1. Understanding the Corporate Annual Report: Nuts, Bolts, and a Few Loose Screws
Chapter 1
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

2. How Companies Manipulate Financial Reporting:
Overstate earnings
Use confusing “profit” terminology
Report profits while failing to generate cash
Make future earnings look better by taking huge, one-time charges
Boost or delay revenue & expenses
Keep debt off balance sheet
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

3. Problems with Auditors
Auditor's reports should provide:
“Independent” opinion about fairness of financial statement presentations
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

4. But. . .are auditors truly independent?
Numerous cases & judgements against auditing firms
Sometimes provide “clean” reports for problem statements
Accounting firms consult for companies they audit
Officers previously employed by audit accounting firm
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

5. Problems with Analysts
Hype marginal companies
Conflicts of interest
Recommend “buy” in severe market downturns
SEC warns public to treat analysts’ advice with caution
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

6. What do you need if you rely on corporate financial statements for important decisions?
Basic understanding of financial reports
Ability to evaluate information
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

7. Corporate Financial Statements
Based on Generally Accepted Accounting Principles (GAAP)
Should reflect economic reality
Should achieve financial information that is:
understandable
relevant
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

8. Authorities Primarily Responsible for Establishing GAAP
Securities & Exchange Commission (SEC)
Financial Accounting Standards Board (FASB)
U.S. Congress
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

9. SEC (Public Sector)
Regulates companies that issue securities to the public
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

10. SEC Requires: Prospectus for new security offerings
Annual reports (10-K)
Quarterly reports (10-Q)
Other reports (Filed as 8-K)
Proxy statement
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

11. FASB (Private Sector) Issues
Statements of Financial Accounting Standards
Interpretations
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

12. The SEC Relies on FASB for most accounting rule-making in U.S.
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

13. What’s in an Annual Report? (The Slick Stuff)
Impressive front cover
Colored photographs on shiny paper
Dazzling graphics
Positive letter to shareholders
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

14. Financial Statements in an Annual Report:
1. Statement of earnings (income statement)
2. Statement of financial condition (balance sheet)
3. Statement of shareholders’ equity
4. Statement of cash flows
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

15. Annual Report Content Continued:
Notes to the financial statements
Report of independent auditors
Management’s discussion & analysis
5-year summary of selected financial data
Market data
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

16. What’s Actually Required?
Financial statements
Notes
Auditor’s report
Management’s discussion
5-year summary of key figures
Market data
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

17. Other Material? Presented at the discretion of management
Packaged to make company appealing
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

18. Watch for a New Financial Ratio
Ratio of Public Relations Fluff to Financial Data
When that is high & rising. . .
Look Out!
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

19. Statement of Earnings (Income Statement)
Results of a firm’s operations
Revenue & expense
Sources of other income & expense
Net profit or loss
Net profit or loss per share
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

20. Statement of Financial Position (Balance Sheet)
Presents
assets
liabilities
shareholders’ equity
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

21. Statement of Shareholders’ Equity
Reconciles beginning & ending balances of all shareholders’ equity accounts
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

22. Statement of Cash Flows
Provides information about inflows & outflows of cash
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

23. Notes to Financial Statements
Immediately follow the four financial statements
Must be read to understand financial statements
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

24. More on Notes. . . First note: Summary of accounting policies
Other notes
Provide specific account details
Other information
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

25. Examples of Financial Statement Notes
Note 1: Significant Accounting Policies
Note 2: Receivables
Note 3: Inventories
Note 4: Properties
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

26. More Examples of Notes Note 5: Payables & Short-Term Borrowings
Note 6: Long-Term Borrowings
Note 7: Other Long-Term Liabilities
Note 8: Commitments & Contingencies
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

27. And Even More Notes. . . Note 9: Financial Instruments
Note 10: Income Taxes
Note 11: Restructuring Programs &
Cost Reductions
Note 12: Retirement Plans
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

28. Notes. . . Note 13: Nonpension Postretirement Benefits
Note 14: Stock Option & Compensation Plans
Note 15: Acquisitions & Joint Ventures
Note 16: Sales of Assets & Divestitures
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

29. The Last of the Notes. . . Note 17: Segment Information
Note 18: Subsequent Events
Note 19: Quarterly Sales & Earnings Data--
Unaudited
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

30. The Auditors’ Report Management prepares financial statements
Independent accountants:
Audit financial statements
Attest to the fairness of their presentation
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

31. The Unqualified Report states:
Financial statements are presented fairly
Financial statements conform to GAAP
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

32. Unqualified Opinion with Explanatory Language
Used when there is/are:
Consistency departures
Uncertainties caused by future events
Events auditors wish to describe
Business risk
Issues affecting firms existence
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

33. Qualified Report Used where there is a Departure from GAAP
Scope limitation
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

34. Management Discussion & Analysis (MD&A)
Valuable tool in evaluating a company
Contains insight into firm’s own perspective on its performance
Presents qualitative information not found in financial data
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

35. MD&A Covers: Favorable trends Unfavorable trends
Significant events or uncertainties in the categories of:
Liquidity
Capital resources
Results of operations
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

36. Limits to Usefulness of MD&A:
It is management’s “take” on the company’s situation
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

37. Five-Year Summary & Market Data
Provides an overview of the firm’s
Performance
Financial condition
Many key items do not appear in summary
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

38. Market Price Data
Snapshot of common stock performance over a two-year period
Shows high & low quarterly stock price
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

39. Enron’s 1996 Annual Report Problems
Revenue growing faster than earnings
Operating income declining
Negative cash flow
Erratic trend in cash flow from operations
Number & volume of contingencies & commitments
Murky or inadequate explanations
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

40. Caution Flags: Change in auditors
Departure from “unqualified” opinion in auditor’s report with “exception or explanatory” language or qualification
Charges filed by SEC against firm or auditors
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

41. More Caution Flags. . . Rising ratio of fluff to financial data
Allowance for doubtful accounts not keeping pace with accounts receivable
Revenue & earnings:
growing at different rates
moving in opposite directions
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

42. Even More Caution Flags. . .
Negative or erratic cash flow from operations
Earnings & cash flow from operations moving:
At different rates
In opposite directions
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing

43. Still More Caution Flags:
Numerous unquantified contingencies & commitments
Company puts name on sports arena
Fraser/Ormiston: Understanding the Corporate Annual Report (C) 2002 Prentice Hall Business Publishing