3.1 The Stockholders’ Report

LG 1 3.1 The Stockholders’ Report

Every corporation has many and varied uses for the standardized records and generally accepted

reports of its financial activities. Periodically, reports must be prepared for regu-

accounting principles (GAAP) lators, creditors (lenders), owners, and management. The guidelines used to pre- The practice and procedure guidelines used to prepare and pare and maintain financial records and reports are known as generally accepted maintain financial records and

accounting principles (GAAP). These accounting practices and procedures are

reports; authorized by the

authorized by the accounting profession’s rule-setting body, the Financial

Financial Accounting

Accounting Standards Board (FASB).

Standards Board (FASB).

In addition, the Sarbanes-Oxley Act of 2002, enacted in an effort to eliminate Financial Accounting

the many disclosure and conflict-of-interest problems of corporations, established Standards Board (FASB)

the Public Company Accounting Oversight Board (PCAOB), a not-for-profit cor-

The accounting profession’s

poration that oversees auditors of public corporations. The PCAOB is charged

rule-setting body, which

with protecting the interests of investors and furthering the public interest in the

authorizes generally accepted

preparation of informative, fair, and independent audit reports. The expectation

accounting principles (GAAP).

is that it will instill confidence in investors with regard to the accuracy of the Public Company Accounting

audited financial statements of public companies.

Oversight Board (PCAOB) Publicly owned corporations with more than $5 million in assets and 500 or

A not-for-profit corporation

more stockholders are required by the Securities and Exchange Commission

established by the Sarbanes-

(SEC)—the federal regulatory body that governs the sale and listing of securities—

Oxley Act of 2002 to protect the interests of investors and

to provide their stockholders with an annual stockholders’ report. The stock-

further the public interest in the

holders’ report summarizes and documents the firm’s financial activities during

preparation of informative, fair, the past year. It begins with a letter to the stockholders from the firm’s president and independent audit reports.

and/or chairman of the board. THE LETTER TO STOCKHOLDERS

The letter to stockholders is the primary communication from management. It describes the events that are considered to have had the greatest effect on the firm

GLOBAL focus More Countries Adopt International Financial Reporting Standards

in practice In the United States,

It is true that IFRS generally requires public companies are

Board (IASB). These standards are

less detail than GAAP. Even so, the required to report financial results using financial statements everywhere under-

designed with the goal of making

Securities and Exchange Commission GAAP. However, accounting standards standable, reliable, comparable, and

has expressed its view that U.S. vary around the world, and that makes accurate. More than 80 countries now

investors will benefit as GAAP and IFRS comparing the financial results of firms

require listed firms to comply with IFRS, converge though there is no expecta- located in different countries quite chal- and dozens more permit or require

tion that firms in the United States will lenging. In recent years, many countries firms to follow IFRS to some degree.

be required to switch to IFRS in the have adopted a system of accounting

Why hasn’t the United States fol-

near future.

principles known as International

lowed the global trend of IFRS adop-

Financial Reporting Standards (IFRS),

3 What costs and benefits might which are established by an independ- “gold standard,” and a movement to

tion? Some argue that GAAP is still the

be associated with a switch to IFRS ent standards-setting body known as

in the United States? the International Accounting Standards

IFRS would lower the overall quality of

financial reporting made by U.S. firms.

CHAPTER 3

Financial Statements and Ratio Analysis

stockholders’ report during the year. It also typically discusses management philosophy, corporate

Annual report that publicly

governance issues, strategies, and actions, as well as plans for the coming year.

owned corporations must provide to stockholders; it summarizes and documents

THE FOUR KEY FINANCIAL STATEMENTS

the firm’s financial activities

The four key financial statements required by the SEC for reporting to share-

during the past year.

holders are (1) the income statement, (2) the balance sheet, (3) the statement of letter to stockholders

stockholders’ equity, and (4) the statement of cash flows. The financial state-

Typically, the first element

ments from the 2012 stockholders’ report of Bartlett Company, a manufacturer

of the annual stockholders’

of metal fasteners, are presented and briefly discussed in this section. Most likely,

report and the primary communication from

you have studied these four financial statements in an accounting course, so the

management.

purpose of looking at them here is to refresh your memory of the basics, rather than provide an exhaustive review.

Income Statement

income statement Provides a financial summary

The income statement provides a financial summary of the firm’s operating results

of the firm’s operating results

during a specified period. Most common are income statements covering a 1-year

during a specified period.

period ending at a specified date, ordinarily December 31 of the calendar year.

focus on ETHICS Taking Earnings Reports at Face Value

in practice Near the end of each albeit not the spirit, of acceptable Warren Buffett offers three bits of quarter, Wall Street’s

accounting practices. Other times, firms advice regarding financial reporting. a much anticipated “earnings season”

First, he warns that weak visible arrives. During earnings season, many

break the rules to make their numbers.

accounting practices are typically a companies unveil their quarterly per-

The practice of manipulating earnings

sign of bigger problems. Second, he formance. Interest is high, as media

to mislead investors is known as earn-

suggests that, when you can’t under- outlets rush to report the latest

ings management.

Some firms are notorious for consis- stand management, the reason is prob- announcements, analysts slice and dice tently beating analysts’ estimates. For

ably that management doesn’t want the numbers, and investors buy and sell example, for one 10-year period

you to understand them. Third, he based on the news. The most antici-

warns that investors should be suspi- pated performance metric for most com- (GE) beat Wall Street earnings esti-

(1995–2004), General Electric Co.

cious of projections because earnings panies is earnings per share (EPS),

and growth do not typically progress in which is typically compared to the esti- penny or two per share. However, in

mates every quarter, often by only a

an orderly fashion. Finally, Buffett notes mates of the analysts that cover a firm.

that “Managers that always promise to Firms that beat analyst estimates often

2009, the U.S. Securities and

‘make the numbers’ will at some point see their share prices jump, while those $50 million for improper accounting

Exchange Commission (SEC) fined GE

be tempted to make up the numbers.” that miss estimates, by even a small

practices, including recording sales that

amount, tend to suffer price declines. Why might financial managers be had not yet occurred. When GE went 3

Many investors are aware of the tempted to manage earnings? back to correct the problems identified pitfalls of judging firms based on

3 Is it unethical for managers to reported earnings. Specifically, the

by the SEC, they found that net earn-

ings between 2001 and 2007 were a manage earnings if they disclose complexity of financial reports makes it total of $280 million lower than origi-