Fin 620 Project

Financial Reporting and Disclosure FIN 620

By Dawit A Tariku July 29, 2009 To Dr. John M. Halstead

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Abstract---------------------------------------------------------------------------------------------------------------3 Short Summary of the article--------------------------------------------------------------------------------------4 Introduction----------------------------------------------------------------------------------------------------------4 Why efficient and sufficient reporting, and how deep the disclosure should be? -------------------------6 What can be archived through financial report disclosure? --------------------------------------------------7 What can be avoided through financial report disclosure? ---------------------------------------------------8 The new reporting and disclosure and financial market-------------------------------------------------------8 Conclusion----------------------------------------------------------------------------------------------------------10 Exhibit---------------------------------------------------------------------------------------------------------------11 Bibliography-------------------------------------------------------------------------------------------------------12

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Abstract The purpose of this research paper is to highlight the change coming in financial reporting and disclosure requirement and its effect on the financial market. The paper is written based on an article “CFOs Anticipate a Filing Crunch” on CFO.com dated on August5, 2008 by Sarah Johnson. Ever since the emergence of the current financial crisis, discussions in the professional community has focused on regulation and stream lined financial disclosure and reporting. The question is how to find the solution to alleviate the crisis and deter further and future crisis. In the process, this paper will try to address issues related to financial reporting and disclosure and its implication in the financial market taking into account the various concern investors and analysts may have. The coming reporting format will also challenge the traditional analysis methods and models used by Wall Street analysts. Profits and operating incomes are considered to be misleading in assessing the financial status of a company, therefore, analysts will in the future shifting their attention towards cash flow statements which shows the actual financial activities of a firm. How sufficient is sufficient reporting and disclosure, what can be achieved through financial reporting and disclosure and what can be averted through financial reporting and disclosure will be discussed.

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Short Summary of the Article Financial Accounting Standards Board's is now working on a new format for financial statements different from the current one. This new structure is structured to focus on earnings of the future rather than historical facts and events of past periods. The project is being designed to capturing all income-related information in a single line. Some items such as gains and losses on cash-flow hedges, available-forsale securities, and foreign-were footnoting as other comprehensive income which is going to change. (Sarah Johnson, 2008) The others effort in the process is to redefine the notions of revenue and fair value. The issue of fair value in the financial statements need to reflect the changes and where the change coming from. (Sarah Johnson, 2008) Companies will be required to disclose there segments to the same level of detail as they currently report for the consolidated statements. The other major change in the horizon is the elimination of net income by design, and the promotion of income from operations though earnings per share computation are not defined. (Sarah Johnson, 2008)

Introduction Financial reporting and disclosure is the most important tool for users of financial statements (inside and outside investors) to evaluate the performance of a firm through various techniques of evaluation of financial statements. The information included in financial reports and their disclosures provides managers with a tool to make critical 4

decisions in capital markets. The new GAAP format which is simplified and informative is an issue with in CFO’s, investors and other professionals who are dealing with the capital market and Accounting reporting. The role of public financial statements is being transformed from a simple document recording and reporting of the company’s financial activities to a tool for analyses, compile and predict financial futures. In addition to reporting and disclosing the financial status of affirm financial statements are now being used as an explanation of the general business environment and management actions. (Alex Stuart, 2008) As mentioned earlier financial reporting and disclosure are potentially the framework for analyzing managers’ reporting and disclosure decisions in a capital markets. The availability of information is critical to the operation of efficient markets. The newly evolving financial reporting and disclosure format is crafted in a way to address the issue of lack of transparency which makes risk evaluation difficult to achieve efficient outcomes particularly with regard to financing and investing. (Alix Stuart, 2008) As proposed, the coming change will reorganize balance sheet and the income statement to follow the three categories of the cash-flow statement which requires companies to report cash flows with direct method; and introducing a new reconciliation schedule that would highlight fair-value changes. This reconfiguration will increase firm’s transparency and fulfill the efficient market hypothesis aiding investors to make educated decision and managers to make strategic decisions. (Sarah Johnson, 2008)

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Why efficient and sufficient reporting, and how deep the disclosure should be? Be it non-profit or profit oriented organization, publicly traded or not the essence of financial reporting and disclosure is the backbone of their operation, decision and evaluation. When making capital decisions such as investing and financing, whether an investor or a company's management need to have sufficient information to make strategic decisions. Financing decision to maximize shareholders benefit by increasing the value of a firm is a way in which a company can inadvertently signal its prospects to investors. Financial, managerial or market decisions are the reflection of an existing business activity based on trend analysis to make prediction for the future. Here the most important part of the analysis process is the future. The future depends the past occurrences, business culture and business environment shows how business is conducted in the firm. As very well known external factors like systemic risk are beyond the control of individual firm that firms have to make them selves ready for such a situation through decisions that keep firms liquid. On the other hand, other risks (un-systemic risk) which can come from bad management decisions are manageable through diversification. But, to make diversification, decision makers and analysts need reliable information. Reliable information comes through accurate evaluation, valuation, timely information and transparency to financial statement users. Transparency comes through proper reporting and most importantly through disclosure. Disclosure justifies unusual occurrences, changes to be noticed, and clarification to events mostly focusing on nonfinancial aspects 6

of the firm. Nonfinancial aspects such as legal issues, related party transaction and the company board meeting minutes are as important as financial reports. The newly coming reporting format is being designed keeping this in mind.

What can be archived through financial report disclosure? The very life of financial market relies on the availability of information to make decisions as to how to invest, finance and manage resources in general. Obviously, financial analysts, regulators, investors and business decision makers are in their highest demand for high-quality financial reporting, since the quality of financial reporting directly affects capital markets. The success of capital financing and investing decision is directly dependent on the quality of accounting and disclosure information availability. The higher the quality of the disclosure the higher the investor’s confidence. Efficient market can only be achieved through the availability of private, public and insider information. If all stakeholders, the public, private and insider information is available through reporting and disclosure we will have an efficient market which will be fair to the active and non-active participants. Some of the benefits of efficient and sufficient financial reporting and disclosure that the new format will provide better than the traditional reporting are: 1

Properly reported and disclosed financial statement will Facilitates Mergers and Acquisitions by providing the necessary information for investors and managers

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Given information is reported and disclosed sufficiently, the Market will reflect fair price to make decision on Warrants, Convertibles, and Derivatives by both investors and managers.

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Leasing and option decision by either investors or management will be done with relative confidence. Confidence comes from reliable and timely information when needed.

What can be avoided through financial report disclosure? The lack of information or inadequate reporting and disclosure will lead to wrong decisions. Investors and management of firms’ will make bad business decision of the following type in the absence of sufficient and efficient financial reporting and disclosure which the new format is hopped to help: 1

In the absence of sufficient information businesses or investors will make decisions on Long Term Debt that may lead the business to bankruptcy.

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Information is critical in investment and financing decisions. Wrong or insufficient information will lead to wrong decision.

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APV, NPV, WACC, etc decisions depend partly on outside or market information.

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Warrants, Convertibles, and Derivatives will be transparent

The new reporting and disclosure and financial market. It is high time to revise the accounting reporting system so that Accounting, Finance professionals and Investors avoiding controversy which data to use, how to use it and when with out difference in using the output. The value of reported earnings should provide the market with more relevant valuation information and accelerate the process of absorption of that information into prices. (Jeffrey. M., et al, 2009) A standardized financial report focusing on showing the true nature of firms’ activity evidencing for easy comparison and correction when errors are made is needed. In the era of information abundance and easy distribution the data firms produce need to be easy to read, understand, interpret and compare with in or across the market. (Andrew J., et al, 2008). 8

Thus, the efficient use of information in the capital markets by creating market efficiency. The proposed new model will provide investors and analysts with more information for predicting future cash flows. The new reporting standard reconciles the cash flow statement to the statement of comprehensive income in three reconciling columns. (Jeffrey. M., et al, 2009). The proposed financial statements are supposed to help predict cash flows for equity valuation. The goal of the new standard is to create a common standard for the form, content, classification, aggregation and display of line items on the face of financial statements. It would also help equity investors and other financial statement users to better understand a business's past and present financial position and assess potential future cash flow. (Andrew J., et al, 2008). A complete set of financial statements for a reporting period should include a statement of financial position, a statement of comprehensive income, a statement of changes in equity and a statement of cash flows. In addition, each financial statement should be shown with equal prominence, and a minimum of two years comparative information is required. (Guy MCClain etal2008). The topics covered in FIN 620 significantly use financial and market information of hypothetical firms. The information used to do exercises and discussion is provided based on a hypothetical firm financial reporting and disclosure. Therefore, we have learned a great deal of the importance of information in doing analytical decision and discussions.

Conclusion 9

The significant importance of financial reporting and disclosure in investment or management decision making is undoubtedly very important. The dynamics of financial market has changed so much with accelerated advancement of information technology. The financial reporting and disclosure should catch-up with the changing environment. The availability of information makes the market efficient. In an efficient market information is unbiased and evenly distributed to its users. The information mentioned here comes in the form of financial reporting, disclosure, news and press release. Focusing more on financial reporting and disclosure, the tradition reporting and disclosure is now becoming irrelevant. Net income is the focal point where the change revolves around. Relying on net income is misleading rather operating income need to be used. Fair value is another issue given emphasis. Disclosure also will change in such a way that it discloses more information than it used to. Overall, the purpose of the new format is to produce sufficient and efficient report and deep disclosure which greatly provides ample and clear information about individual firms or the general economy. Systemic risk will be managed better and un-systemic risk could possibly be avoided.

The format is summarized as follow:

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Source: (Andrew J., et al, 2008).

Bibliography

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McClain, G., & McLelland, A. J. (n.d.). Shaking Up Financial Statement Presentation. Retrieved August 1, 2009, from http://www.journalofaccountancy.com/Issues/2008/Nov/ShakingUpFinan cialStatementPre

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McClain, G., & McLelland, A. J. (n.d.). Shaking Up Financial Statement Presentation. Retrieved August 1, 2009, from http://www.journalofaccountancy.com/Issues/2008/Nov/ShakingUpFinan cialStatementPre

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Planning now for a 2010 IPO. | Banking & Finance > Financial Markets & Investing from AllBusiness.com. (2009, June 1). Retrieved August 1, 2009, from http://www.allbusiness.com/company-activitiesmanagement/company-structures-ownership/12386634-1.html

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Stephen, R., Randolpr, W., & Jeffrey, J. (2008). Corporate Finance, 8th ed. New York: McGraw-Hill.

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Planning now for a 2010 IPO. | Banking & Finance > Financial Markets & Investing from AllBusiness.com. (2009, June 1). Retrieved August 1, 2009, from http://www.allbusiness.com/company-activitiesmanagement/company-structures-ownership/12386634-1.html

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Albrecht, C. O., Albrecht, C. C., & Albrecht, W. S. (2005). Fraud Examination. Mason, OH: South-Western College Pub.

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