(c) 2007 prentice hall, inc.1-1 financial statements an overview mapormaze
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(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Financial StatementsFinancial StatementsAn OverviewAn Overview
MaporMaze
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Financial StatementsFinancial StatementsAn OverviewAn Overview
Map
Auditor’s Report
Statement of Cash Flows
MD&A
Statement of Shareholders’ EquityBalance Sheet
Note
s
Inco
me S
tate
ment
orMaze
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Our Objective:Our Objective:
To ensure that financial statements To ensure that financial statements serve as a map, not a mazeserve as a map, not a maze
The better one can read and The better one can read and understand the financial understand the financial statements, the more useful statements, the more useful they are as a MAP to intelligent they are as a MAP to intelligent decision-making decision-making
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Volume of Information:Volume of Information:The Annual ReportThe Annual Report
1.1. Introduction (period covered; board of Introduction (period covered; board of directors; change in capital; dividends directors; change in capital; dividends distributed in the last 3 years; major distributed in the last 3 years; major shareholders; business industry) shareholders; business industry)
2.2. ActivitiesActivities1.1. InvestmentsInvestments2.2. Production of Goods and ServicesProduction of Goods and Services3.3. Financial StructureFinancial Structure
1.1. Financial StatementsFinancial Statements
4.4. AdministrativeAdministrative
3.3. Proposed Profit Distribution Proposed Profit Distribution
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Financial StatementsFinancial Statements
Prepared according to generally Prepared according to generally accepted accounting principles accepted accounting principles (GAAP)(GAAP)
Present financial information that is Present financial information that is understandable by users ANDunderstandable by users AND
relevant and reliable for relevant and reliable for decisiondecision
making making
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GAAPGAAP Global: Two major accounting Global: Two major accounting
standards:standards: IFRS (IASB)IFRS (IASB) US GAAP (FASB)US GAAP (FASB)
TURKEYTURKEY Capital Markets Board StandardsCapital Markets Board Standards TAS (TMSK)TAS (TMSK)
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Classification of Accounting Classification of Accounting SystemsSystems Continental Europe Anglo Saxon
Economic Environment
Capital MArkets Funds obtained through the banking system
Funds obtained through capital markets
Legal System Detailed laws and regulations Case based laws
Fiscal system Financial accounting and tax regulations are interrelated
Tax regulations don’t affect financial accounting
Objective of Accounting
Users of accounting information
Banks and other financial institutions, tax offices and investors
Especially investors
Accounting principles Aims at accurate tax assessment
Aims at accurate reporting of financial position
Scope of disclosure Inadequate disclosure Disclose information as much as possible
Examples Turkey Belgium Germany France Italy Japan Portugal Switzerland
Australia United Kingdom Ireland Canada New Zeland Netherlands Singapore USA
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Development of International Development of International Accounting StandardsAccounting Standards
International Financial Reporting International Financial Reporting Standards (IFRS-IASB)Standards (IFRS-IASB)
14 member committee of auditors, 14 member committee of auditors, accountants, academics and financial accountants, academics and financial statement usersstatement users
Developed International Accounting Developed International Accounting Standards (IAS) to help investors cope with Standards (IAS) to help investors cope with financial analysis in global capital marketsfinancial analysis in global capital markets
Currently in use by European Union, Currently in use by European Union, Australia, South Africa …Australia, South Africa …
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Where to Find a Where to Find a Company’s Financial Company’s Financial Statements:Statements:
Istanbul Stock Exchange web siteIstanbul Stock Exchange web sitehttp://www.imkb.gov.tr/bilanco/http://www.imkb.gov.tr/bilanco/
mtablodonem.htm mtablodonem.htm
Annual reportAnnual report Website of the companyWebsite of the company
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The Four Basic The Four Basic Financial StatementsFinancial Statements
1.1. Balance SheetBalance Sheet
2.2. Income Statement or Earnings Income Statement or Earnings Statement Statement
3.3. Statement of Stockholders’ Statement of Stockholders’ EquityEquity
4.4. Statement of Cash FlowsStatement of Cash Flows
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Financial Statement NotesFinancial Statement Notes
An INTEGRAL part of the statementsAn INTEGRAL part of the statements Provide summary of accounting policiesProvide summary of accounting policies Present detail about particular accounts Present detail about particular accounts
(e.g. inventory, investments, etc.)(e.g. inventory, investments, etc.) Include other information (e.g. leasing Include other information (e.g. leasing
arrangements, pending legal arrangements, pending legal proceedings, income taxes, etc.) proceedings, income taxes, etc.)
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Financial Statement NotesFinancial Statement Notes (cont.)(cont.) some supplementary informationsome supplementary information
such as:such as: Information on foreign currency Information on foreign currency
translations for firms operating in translations for firms operating in foreign countriesforeign countries
Information by segment for firms Information by segment for firms with several lines of businesswith several lines of business
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Auditor’s ReportAuditor’s Report
UnqualifiedUnqualified
QualifiedQualified
Adverse opinionAdverse opinion
Disclaimer of opinion Disclaimer of opinion
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Auditor’s Report Auditor’s Report (cont.)(cont.)
UnqualifiedUnqualified (what you want!) (what you want!) Statements present information in Statements present information in
conformity with GAAPconformity with GAAP
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Auditor’s Report Auditor’s Report (cont.)(cont.)
UnqualifiedUnqualified (what you want!) (what you want!) Statements present information in Statements present information in
conformity with GAAPconformity with GAAP
QualifiedQualified Reports other than an unqualified Reports other than an unqualified
opinion due to various opinion due to various circumstancescircumstances
Typically use word “except for”Typically use word “except for”
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Auditor’s Report Auditor’s Report (cont.)(cont.)
Adverse opinion Adverse opinion (not what you (not what you want!) want!)
Financial statements have not been Financial statements have not been presented fairly in accordance with presented fairly in accordance with
GAAPGAAP
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Auditor’s Report Auditor’s Report (cont.)(cont.)
Disclaimer of opinion Disclaimer of opinion isis issued issued whenwhen
auditor can’t evaluate the fairness of auditor can’t evaluate the fairness of the statements and expresses no the statements and expresses no opinionopinion
there is material scope limitation of there is material scope limitation of the auditthe audit
there is lack of independence by the there is lack of independence by the auditorauditor
remember, the auditor is hired by the remember, the auditor is hired by the firm being audited, so there is always firm being audited, so there is always the possibility of conflict of interestthe possibility of conflict of interest
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Auditor’s Report Auditor’s Report (cont.)(cont.)
Unqualified opinion with Unqualified opinion with explanatory languageexplanatory language is is warranted when there is warranted when there is
a consistency departure due to a a consistency departure due to a change in accounting principlechange in accounting principle
uncertainty caused by future events uncertainty caused by future events such as contract disputes and such as contract disputes and lawsuits lawsuits
an event (or events) that the auditor an event (or events) that the auditor wisheswishes to describe because they to describe because they maymay present business risk and/or present business risk and/or going-concerngoing-concern problemsproblems
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Why use financial Why use financial statements? statements?
Financial position of the companyFinancial position of the company Success of its operationsSuccess of its operations Policies and strategies of Policies and strategies of
managementmanagement Insight into future performanceInsight into future performance
Savvy use of financial statements allows user to assess:
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Questions one might ask:Questions one might ask:
Would an investment generate Would an investment generate attractive returns?attractive returns?
What is the degree of risk What is the degree of risk inherent in the investment?inherent in the investment?
Should existing investing Should existing investing holdings be liquidated?holdings be liquidated?
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Questions one might askQuestions one might ask (cont.)(cont.) Will cash flows be sufficient to Will cash flows be sufficient to
service interest and principal service interest and principal payments on debt?payments on debt?
Does company provide a good Does company provide a good opportunity for employment?opportunity for employment?
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Questions one might ask Questions one might ask (cont.)(cont.) How well does this company How well does this company
compete in its operating compete in its operating environment?environment?
Is this firm a good prospect as Is this firm a good prospect as a customer?a customer?
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Missing and Missing and Hard-to-Find InformationHard-to-Find Information
Employee relations with Employee relations with managementmanagement
Morale/efficiency of employeesMorale/efficiency of employees Reputation/public perceptions Reputation/public perceptions
of firmof firm
Not available in the financial statements:
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Missing andMissing and Hard-to-Find InformationHard-to-Find Information (cont.)(cont.) Effectiveness of management Effectiveness of management
team/provisions for successionteam/provisions for succession Potential exposure to Potential exposure to
regulatory changesregulatory changes
QUALITIES THAT IMPACT QUALITIES THAT IMPACT OPERATING SUCCESS BUT ARE OPERATING SUCCESS BUT ARE
DIFFICULT TO QUANTIFY DIFFICULT TO QUANTIFY
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Missing and Missing and Hard-to-Find Information Hard-to-Find Information (cont.)(cont.)
Affects public perception of firm Affects public perception of firm and can impact financial and can impact financial performanceperformance
Proven correlation between Proven correlation between financial returns and reputationfinancial returns and reputation
A recent example of adverse A recent example of adverse publicity is Enron for denying their publicity is Enron for denying their involvement in any wrongdoing involvement in any wrongdoing
Publicity in the Media
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Complexities-1Complexities-1
Accounting choices and estimatesAccounting choices and estimates Management judgment- accrual basis Management judgment- accrual basis
of accountingof accounting Complex merger&acquisition Complex merger&acquisition
transactionstransactions GoodwillGoodwill ConsolidationConsolidation
Use and accounting for derivativesUse and accounting for derivatives Foreign OperationsForeign Operations
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Complexities-2Complexities-2
Complexity of GAAP (i.e. IFRS)Complexity of GAAP (i.e. IFRS) Frequent change in GAAPFrequent change in GAAP
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Quality of Financial Quality of Financial Reporting (Earnings)Reporting (Earnings)
Persistence (Sustainability)Persistence (Sustainability) Predictability (ability of past Predictability (ability of past
earnings to predict future earnings to predict future earnings)earnings)
Closeness to cashCloseness to cash
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Earnings ManagementEarnings Management
Approach Total Increase DecreaseNo Clear
EffectExpenses and Other Losses 52% 49% 42% 9%Revenue and Other Gains 22% 75% 18% 7%Business Combinations 13% 18% 33% 49%Other Approaches 13% 63% 6% 31%
Current Period Income EffectSummary of Earnings Management Approaches
A survey study carried out in 1998. Based On 253 response of senior auditors. Identified 515 attempts of earnings management.
•Nelson, Elliot and Tarpley (2003), How are Earnings Managed?, Accounting Horizons
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