© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 2 1

CHAPTER 2 Accounting and its relationship to Shareholder Value and Corporate Governance © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 2 2

Learning Objectives What is the relationship between capital markets and product markets? What is value-based management and how does it relate to accounting? What is economic value added (EVA) and why is it important to management? What is the relationship between strategy, shareholder value, and accounting? What is corporate governance and what are the basic principles of corporate governance in Canada? © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 2 3

4 Capital and Product Market Structure and Interaction

Capital Markets Equity = shareholders’ investment Debt = borrowings from financiers Cost of capital  Cost of Debt = interest rate  Cost of Equity = dividend and capital growth  Weighted average cost of capital (WACC) = the different costs of each form of capital, weighted by the proportions of different forms of debt and equity © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 2 5

Product Markets Companies use of their capital to invest in technologies, people, and materials in order to make, buy, and sell products or services to customers © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 2 6

Value-based Management Shareholder value is the primary goal of every business  Total shareholder return  Dividends + increase in share price as a % of initial investment  Market value added  Market capitalization minus capital invested  Shareholder value added  Increase in shareholder value over time based on discounted future cash flows  Economic value added (EVA™)  Economic profits generated by a business: net operating profit after deducting a charge to cover the opportunity cost of the capital invested in the business © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 2 7

8 The Shareholder Value Network

Decisions Influencing Value Drivers 1. Operating decisions  including product mix, pricing, promotion, and customer service, which are then reflected in the sales growth rate, operating profit margin, and income tax rate. 2. Investment decisions  in both inventory and capacity, which are then reflected in both working capital and fixed capital investment. 3. Financing decisions  the mix of debt and equity and the choice of financial instrument determine the cost of capital, which is assessed by capital markets in terms of business risk. © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 2 9

Shareholder Value, Strategy and Accounting Strategy  Influences and is influenced by shareholder value  Reflected in marketing, operations and human resources Financial management  Raising debt and equity; managing cost of capital Financial accounting  Stewardship function Management accounting  Information for planning, decision making and control © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 2 10

Shareholder Value, Strategy and Accounting © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 2 11

THE REGULATION OF COMPANIES An organization can incorporate under federal, provincial, or territorial law.  If registered federally is governed by the Canada Business Corporations Act (CBCA).  If a company is incorporated provincially, it will fall under one of the provincial corporation acts, such as the British Columbia Business Corporations Act or the Ontario Corporations Act. Sets out the effect of incorporation  Memorandum and Articles of Association  Rights of shareholders to appoint directors  Auditors  Annual Report © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 2 12

Corporate Governance System by which companies are directed and controlled Shareholder value versus stakeholder model  UK Combined Code on Corporate Governance versus King Report in South Africa  US Sarbanes-Oxley Act Emergence of corporate governance  Enforcement following corporate failures  Changing financial markets and institutional investors  Ageing population and reliance on pensions © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 2 13

Role of Board of Directors To provide entrepreneurial leadership of the company within a framework of prudent and effective controls which enables risk to be assessed and managed. To set the company’s strategic aims, and ensure that the necessary financial and human resources are in place for the company to meet its objectives and review management performance. To set the company’s values and standards and ensure that its obligations to its shareholders and others are understood and met. © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 2 14

Principles of Corporate Governance Manipulation of share prices  Prohibited from committing fraud that will mislead the public or create an artificial price for the company’s shares The roles and responsibilities of directors and their remuneration Accountability and audit Internal control Disclosure of governance arrangements in annual reports. Obligations to its shareholders and others are understood and met © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 2 15

Responsibility of Directors Keeping proper accounting records that disclose with reasonable accuracy the financial position of the company at any time Ensure that financial reports comply with generally accepted accounting principles (GAAP) Safeguarding the company’s assets and for taking reasonable steps to prevent and detect fraud Chief executive officers (CEOs) and chief financial officers (CFOs) are required to personally certify  that the company’s financial statements do not contain any material misrepresentations  that the financial statements and other financial information fairly present the corporation’s financial condition Select suitable accounting policies and apply them consistently Make judgments and estimates that are reasonable and prudent Prepare financial reports on a going concern basis unless it is inappropriate to presume that the company will continue in business © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 2 16

Audit Periodic examination of the accounting records of a company carried out by an independent auditor to ensure that  Those records have been properly maintained  The financial statements that are drawn up from those records do not contain any material misrepresentations  The financial statements and other financial information fairly present the corporation’s financial condition An audit committee is a committee of the board of directors to which the board delegates responsibility for oversight of the financial reporting process © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 2 17

Other Forms of Audit Reports Review engagements Agreed-on procedures Compilation reports © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 2 18

Risk, Internal Control and Management Accounting Risk  Uncertain future events which could influence the achievement of organization’s strategic, operational, and financial objectives  Risk management  Identifying & assessing risk, risk response, monitoring & reporting © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 2 19

Risk, Internal Control and Management Accounting Internal control  The whole system of internal controls (financial and other) to provide reasonable assurance of effective and efficient operation, internal financial control and compliance with legislation Internal financial controls are established to provide  reasonable assurance of the safeguarding of assets against unauthorized use or disposition  the maintenance of proper accounting records  the reliability of financial information used within the business or for publication. © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 2 20

© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 2 21 A Critical Perspective Stakeholder theory  Looks beyond shareholders to those groups who influence, or are influenced by, the organization  Concerned with how the power of stakeholders, with their competing interests, is managed by the organization in terms of its broader accountabilities Strategy  Mintzberg (1994) was critical of strategic planning because it is a “calculating style of management,” resulting in strategies that are extrapolated from the past or copied from others  Saw some strategy as deliberate but other strategy as an emergent process, which should lead to learning  Dermer (1988) suggested a broader view of organizations with interdependent but conflicting stakeholders, arguing  Cognitive and/or political models view organizations as non-goal-oriented, non- instrumental social systems, enmeshed in broader socio-political contexts

Conclusion The context of accounting  Capital and Product Markets  Value-Based Management  Shareholder Value, Strategy, and Accounting  Company Regulation and Corporate governance and Audit  Risk, Internal Control of Financial Reporting, and Management Accounting  Stakeholder Perspective © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 2 22