Finding The Story
Behind The Numbers
Training Journalists to Report on
How a Company is Governed and Controlled
Objectives:
• Discuss financial statements
– Why they matter to journalists
• Analyze financial statements to
uncover stories
– Theft of assets
– Fake profits
– Hidden losses
• Apply training to strengthen
reporting and analysis of
companies’ finances
– Simplify the complex
“Spotting irregularities in
financial and nonfinancial
disclosures made in
regulatory filings is a must
for investigative business
reporting. That often
means reading the fine
print and doggedly
attempting to understand
the financial information
and technical language.”
Guide
Olympus, AIG, Fortis Healthcare...
Olympus ─“One of the biggest and longestrunning loss-hiding arrangements in
Japanese corporate history“
Wall Street Journal
AIG ”suddenly collapsed in September 2008 under
the weight of bad bets it made insuring mortgagebacked securities. … [Federal] rescue packages
brought the total to $182 billion, making it the
biggest federal bailout in United States history.”
New York Times
“The Economic Times of India questioned
whether Fortis Healthcare India was paying a
premium of as much as 20 percent to buy a
family owned healthcare business.” Guide
Many Stories To Uncover ─ Why?
Pressure
Management increasingly driven to generate
profits in tough economic times
Unethical business practices
• One-in-five surveyed saw financial
“manipulation” in their companies
• 57% believe bribery and corruption are
widespread in their countries
Compliance works, but not well enough
Ernst & Young, 2013 fraud survey
“Intentional,
deliberate,
misstatement or
omission of material
facts, or accounting
data which is
misleading and, when
considered with all the
information made
available, would cause
the reader to change or
alter his or her
judgment or decision.”
Association of Certified Fraud
Examiners
Cooking The Books
“An alarming number
appear to be comfortable
with or aware of unethical
conduct. This includes
recording revenues early;
under-reporting costs or
encouraging customers to buy
unnecessary stock. This is
coupled with the perception
that bribery and corruption
remain widespread in several
markets.”
David L. Stulb
Ernst and Young
Hiding Losses, Inflating Profits
Company
Accounting Frauds
Losses
Satyam
Manipulated accounts to disguise losses
$1.8 billion
Parmalat
Falsified accounting documents to hide: nonBankruptcy in 2003
existent cash in bank; fake transactions; debts; use
of derivatives
$20 billion
Enron
• Hid huge debts off the balance sheet through
complex structures
• Inflated revenue and profits
Olympus
Accounting disguised investment losses
Perwaja
Steel
(Malaysia)
Joint venture between government-owned and
private steel company used accounting frauds to
hide theft of assets, other crimes
$74 billion
Bankruptcy
Scandal wiped out 75%
stock value ($6 billion)
Malaysian Ringgit10
billion ($3 billion)
Market Peaks, CEO Spending Habits
• More managers commit
accounting fraud in the two
years before economy peaks
(Davidson)
• CEOs with excessive spending on
yacht, high-end car, and home ─
10 times more likely to preside
over firms engaged in fraud
“Market-wide incentives
for managers to
manipulate earnings
influence the decision to
commit accounting fraud.”
Spendthrift CEOs “change
the composition of the
firm’s board [and]
compensation structure.”
Robert H. Davidson
Developing Sources,
Driving Reforms
• Good companies are open to reporters,
especially if you understand accounting
– Expertise widens access
– Trust comes from sources’ confidence in
reporter’s knowledge, reputation
• Exposing wrongdoing leads to reforms
– Accounting frauds in 2001-02 in United
States led to Sarbanes-Oxley
• Insights, analysis benefit many
• Investors, regulators, policymakers, board
directors, senior management, stakeholders
“Maintaining our
trust with our
audience is
fundamental to our
mission. Reporting
truthfully, reporting
accurately, correcting
errors, obeying our
standards are all vital
and cannot be
compromised.”
David Schlesinger
Editor-in-Chief
Reuters
k
AC/Controls
Audit
Risk
Compliance
Control Environment
Disclosure
“Ensuring the integrity of the
corporation’s accounting and
financial reporting systems,
including the independent
audit, and that appropriate
systems of control are in
place, in particular, systems
for risk management,
financial and operational
control, and compliance with
the law and relevant
standards”
OECD Principles of
Corporate Governance
9
Dissect Financial Statements
• Statement of Financial Position (“balance
sheet”)
– Financial health
– “Snapshot"
• Statement of Comprehensive Income
(“profits and loss” or “P&L”)
– Performance
• Statement of Cash Flows
– Changes in financial position
• Notes
– Most interesting information to uncover
fraud
– What’s hidden? Why?
“They show where a
company’s money
came from, where it
went, and where it
is now.“ SEC
Maintain a healthy
skepticism toward
all financial reports
“Details create the
big picture.“
Balance Sheet
Snapshot of a
company at
close of
reporting
period:
• Assets
• Liabilities
• Shareholders’
equity
Example
Source: Accounting Coach
Assets (Left Side)
• Current: turn to cash or to be depleted within
one year of balance sheet date (e.g., inventory)
• Noncurrent: not likely to convert to cash within
one year (may take longer than one year to sell)
• Investments: stocks, bonds, and life insurance
policies company owns for top executives
• Property, Plant, and Equipment (“fixed”)
• Intangible: copyrights, patents, goodwill, trade
names, trademarks
• Other Assets: bond issue costs amortized to
expense over bonds’ life; property readied for
sale
• Vary greatly year to year
Assets help
companies:
• weather
emergencies
• borrow at
lowest rates
• promote longterm thinking and
growth
• earn high stock
prices
Company’s assets
have to “balance”
Apple: Assets
Liabilities (Right Side)
• Liabilities: company’s obligations during business
operations (listed by due dates)
• Current liabilities: expect to pay off within the
year
• Wages
• Accounts
• Taxes
• Long-term liabilities: obligations due more than
one year away
• Long-term bonds/debt (principal and interest)
• Leases
• Pensions, other retirement benefits
• Product warranties
Helps reporter to
quickly detect the
financial strength
and capabilities
of the business
Rising liabilities
may signal
problems
Value may be
reduced
Apple: Liabilities
Shareholder Equity
“Net Worth”
= Assets – Liabilities
Or
= Capital + Retained Earnings –
Treasury Shares
• Share capital: portion of company held as
stock
• Retained earnings: profits
• Treasury shares: shares the company sells
and then repurchases
Helps reporter
quickly detect
the financial
strength and
capabilities of
the business
Typical changes
in equity result
from company
profits or losses,
dividends, or
stock issuances
Apple: Shareholder Equity
Income Statement
• Sales (Minus) Cost of Goods =
Gross Profit
• (Minus) Expenses = Net
Operating Income
• (Minus) Other Income and
Expenses
• (Minus) Extraordinary Items
• (Minus) Income Taxes =
• Net Income (Profits)
• Retained Earnings (if any)
• Amount of revenue
a company earned
over a specific
time period
(usually one year)
• Costs and expenses
associated with
earning that
revenue
• “Bottom line”
reveals company’s
net earnings or
losses
Apple Income Statement
Cash Flow: Key Terms
Cash generated and used during the
interval specified:
• Operations: day-to-day business
operations
• Investing : asset investments and
proceeds from the sale of other
businesses, equipment, or other
long-term assets
• Financing: cash paid or received
from issuing and borrowing of funds
(includes dividends paid)
• Net Increase or Decrease in Cash
To survive and succeed,
every business depends
on its ability to create or
otherwise attain cash.
Strong cash flow allows
a company to increase
dividends, develop new
products, enter
new markets, pay off
liabilities, buy back
shares, and become an
acquisition target.
Cash Flow Statement
How much money
did the company
generate?
Where is the cash
coming from?
Can the company
pay its bills?
Does it have
money to expand?
Apple Cash Flow
Financial Statements ─ Notes
• Enhance understanding of financial
statements
• Contain accounting policies, key
assumptions and judgments made in
preparing the financial statements
• Explain items in greater detail (for example,
pension accounting assumptions)
• Provide detail on any uncertainties
• Required by national or listing
requirements
• Some companies voluntarily provide
additional information
What accounting
methods were
used for
recording and
reporting
transactions?
Assets
overvalued?
Liabilities
undervalued?
Earnings Manipulation
• Recording revenue too soon
• Booking bogus revenue
• Boosting income using onetime or unsustainable
activities
• Shifting current expenses to
a later period
• Employing other techniques
to hide expenses or losses
• Shifting current income to a
later period
• Shifting future expenses to
an earlier period
SOURCE: Schilit/Perler, Financial Shenanigans
"I give you the seven-billion-dollar
pup, then you give me back the
seven-billion-dollar pup, and
we’ve each made seven billion
dollars.”
Cash Flow Games
• Shifting financing cash inflows
to the operating section
• Shifting normal operating
cash outflows to the investing
section
• Inflating operating cash flow
using acquisitions or disposals
• Boosting operating cash flow
using unsustainable activities
SOURCE: Schilit/Perler, Financial Shenanigans
“Sorry, sir — we seem to have
lost five-million dollars in the fog
of accounting.”
AC/Controls
Audit
Risk
Compliance
Disclosure
External Audit vs. Internal Audit
External audit means business
activities involving independent
audit of accounting records and
financial (accounting) reporting
of companies and individual
entrepreneurs
“The most common auditor failings
were lack of competence and
diligence, lack of professional
skepticism, and failure to assess and
respond to fraud risks,” according to
a 2013 study.
Internal audit means an
independent, objective
assurance and consulting activity
designed to add value and
improve an organization’s
operations. It helps an
organization accomplish its
objectives by bringing a
systematic, disciplined approach
to evaluate and improve the
effectiveness of risk
management, control, and
governance processes
Reuters May 9, 2013
27
Unqualified vs. Qualified Opinion
Auditor’s report helps attract investors, obtain
loans, and improve public appearance
Unqualified/”clean” opinion
Financial statements give a “true and fair” view,
comply with:
• Accounting principles
• Relevant statutory requirements, regulations
• Disclosure obligations of all material matters
– Changes in accounting principles, methods
Qualified ─ not good
Information incomplete and/or the company has
not prepared statements according to sound
accounting principles
Auditors may fail to:
• gather sufficient
evidence to verify
management’s
information
• exercise
professional care
• be sufficiently
skeptical
• express the
appropriate opinion
Annual Report Contents
Chairman’s Report
CEO’s Report
Directors’ Report
Corporate Governance Statement
Statement of Directors’
Responsibilities
• Auditors’ Report on Financial
Statements
• Financial Statements
• Invitation to the AGM plus proxy form
•
•
•
•
•
The annual report
provides a summary
of exactly how a
company has
performed in the
preceding year, and
offers a glimpse of
the future.
An Acquisition
• Nevaris Enterprises wants to buy another company, Alexey
Holdings, to expand sales worldwide.
• What broad questions would you ask about each company’s
financial statement?
• Divide participants into two groups:
– Group A develops questions for Nevaris
– Group B develops questions for Alexey
Key Questions
Nevaris Enterprises
Alexey Holdings
Red Flags
Topics
Questions
Changes
Size? Reasons?
Make sense in light of economy?
Accounting
New accountants, auditors?
Methods changed in valuing assets, liabilities
Risks
Properly assessed and prepared for?
Footnotes
Insights into relationships with clients, suppliers?
Debt
Increase? By how much?
Company’s revenues adequate to repay loans?
Lawsuits
From investors, vendors, competitors, government?
Why?
Management
Discussion and Analysis
Unaudited information – shed light on soundness of business
model and management’s style?
Growth outlook realistic?
Questions
Action Ideas
• I plan to apply the following ideas, skills, and
procedures:
• Obstacles that may prevent me from
implementing improvements in my reporting
and analysis are:
• Opportunities to acquire skills and resources
include:
THANK YOU