FINANCIAL STATEMENT

ANALYSIS AND VALUE

INVESTING
XINJIE MA

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 FINANCIAL STATEMENT ANALYSIS
AND VALUE INVESTING

• Course introduction
• Student Survey: https://forms.gle/GjNdgeg9sKeCusjz5
• General Announcement on LumiNUS
• Office Hours:
• Tuesday 8:30 am – 11:30 am via Zoom
• By appointment
• Online teaching initially
• Assigned seating (if change to hybrid or in-person mode later)
• Course Outline - Syllabus

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 ACCOUNTING
- PERCEPTION VS. REALITY

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 ACCOUNTING:
THE PERCEPTION

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 ACCOUNTING:
THE REALITY

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 FINANCIAL STATEMENT
ANALYSIS AND VALUE
INVESTING
XINJIE MA

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 OVERVIEW

• Part I: Economics of Financial Reporting

• Part II: Financial Reporting Environment in Singapore
• Part III: Singapore Financial Reporting and Disclosure
Requirements
• Part IV: Singapore Exchange (SGX) Corporate Disclosure Policy

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 READING MATERIALS

• Revsine et al. Ch. 1 & 7.

• SFRS(I)s Preface to the Financial Reporting Standards (International)
• SFRS(I)s The Conceptual Framework for Financial Reporting
• SFRS(I)s 1-1 Presentation of Financial Statements
• SFRS(I)s 1-34 Interim Financial Reporting
• Companies Act s199-209A
• Accounting Standards Act 2007
• SGX Listing Manual
• Chap 7 Rules 703-711, Chap 12, and Appendices 7.1 & 7.2
• Self Review of Financial Statements: Revsine et al. Ch. 2, 4, & 17

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 PART I: ECONOMICS OF FINANCIAL
REPORTING

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 DEMAND AND SUPPLY
OF ACCOUNTING INFORMATION

Financial statement is demanded The supply of financial statement is

because of its value as a source of guided by the costs of producing
information about company and disseminating it and the
performance, financial condition, benefits it will provide to the
and resource stewardship. company.

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 DEMAND OF ACCOUNTING INFORMATION

The financial statements of business

enterprises serve two key functions:

Information Asymmetry
• Provide a way for company management to
transfer information about business activities to
people outside the company
Contract Efficiency
• Financial statement information is often included in
contracts between the company and other parties

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 INFORMATION ASYMMETRY PROBLEM

• Adverse selection (selection problem)

• Example: “lemons problem” by Akerlof (1970)
• Managers (seller) have information about the company that investors (buyer)
do not have but want to have
• Moral hazard (monitor problem)
• Investor (principal) demands financial/accounting information about company
in order to evaluate manager’s (agent) performance
• But information is supplied/produced by manager himself and he has
incentive to reveal information that maximizes his own interest

How to get managers to truthfully reveal the information that is useful to

users and can accurately reflect managers’ efforts?

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 HOW TO MITIGATE INFORMATION
ASYMMETRY PROBLEMS

• Internal mechanisms
• Corporate governance mechanisms
• More effective compensation packages (Revsine et al. Ch. 7)
• e.g. Stock options – to align interest of investors and managers

• External mechanisms
• Disclosure rules and accounting standards
• Audit and assurance
• Managers’ career concern
• Market for mergers and acquisitions
• Criminal penalty (jail) for misrepresentation, untruthful disclosure, fraud

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 SUPPLY OF ACCOUNTING INFORMATION

• Mandated reporting (e.g., SEC in the US, ASC in Singapore)

• Voluntary disclosures that go beyond the minimum requirements

• guided by cost/benefit considerations (i.e., disclosure incentives)
Disclosure Benefits Disclosure costs
• Information production
• Avoid the “lemons” problem, • Competitive disadvantage
i.e. signaling • Litigation cost
• Lower cost access to capital • Political cost

Companies that confront different financial reporting costs and benefits

are likely to choose different accounting and reporting practices.

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 TRANSPARENCY/OPACITY AND
COST OF CAPITAL (PWC 2001)

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 COST OF CAPITAL AND
EARNINGS TRANSPARENCY (JAE 2013)

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 GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES (GAAP)

• Financial statements are prepared under a set of Generally

Accepted Accounting Principles (GAAP).
• GAAP is reflected in a set of Accounting Standards promulgated by
the standards setting body in each country.
• International Accounting Standards Board (IASB) – based in London – sets
International Financial Reporting Standards (IFRS) which are adopted by
many countries including Singapore, Hong Kong, Mainland China.
• In the U.S., the Financial Accounting Standards Board (FASB) sets
Accounting Standards Codification (US GAAP).
• In Singapore, the Accounting Standards Council sets Financial Reporting
Standards (FRS). http://www.asc.gov.sg
• In China, the Ministry of Finance sets Chinese Accounting Standards
(CAS).

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 ADVERSARIAL NATURE OF FINANCIAL
REPORTING
• Flexibility exists because GAAP
• permits alternatives (e.g., FIFO vs Average)
• requires estimates (e.g., useful life of building)
• incorporates management judgments (capitalized or expensed?)
• Managers have incentives to sometimes exploit the flexibility
• smoothing the reported earnings numbers
• manipulating revenues or expenses to achieve bonus goals
• Forces to counterbalance opportunistic financial reporting practices
• Government authorities
• Auditors
• Courts

Case study: flexibility of GAAP and role of financial analysts

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 CASE STUDY: AMERICA ONLINE (AOL INC.)

• Wall Street analysts were uneasy about earnings quality because

of AOL’s unorthodox and aggressive accounting for certain
marketing costs.
• PR Newswire (Oct 29, 1996): The company also announced that
effective immediately it will expense all marketing costs as they are
incurred. Previously, the company has deferred the cost of certain
of its marketing activities, such as the costs of mailing diskettes to
prospective customers, and then amortized those costs over a
period of time.

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 AOL’S ACCOUNTING METHOD CHANGE

• Triggered a $385 million balance sheet write-off.

• Produced a net loss of $354 million for the quarter and erased five-
years of reported “profits”.
• Question to think about:
• Should AOL’s stock price fall or up
when the change was announced?
Assuming the change was
the only new information.

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 AOL’S ACCOUNTING METHOD CHANGE

• Triggered a $385 million balance sheet write-off.

• Produced a net loss of $354 million for the quarter and erased five-
years of reported “profits”.
• Question to think about:
• Should AOL’s stock price fall or up
when the change was announced?
Assuming the change was
the only new information.

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 PART II: FINANCIAL REPORTING
ENVIRONMENT IN SINGAPORE

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 STANDARD SETTING IN SINGAPORE

• Accounting Standards Council (ASC)

• Established by the Accounting Standards Act
• Responsible for setting accounting standards in Singapore
• Singapore Financial Reporting Standards (International) (SFRS(I)s)
• Financial Reporting Standards in Singapore (FRS)
• Singapore Financial Reporting Standard for Small Entities
• Accounting Standards for charities, co-operatives societies and societies

• Accounting Corporate Regulatory Authority (ACRA)

• Established by the Accounting and Corporate Regulatory Authority Act
• Responsible for monitoring corporate compliance with disclosure
requirements and regulating public accountants in Singapore

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 FULL CONVERGENCE WITH IFRS IN
SINGAPORE

• On 29 December 2017, the ASC issued Singapore Financial Reporting

Standards (International) (SFRS(I)s)
• The first volume of SFRS(I)s comprises standards and interpretations
equivalent to IFRSs that are applicable for annual reporting period
beginning on 1 January 2018
• The ASC will consider subsequent changes to IFRSs for adoption into
SFRS(I)s through its standard-setting due process
• For annual periods beginning on or after 1 January 2018, Singapore-
incorporated companies that have issued, or are in the process of issuing,
equity or debt instruments for trading in a public market in Singapore are
required to apply SFRS(I)s
• Entities applying SFRS(I)s can elect to state simultaneous compliance with
IFRSs in its SFRS(I) financial statements

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 FULL CONVERGENCE WITH IFRS IN
SINGAPORE: SIA (2019)

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 COMPLIANCE WITH THE ACCOUNTING
STANDARDS

• Compliance with the accounting standards is legally required; must

be 100%.
• Legal penalty otherwise
• Non-compliance exceptions:
• May be allowed if companies apply standard other than FRS (e.g., US
GAAP)
• May be approved if noncompliance is necessary for the accounts to present
a true and fair view of the company.

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 SUBSTANCE OVER FORM

• Is compliance with the accounting standards the only goal?

• No, compliance is necessary but not sufficient
• “True and fair” view overrides compliance with the accounting standards
(i.e., substance over form)
• The overriding factor is that financial statements must present a true and fair view of
the financial affairs of the enterprise (SFRS(I) 1-1, IAS 1, Companies Act s201)

Therefore, If it is a wolf but it was disguised in a “legal” form to look like

a goat, Substance Over Form would prevail to reinstate it is a wolf and
not a goat!

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 EXAMPLES: SUBSTANCE OVER FORM

Example
Company XYZ recorded two transactions:
• One (in a group of transactions) as a sale to customer ABC
• The other as a loan to the same customer with a similar amount

Analysis
• Form: a sale (hence sales revenue) and a loan, independently
• Substance: the sale is without substance as it is funded by the company

Attention
• To differentiate Substance from Form, one need to be vigilant, have very
good inner knowledge of the company’s operation and takes a more
investigative in-depth approach so as to seek further evidence or proof
• Many accounting fraud/scams occur as a result of the lack of Substance
over Form (Enron)

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PART II: FINANCIAL REPORTING
ENVIRONMENT IN SINGAPORE
• Regulatory agencies (ASC and ACRA)

• Accounting standards (SFRS(I), FRS, …)

• Compliance with the accounting standards

• Substance over form

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 PART III: SINGAPORE FINANCIAL
REPORTING AND DISCLOSURE
REQUIREMENTS

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 SINGAPORE DISCLOSURE REQUIREMENTS

• Companies Act (Chap. 50), as amended to-date – Part VI (s199-

209A)
• Singapore Financial Reporting Standards (International) (SFRS(I)s)
– issued by ASC
• SFRS(I) Interpretation (SFRS(I) INT) – issued by ASC
• Singapore Exchange Listing Manual (SGXLM) – issued by SGX
• Code of Corporate Governance – issued by CCDG, now governed
by MAS and SGX (not covered)
• Securities & Futures Act (Part XIII) – dealing with share offering
prospectuses (not covered)

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 KEY FINANCIAL REPORTS TO BE
PRODUCED
Operating and Financial Review (OFR) - a.k.a. Management
SGXLM OFR Guide
Discussion & Analysis (MD&A)

SGXLM
Corporate Governance Report
Code of Corporate Governance
Directors’ Statement (signed by at least 2 directors) CA s201 (16)
Auditors’ Report CA s201 (8)
Statement of Comprehensive Income CA s201; SFRS(I) 1-1; SGXLM
Statement of Financial Position (Balance Sheet) CA s201; SFRS(I) 1-1; SGXLM
Statement of Changes in Equity SFRS(I) 1-1
SFRS(I) 1-1, 1-7
Statement of Cash Flows

Accounting Policies SFRS(I) 1-1, 1-8

Explanatory Notes to Accounts SFRS(I) 1-1
Miscellaneous Items CA; SFRS(I) 1-1; SGXLM

• Illustrative examples: https://isca.org.sg/tkc/fr/resources/illustrative-financial-statements-disclosure-checklists/

• Real examples: https://www.sgx.com/securities/annual-reports-related-documents

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 DIRECTORS’ STATEMENT: SIA (2019)

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 AUDITOR’S REPORT: SIA (2019)

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 COMPLETE SET OF FINANCIAL
STATEMENTS

• A complete set of financial statements comprises of:

1. a statement of financial position at the end of the period;
2. a statement of comprehensive income for the period;
3. a statement of changes in equity for the period;
4. a statement of cash flows for the period;
5. notes, comprising a summary of significant accounting policies and other
explanatory information; and
6. comparative financial statements of the prior periods.
• An entity may use titles for the statements other than those
used in this Standard.
• Balance Sheet, Profit or Loss Account, Statement of Earnings, etc.

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 STATEMENT OF FINANCIAL POSITION

• Presentation of assets, liabilities and equity

• Based on a current and non-current distinction
• Main criteria: cash or cash equivalent, or expected to be realized, sold,
consumed or settled within the entity’s normal operating cycle or within 12
months after balance sheet date
• All other assets and liabilities are non-current
• Exception: presentation based on liquidity is more relevant and
reliable (e.g. for financial institutions)
• Note: some liquid investments could be non-current if companies
intend to hold it to maturity

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 STATEMENT OF FINANCIAL POSITION:
ILLUSTRATIVE EXAMPLE

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 STATEMENT OF FINANCIAL POSITION:
SIA (2019)

equity + non-current liabilities =

non-current assets +
current assets – current liabilities

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 STATEMENT OF COMPREHENSIVE INCOME

• Comprehensive income is the change in equity (or net assets) of a business

enterprise during a period from transactions and other events and circumstances from
nonowner sources. It includes all changes in equity during a period except those
resulting from investments by owners and distributions to owners.
• All components of “profit or loss”
• Other comprehensive income (OCI)
• Other comprehensive income comprises items of income and expense (including
reclassification adjustments) that are not recognized in profit or loss as required or
permitted by other FRSs.
• (a) changes in revaluation surplus (see SFRS(I) 1-16 Property, Plant and
Equipment and SFRS(I) 1-38 Intangible Assets);
• (b) gains and losses arising from translating the financial statements of a foreign
operation (see SFRS(I) 1-21 The Effects of Changes in Foreign Exchange Rates);
• (c) gains and losses on remeasuring available-for-sale financial assets (see
SFRS(I) 1-39 Financial Instruments: Recognition and Measurement);
• (d) actuarial gains and losses on defined benefit plans - not covered
• (e) the effective portion of gains and losses on hedging instruments - not covered

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 STATEMENT OF COMPREHENSIVE INCOME
- PROFIT OR LOSS

• An entity shall recognize all items of income and expense in a

period in profit or loss unless an FRS requires or permits otherwise
(SFRS(I) 1-1.88).
• When items of income and expense are material, their nature and
amount shall be disclosed separately (SFRS(I) 1-1.97-98). e.g.
• Write-downs of inventories or property, plant and equipment (PPE).
• Restructuring costs
• Gains or losses on disposal of non-current assets
• Discontinued operations
• Litigation settlements

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 STATEMENT OF COMPREHENSIVE INCOME:
SIA (2019)

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 STATEMENT OF CHANGES IN EQUITY
• An entity shall present a statement of changes in equity showing in
the statement:
• (a) total comprehensive income for the period, showing separately the total
amounts attributable to owners of the parent and to minority interest;
• (b) the amounts of transactions with owners in their capacity as owners,
showing separately contributions by and distributions to owners.

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OTHER REQUIRED DISCLOSURES (SFRS(I) 1-
1)

• Statement of Cash Flows – SFRS(I) 1-7 (Cash Flow Statements)

• Notes to the financial statements
• Accounting Policies used
• Key sources of estimation uncertainty
• Assumptions used in estimating the effects of uncertain future events on the carrying
amounts of assets and liabilities
• Entity’s objectives, policies and processes for managing capital
• Summary qualitative and quantitative information to explain debt capital structure
• Compliance with externally imposed capital requirements, if any (e.g. capital adequacy
requirements for banks)
• Others:
• Dividends proposed or declared but not yet recognized in accounts
• Country of incorporation and registered address
• Description of principal activities and operations
• Name of immediate parent and ultimate parent company

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 ADDITIONAL DISCLOSURES UNDER SGX
LISTING MANUAL (ONLY FOR LISTED FIRMS)

• Some of the key additional disclosures required under SGX Listing Manual
Chap 12 & Appendix 7.2:
• Review of operating and financial performance, business outlook, and
commentary of significant trends and competitive industry conditions
• See also CCDG Guide for Operating and Financial Review – for listed companies.
However, adherence to this guide is voluntary.
• Fees paid to auditors for non-audit work. (in case of conflicts that
auditors need to settle)
• Directors’ interests in shares of the company.
• Material contracts with CEO, directors or controlling shareholders.
• Shareholding structure.
• Listing of real estate properties (with details).
• Directors’ remuneration.
• Employee share option scheme.
• Debt due – within one year/after one year, secured/unsecured.
• Net asset value per share.

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 DEADLINES FOR RELEASE OF ANNUAL
RESULTS

4 months

60 days 14 days

Financial Preliminary annual Full annual financial Share-

year-end financial statements report (audited) to holders
(e.g. Dec 31, (unaudited) shareholders & AGM
2007) SGX

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PART III: SINGAPORE FINANCIAL
REPORTING AND DISCLOSURE
REQUIREMENTS
Directors’ Statement (signed by at least 2 directors) CA s201 (16)
Auditors’ Report CA s201 (8)
Statement of Comprehensive Income CA s201; SFRS(I) 1-1; SGXLM
Statement of Financial Position (Balance Sheet) CA s201; SFRS(I) 1-1; SGXLM
Statement of Changes in Equity SFRS(I) 1-1
SFRS(I) 1-1, 1-7
Statement of Cash Flows

Accounting Policies SFRS(I) 1-1, 1-8

Explanatory Notes to Accounts SFRS(I) 1-1
Miscellaneous Items CA; SFRS(I) 1-1; SGXLM

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 PART IV:
SINGAPORE EXCHANGE (SGX)
CORPORATE DISCLOSURE POLICY

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• 678 companies listed on SGX as of 30 June 2021

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 INTERIM FINANCIAL REPORTING
(SFRS(I) 1-34)
• For interim reports, a company may produce a complete set of financial
statements (as in annual reporting) or a condensed set of financial statements.
• Interim reports must be released within 45 days after the relevant financial
period.
• Financial report for the final interim period is not necessary, but…
• if an estimate is changed significantly during the final interim period, the
nature and amount of the change should be disclosed in the annual
statements.
• Semi-annual reporting:
• Mandatory for all SGX-listed companies
• Quarterly reporting:
• Voluntary
• Exception: SGX risk-based quarterly reporting (see next page)

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 SGX RISK-BASED QUARTERLY REPORTING

• Singapore Exchange Regulation (SGX RegCo) applies quarterly reporting

(QR) requirements only for companies associated with higher risks while
strengthening continuous disclosure requirements on all listed companies
(Effective 7 February 2020).
• Previous reporting requirement (market cap > 75 mil.) too arbitrary and not
meaningful
• Now “a risk-based approach is more appropriate because it targets
companies that are of greatest concerns to regulators and investors,
enabling more effective monitoring of how their concerns are being
addressed”
• Companies associated with higher risks:
1. they have a modified audit opinion on their latest financial statements,
2. their auditors have highlighted a material uncertainty relating to going
concern based on their latest financial statements; and/or
3. SGX has regulatory concerns about them. Issuers have a 1-year grace
period to commence QR, unless otherwise determined by the SGX.

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 SGX CORPORATE DISCLOSURE POLICY

https://www.sgx.com/regulation/quarterly-reporting
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 SGX CORPORATE DISCLOSURE POLICY

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 SGX CORPORATE DISCLOSURE POLICY

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 SGX CONTINUOUS DISCLOSURE

• SGX Listing Manual chap 7 Rule 703, Appendix 7.1, Practice Note 7.1
• Require all listed firms to timely disclose (immediately - within 24 hours)
material information
• that is necessary to avoid the establishment of a false market for the company’s
securities (trade-sensitive information)
• that would likely have a material effect on price or value of its securities (materially
price-sensitive information)

• Dissemination of information should be thorough and public, not selective.

• Except disclosure to relevant parties (e.g. banks, financial advisers) in a major
corporate exercise under appropriate confidentiality restraints (e.g. non-disclosure
agreement or NDA).

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 DISCLOSURE EXEMPTIONS UNDER RULE
703
• Disclosure is exempted if:
• Disclosure would breach the law (e.g. confidentiality) or
• 1) a reasonable person would not expect the information to be disclosed, 2) the
information is confidential, and 3) one or more of the following applies:
o It concerns an incomplete proposal or negotiation
o It comprises matters of supposition or is insufficiently definite.
o It is generated for internal management use.
o It is a trade secret.
• Such exemption from disclosure may be temporary; disclosure may become necessary at
some later stage.
• However, the following should be observed:
• Undisclosed information should be kept strictly confidential.
• Access to information should be restricted to key officers on need-to-know basis.
• Such officers should be either prohibited from trading in the firm’s securities during a
specified time frame or be required to report all such trades.

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 COMMON EVENTS TRIGGERING
DISCLOSURE UNDER RULE 703
• Merger, acquisition, joint venture
• Firm evidence of significant improvement
or deterioration in near-term prospects
• Acquisition or loss of significant contract
• Purchase or sale of significant asset
• Significant new product or discovery
• Significant sale of securities
• Change in control, tender offer
• Significant change in management
• Large borrowing
• Event of default on debt securities
• Significant litigation
• Dispute with customers or supplies
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• Significant change in capital investment
plans
• Significant change in valuation of assets
• Rumors or reports in the media that
require confirmation, denial and/or
clarification.
(But no response to an analyst or media
report predicting future sales or earnings
is required, unless the report is materially
incorrect and may mislead investors, or
report suggests leakage of confidential
information.)
• Unusual trading activity in the firm’s
shares
• Leakage of hitherto confidential
information
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 EXAMPLE: NEPTUNE ORIENT LINES

NOL dives on Dow Jones report of rights issue plan

Tuesday, 10 March 2009 16:23
The EDGE Singapore

Shares of Neptune Orient Lines (NEPS.SI), the world’s seventh-largest container

shipper, fell as much as 12.7% today after a Dow Jones report that the
company is considering a rights issue to raise more than US$250 million,
according to Reuters.
By 3:52pm, NOL was down 10.8% at 91 cents, underperforming the benchmark
Straits Times Index which gained 0.8%.
NOL did not respond to emails asking for a comment or answer telephone calls.
Banking sources told Reuters that NOL, like other companies in which Singapore
state investor Temasek Holdings (TEM.UL) has a stake, is considering ways to
bolster its capital, but no mandates have been given out.

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 EXAMPLE: NEPTUNE ORIENT LINES

ANNOUNCEMENT ON SHARE PRICE FLUCTUATIONS

Neptune Orient Lines Limited (the "Company") wishes to announce that in the
course of its business, the Company continually evaluates all available options to
improve its performance and strategic position. It is the Company’s policy not to
comment on market rumour or speculation. We confirm that the Company has not
entered into any agreements that would require disclosure in accordance with the
SGX-ST Listing Rules.
It is the Company’s policy to make appropriate announcements to update
shareholders as and when circumstances warrant.
10 March 2009

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PART IV: SINGAPORE EXCHANGE
(SGX) CORPORATE DISCLOSURE
POLICY

• Interim reporting

• Continuous reporting

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 WRAP-UP

• Part I: Economics of Financial Reporting

• Part II: Financial Reporting Environment in Singapore
• Part III: Singapore Financial Reporting and Disclosure
Requirements
• Part IV: Singapore Exchange (SGX) Corporate Disclosure Policy

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