Footnotes, Audit, & Analysis (15.2) Flashcards
Describe the importance & key points of financial statement notes
Financial statement notes (footnotes) include disclosures that provide further details about the information summarized in the financial statements. Footnotes allow users to improve their assessments of the amount, timing, and uncertainty of the estimates reported in the financial statements.
Footnotes:
Discuss the basis of presentation such as the fiscal period covered by the statements and the inclusion of consolidated entities.
Provide information about accounting methods, assumptions, and estimates used by management.
Provide additional information on items such as business acquisitions or disposals, legal actions, employee benefit plans, contingencies and commitments, significant customers, sales to related parties, and segments of the firm.
Describe the importance of Management’s commentary
**also known as management’s report, operating and financial review, and Management’s Discussion and Analysis (MD&A)
MD&A is one of the most useful sections of the annual report. In this section, management discusses a variety of issues. IFRS guidance recommends that management commentary address:
the nature of the business
management’s objectives
the company’s past performance (& the performance measures used)
the company’s key relationships, resources, and risks.
*Analysts must be aware that some parts of management’s commentary may be unaudited.
SEC requirements for MD&A for publicly held firms in the United States
For publicly held firms in the United States, the SEC requires that MD&A discuss trends and identify significant events and uncertainties that affect the firm’s liquidity, capital resources, and results of operations.
MD&A must also discuss:
Effects of inflation and changing prices IF MATERIAL.
Impact of off-balance-sheet obligations and contractual obligations such as purchase commitments.
Accounting policies that require significant judgment by management.
Forward-looking expenditures and divestitures.
Describe an audit, and it’s objective.
An audit is an independent review of an entity’s financial statements. Public accountants conduct audits and examine the financial reports and supporting records. The objective of an audit is to enable the auditor to provide an opinion on the fairness and reliability of the financial statements.
The auditor examines the company’s accounting and internal control systems, confirms assets and liabilities, and generally tries to determine that there are no material errors in the financial statements.
Describe the standard auditors opinion (3 parts)
Whereas the financial statements are prepared by management and are its responsibility, the auditor has performed an independent review.
Generally accepted auditing standards were followed, thus providing reasonable assurance that the financial statements contain no material errors. The auditor is satisfied that the statements were prepared in accordance with accepted accounting principles and that the principles chosen and estimates made are reasonable. The auditor's report must also contain additional explanation when accounting methods have not been used consistently between periods.
Describe an unqualified opinion
An unqualified opinion (also known as an unmodified or clean opinion) indicates that the auditor believes the statements are free from material omissions and errors.
Describe a qualified opinion
If the statements make any exceptions to the accounting principles, the auditor may issue a qualified opinion and explain these exceptions in the audit report.
describe an adverse opinion
The auditor can issue an adverse opinion if the statements are not presented fairly or are materially nonconforming with accounting standards.
describe a modified opinion
Any opinion other than unqualified is sometimes referred to as a modified opinion.
describe a disclaimer of opinion
If the auditor is unable to express an opinion (e.g., in the case of a scope limitation), a disclaimer of opinion is issued.
Describe the ‘going concern’ assumption
the assumption that the firm will continue to operate for the foreseeable future
*The auditor’s opinion will also contain an explanatory paragraph when a material loss is probable but the amount cannot be reasonably estimated. These “uncertainties” may relate to the going concern assumption, the valuation or realization of asset values, or to litigation.
This type of disclosure may be a signal of serious problems and may call for close examination by the analyst.
Describe the importance of internal controls
Internal controls are the processes by which the company ensures that it presents accurate financial statements.
Internal controls are the responsibility of management.
For publicly traded firms in the United States, the auditor must express an opinion on the firm’s internal controls. The auditor can provide this opinion separately or as the fourth element of the standard opinion.
Describe the audit report section: Key Audit Matters (international) or Critical Audit Matters (U.S.)
highlights accounting choices that are of greatest significance to users of financial statements.
These would include accounting choices that require significant management judgments and estimates, how significant transactions during a period were accounted for, or choices the auditor finds especially challenging or subjective and which therefore have a significant likelihood of being misstated.
6 steps of financial statement analysis framework
Step 1: State the objective and context. Determine what questions the analysis seeks to answer, the form in which this information needs to be presented, and what resources and how much time are available to perform the analysis.
Step 2: Gather data. Acquire the company’s financial statements and other relevant data on its industry and the economy. Ask questions of the company’s management, suppliers, and customers, and visit company sites.
Step 3: Process the data. Make any appropriate adjustments to the financial statements. Calculate ratios. Prepare exhibits such as graphs and common-size balance sheets.
Step 4: Analyze and interpret the data. Use the data to answer the questions stated in the first step. Decide what conclusions or recommendations the information supports.
Step 5: Report the conclusions or recommendations. Prepare a report and communicate it to its intended audience. Be sure the report and its dissemination comply with the Code and Standards that relate to investment analysis and recommendations.
Step 6: Update the analysis. Repeat these steps periodically and change the conclusions or recommendations when necessary.
What are the required SEC filings?
Form S-1. Registration statement filed prior to the sale of new securities to the public. The registration statement includes audited financial statements, risk assessment, underwriter identification, and the estimated amount and use of the offering proceeds.
Form 10-K. Required annual filing that includes information about the business and its management, audited financial statements and disclosures, and disclosures about legal matters involving the firm. Information required in Form 10-K is similar to that which a firm typically provides in its annual report to shareholders. However, a firm’s annual report is not a substitute for the required 10-K filing. Equivalent SEC forms for foreign issuers in the U.S. markets are Form 40-F for Canadian companies and Form 20-F for other foreign issuers.
Form 10-Q. U.S. firms are required to file this form quarterly, with updated financial statements (unlike Form 10-K, these statements do not have to be audited) and disclosures about certain events such as significant legal proceedings or changes in accounting policy. Non-U.S. companies are typically required to file the equivalent Form 6-K semiannually.
Form DEF-14A. When a company prepares a proxy statement for its shareholders prior to the annual meeting or other shareholder vote, it also files the statement with the SEC as Form DEF-14A.
Form 8-K. Companies must file this form to disclose material events including significant asset acquisitions and disposals, changes in management or corporate governance, or matters related to its accountants, its financial statements, or the markets in which its securities trade.
Form 144. A company can issue securities to certain qualified buyers without registering the securities with the SEC but must notify the SEC that it intends to do so.
Forms 3, 4, and 5 involve the beneficial ownership of securities by a company’s officers and directors. Analysts can use these filings to learn about purchases and sales of company securities by corporate insiders.
