
interest expensing.

 Show lower profits by expensing the

capital costs

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 Case 4:
Playing with credits
 Show higher profits by treating
liabilities as incomes, e.g.
 An advance from a client/taxes may be
credited to revenue.
 A loan may be channeled through a SPV
and treated as income
 Show lower profits by treating
revenue as a liability, e.g. Microsoft.

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 Case 5:
Change in Accounting
Policy
A company can alter its profit figures
A company can alter its profit figures
through change in accounting policy
and deliberately omit to mention the
change of policy in notes, or omit to
give the correct impact of the change.
Examples:
 Valuation Basis

 Depreciation Basis

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 Case 6:
Complicating Fin
Statements
A company can make its financial
statements too complex for an
average investor to understand. In
particular, having different
accounting policies, closing dates
and natures of business offers
tremendous scope for play in
consolidated financial statements.

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 Responsibility for health
of
Financial Statements
 The Board
 Management (including internal
auditor)
 External Auditors
 External Bodies
 Regulators: KSE/SECP
 Accounting bodies: ICAP/ICMAP

 Trade associations

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 The Board’s Role
 Importance of NEDs
 Significance of INEDs
 Audit Committee

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 Management’s Role
 Management draws accounting
policies, keep accounts and prepares
financial statements.
 Management has most to gain or
lose from the defects of financial
statements
 Hence, management needs highest
degree of monitoring in this aspect.

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 External Auditors’ Role
 Every one depends on external
auditors’ report.
 Independence of external auditors
must be assured:
 Rotating them regularly
 Not giving them any other business

 Granting them full access to all records

 Limiting their relationship with

management
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 External Audit: Purpose
 Only purpose is to obtain an opinion.
 External auditors is not supposed to
fix the financial statements.
 Report:
 Unqualified
 Qualified

 Disclaimer

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 Audit Report: Scope
 Clarify basis of forming an opinion
 Proper records have been kept
 Financial statements:
 are in accordance with the records
 reflect a true and fair view of the profit
& position
 comply with the laws

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 Errors and Frauds
 Difference is only of intent
 Both result in:
 Incorrect use of accounting policies,
 Omission of facts, or

 Misinterpretation of facts

 Basic responsibility to prevent and

detect errors/frauds lies with
management, not external auditor.

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 Professional Monitors of
External Auditors
 Accounting Standards from IFAC
 International Federation of Accountants
 Ethical Standards from ESB
 Audit Standards from APB (UK)
 Audit practicing Board
 Investigation & Discipline Board
(UK)

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Professional Monitors of
External Auditors
 Review Board (UK)
 Public Company Accounting
Oversight Board (Sarbanes-Oxley
Act) in USA
 ICAP and SECP in Pakistan
 The Institute of Chartered Accountants of
Pakistan
 Securities & Exchange Commission of Pakistan

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Guidelines to Audit firms
 Do not rely on one client for major
part of firm’s fee revenue.
 No linkages with clients
 Non-audit services should not be
given (or at least be restricted) to
clients

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 Non-Audit Work
 Taxation
 Investigations (for acquisitions, etc.)
 General consultancy on new projects
 Systems development
 Low-balling

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How to control non-audit
work
 No restriction on audit firms –
leaving it to their professional
judgment.
 Total prohibition on non-audit work.
 Partial prohibition on non-audit
work, defined either by nature of
work, or level of approval.

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 Rotation of External
Auditors
 Rotation of audit firm – as
prescribed by Pakistan laws
 Rotation of partners within the same
firm.
 Different partners for different tasks
 Appointment by open tender

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 Objectives of Fixing
Financial Statements
 Managing Position
 Managing Profits

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 Managing Position
 To meet rules and regulations
 To meet lenders’ covenants
 To portray better picture to public
 Keep assets or liabilities off balance
sheet
 Window dressing

 Misclassification of items

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 Earnings Management
 To keep share price stable, or rising
 To meet market expectations
 To maintain dividend payout pattern
 Smoothening needs
 Hidden (misclassified) reserves

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 Creative Accounting
 Standards do not cover every thing.
 There is always more than one
correct way of handling things
 Legitimate and dishonest intentions
 Outright fraud: double set of books

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 Directors
Responsibilities
 To prepare accounts
 To prepare directors’ report
 Balanced and understandable assessment
 State of affairs; going concern

 Outline directors’

 To make legal disclosure

 To present the above to shareholders
 To file returns

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 Voluntary Disclosures
 Future events or plans
 Changes in administration or policy
 Achievements
 Concerns

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Role of Audit Committee
 To monitor the integrity of financial
statements
 To review internal controls & audit
 To review risk management systems
 To approve terms & remuneration of
external auditors
 To ensure independence of external
Auditors
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 External Auditor &
Audit Committee
 Negotiations with external auditor
 Verifies suitability of the external auditor
 Their resources, qualifications, independence,
past record
 Ensures independence
 Linkages, non-audit work
 Rotation, former employees of audit firm
 Audit firm’s performance, ethics
 Discusses report / management letter with
external auditor
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 Audit Cycle
 Audit plan / internal / external
 Discussion of audit plan with auditors
 Contact during audit
 Review of findings, major issues
 Oversee all correspondence with
external auditors
 Representations letter
 Management letter

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Thank you

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