The Advocates’ Society
Understanding Financial StatementsA Litigator’s Guide to Persuading with Numbers
Randy Williamson
June 4, 2013
“It has passed into a proverb that solicitors are
the worst accountants, and … the accountant
makes a very bad lawyer. The action of the
solicitor’s ingenious and subtle mind is naturally
adverse in its operations from the sharp and
rapid action of the vivid and concentrative mind of
the accountant. Both sets of qualities are seldom
to be found in one brain, and there is little risk of
the two running against each other if care be
exercised in their professional practice … To
dabble in law should be utterly renounced by
accountants, and to dabble in accounts should be
completely renounced by solicitors”
October 1874, The Accountant
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Reading and Understanding
Financial Statements
• Why it Matters
• Users and Uses
• Types of Financial Information
• Statement Elements, Management Responsibility
• Limitations and Auditor Involvement
• Basic Financial Statement Ratios & Uses
• GAAP Reporting Landscape
• Conclusions
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Why it Matters
• Most disputes between commercial litigants intend to
achieve a financial result
• Assessing financial information at a high level may help
determine claim viability
• May also help identify further analyses or expertise
required
• Financial statements may offer key information necessary
to resolve dispute
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Users and Uses
• Management and Employees
• Employers and Owners
• Lenders and Creditors
• Analysts and Regulators (e.g. CRA, Competition Bureau,
Investment Canada director)
• Investors and Acquirers
• Receivers/Monitors
Understanding how users use financial information can
help determine what information is relevant to a dispute
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Types of Financial Information
• Annual Consolidated Financial Statements
• Annual Reports, MD&A
• Quarterly Statements
• Combined, Unconsolidated
• Tax-based financial reports
• Unaudited, Internal operating information
• Budgets & Forecasts (e.g. for financings)
• Special Purpose and Compliance Reports (e.g.
contractual, bank requirements)
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Financial Statement Elements
• Balance Sheet
• Statement of Operations / Income Statement
• Statement of Shareholders’ Equity
• Statement of Cash Flows
• Notes
• Accounting Policies – statement presentation basis, choices
• Other Material Disclosures - e.g. commitments and contingencies,
litigation, related party dealings, etc.
• Management Responsibility
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Management’s Responsibility for
Financial Statements
The accompanying financial statements are the responsibility of management. The
financial statements have been prepared in conformity with Canadian generally accepted
accounting principles using management’s best estimates and judgments based on
currently available information, where appropriate.
Management is also responsible for a system of internal controls which is designed to
provide reasonable assurance that assets are safeguarded, liabilities are recognized and
that financial records are properly maintained to provide timely and accurate financial
reports.
The Board of Directors is responsible for ensuring that management fulfills its
responsibility in respect of financial reporting and internal control. The Audit Committee of
the Board, which is comprised solely of unrelated and outside directors, meets regularly to
review significant accounting and auditing matters with management and the independent
auditors and to review the interim and annual financial statements.
The financial statements have been audited by John Smith, the independent auditor, in
accordance with Canadian generally accepted auditing standards on behalf of the
shareholders. The Auditors’ Report outlines the nature of his examination and his opinion
on the financial statements. John Smith has full and unrestricted access to the Audit
Committee to discuss his their audit and related findings as to the integrity of the financial
reporting.
William Johnson
President and CEO
Susan Jones, C.A.
Chief Financial Officer
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Financial Statement Limitations
• Mostly reflects historical details – not present values or
how the future may affect enterprise
• Dependent on input information upon which it’s based –
not all items reflect their fair value
• Policies, judgments, estimates – different enterprises,
even in same industry, may account for the same items
differently
• May not allow for effective comparison between
enterprises, industries, even different time periods
• Auditor or outside accountant involvement and assurance
may increase comfort with information
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Auditor / Accountant Involvement
• Auditor Responsibility and Limits
• Audited Statement (“present fairly, in all material
respects”)
• Notice to Reader (“compiled statements”)
• Reviewed (“nothing came to our attention”)
• MD&A, Annual Reports
• Public Offering & Disclosure Documents
10
Audit Report
I have audited the consolidated balance sheets of ABC Limited as at December 31,
2012 and the income and cash flow statements for the period then ended. These
financial statements are the responsibility of the company’s management. Our
responsibility is to express an opinion on the financial statements based on our audits.
I conducted my audit in accordance with Canadian generally accepted auditing
standards. Those standards require that I plan and perform an audit to obtain
reasonable assurance whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements. An audit also includes assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation.
In my opinion, these financial statements present fairly, in all material respects, the
financial position of ABC Limited as at August 31, 2010 and the results of its
operations and its cash flows for the period then ended in accordance with Canadian
generally accepted accounting principles.
Toronto, Canada
June 4, 2013
John Smith, C.A.
(Note – underlining emphasis added)
(Note – U.S. companies include an Audit Report on Internal Control over Financial Reporting)
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Notice to Reader / Review Report
Notice to Reader
I have compiled the balance sheet of ABC Limited as at December 31, 2012 and the
statements of income, retained earnings and cash flows for the period then ended from
information provided by management. I have not audited, reviewed or otherwise
attempted to verify the accuracy or completeness of such information. Readers are
cautioned that these statements may not be appropriate for their purposes.
Review Report
I have reviewed the balance sheet of ABC Limited as at December 31, 2012, and the
statements of income, and retained earnings and cash flow for the period then ended.
Our review was made in accordance with Canadian generally accepted standards for
review engagements and, accordingly, consisted primarily of enquiry, analytical
procedures and discussion related to information supplied to us by the company.
A review does not constitute an audit and consequently I do not express an audit
opinion on these financial statements.
Based only on my review, nothing has come to my attention that causes me to believe
that these financial statements are not, in all material respects, in accordance with
Canadian generally accepted accounting principles.
(Note – underlining emphasis added)
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Basic Financial Statement Ratios
• Balance Sheet – Asset Intensity / Availability Measures
• Working Capital, Quick Ratios
• Debt/Equity Ratio
• Income Statement – Business Profitability Measures
• Gross Margin, EBITDA, Pre-tax Income, Net Income
• Mixed Ratios – Cash Flow, Capital Intensity Measures
• Debt Service, Fixed Charge Coverage Ratios
• Return on Asset, Equity
• Management Ratios – Operating Measures
• Days Sales in Receivables, Inventory Turnover
• Backlog, “Booked to Billed”, Sales Wins ratios
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Use of Ratios
• Point in time ratios are of limited use
• More useful to signal important trends, or to make
comparisons to benchmarks
• Ratio analysis reflects quality of underlying financial
information
• Different enterprises may use different inputs
• Depends on people providing it - knowledge, sophistication, detail
• Makes comparison across enterprises or industries
challenging
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GAAP Reporting Landscape
• From January 1, 2011, Canadian GAAP as we knew it
ceased to exist
• All Canadian enterprises were required to change
• IFRS – International Financial Reporting Standards
• Applies to “Publicly Accountable Enterprises”
• Likely resulted in increased note disclosure – potentially more
useful information for review
• ASPE - Accounting Standards for Private Enterprise
• Intended to simplify some reporting for enterprises whose
financial statement readers require less detail
• Use of multi-year financial statements may require
reconciliation of information that used ‘old’ GAAP
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Conclusion
• Consider relevant financial information for the dispute on
which you are advising
• Understand role that auditor/accountant played to assess
the financial statements, perhaps giving some comfort on
reasonableness of information
• Understand limitations inherent in the financial
information you are considering, including on ratios
• BUT, don’t try to be an accountant! Reach out to
appropriate experts for detailed analysis of financial
information in dispute!
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Thank You
Randy Williamson
Aird & Berlis LLP
Brookfield Place, 181 Bay Street
Suite 1800, Box 754
Toronto, Ontario M5J 2T9 Canada
E rwilliamson@airdberlis.com
T 1.416.865.7705
F 1.416.863.1515
www.airdberlis.com