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All agency action can be classified in three categories: quasi-adjudication: order making, judicial quasi-legislation: rulemaking executive
Posted On: Nov. 7, 2017
Author: Shipra


Total Words ( 3015 ): Report on Financial Statements: Classification, Analysis and Disclosures Table of Contents 1. Voluntary Disclosure of Non Financial Information………………………………….Page 3 2. Distinction Between Debt and Equity From Accounting Standard Setters and Regulators Point of View………………………………..Page 7 3. Should All Types of Shares Issued By Companies Be Treated as Equity……….Page 9 4. How would you treat the cumulative perpetual preferred preference shares of Casino? Justify your view based on any accounting standards or pronouncements that you may have access to. ……………………………………………...Page 13 5.References……………………………...Page 14 Why Companies voluntarily disclose non financial information in their annual report. Explanation: In Part A it has been explained as to how good Corporate Governance that includes Disclosures in its fold; results in significant benefits - both financial and non financial to the companies. It being so ; in view of the aforesaid and in an overall environment of Integrity, transparency, fair practices, ethics and accountability ; Companies go in for voluntary disclosures of non financial information in their annual report. In Part B; it has been explained through examples and specific items; Implications viz Frauds suffered by companies; if non disclosure is there or disclosures are made but that are incomplete, inaccurate and not timely. It been so; it makes voluntary disclosures by companies all the more relevant and important to identify ethical companies from the rest. PART A The below text shall give enough reasons and rationale/benefits from adequate disclosures made for Non Financial Information like Lawsuits,Enviromental Concerns, Restructuring, Discontinued Operations, Trade Sanctions, Target Markets etc ; aligned to Good Corporate Governance programme. Corporate Governance refers to the processes and structure by which the business and affairs of the company are directed and managed. The primary objective of sound corporate governance is to contribute to improved corporate performance and accountability in creating long term shareholder value. Good corporate governance is fundamentally about trust and confidence. These are vital underpinnings of commercial transactions, and indeed, of the market economy. Companies in Singapore rank highly in corporate governance. The high standards achieved by Singapore are the results of three mutually reinforcing components in system - legal, supervisory and enforcement regime; disclosure standards and market discipline; and finally, the commitment of corporate leaders to maintaining integrity. Studies have shown that companies with good corporate governance command a premium in their valuation. At the national level, the benefit of good corporate governance and ethical behavior is quite clear. Singapore's strong reputation as a trustworthy jurisdiction is a key competitive advantage in attracting trade and investment, and in positioning Singapore as a premier financial centre and business hub. When companies based here are associated with the values of integrity and credibility, they receive the recognition from global investors who are willing to pay a premium for their strong branding as trusted entities. Many companies, local and foreign, use Singapore as the home base to raise capital, to site command and control functions, and to engage in high value R&D and marketing functions. The Council On Corporate Disclosure and Governance (“CCDG”) is responsible for strengthening the framework on disclosure practices and reporting standards taking into account trends in corporate regulatory issues and international best practices, reviewing and enhancing the existing framework on Corporate Governance and promote good Corporate Governance in Singapore, taking into account international best practices, and prescribing accounting standards in Singapore. PART B Improper Disclosures: In the below mentioned text; it will make it clear; as to in the absence of Proper Disclosures – Voluntary – there is strong possibility of Fraud in the Financial Statements. Accounting Principles require that financial statements include all the information necessary to prevent a reasonably discerning user of the financial statements from being misled. The notes should include narrative disclosures, supporting schedules, and any other information required to avoid misleading potential investors, creditors, or any other users of the financial statements. Management has an obligation to disclose all significant information appropriately in the financial statements and in management’s discussion and analysis. In addition, the disclosed information must not be misleading. Improper disclosures relating to financial statement fraud may involve the following: • Liability Omissions • Subsequent Events • Related Party Transactions • Accounting Changes Liability Omissions Typical omissions include the failure to disclose loan covenants or contingent liabilities. Loan covenants are agreements, in addition to or as part of a financing arrangement, which a borrower has promised to keep as long as the financing is in place. Contingent liabilities are potential obligations that will materialize only if certain events occur in the future. A corporate guarantee of personal loans taken out by an officer or of a private company controlled by an officer is an example of a contingent liability. Under most accounting standards, the company’s potential liability, if material, must be disclosed. Subsequent Events Events occurring or becoming known after the close of the period may have a significant effect on the financial statements and should be disclosed. Fraudsters typically avoid disclosing court judgements and regulatory decisions that undermine the reported values of assets, that indicate unrecorded liabilities, or that adversely reflect upon management integrity. Public record searches can often reveal this information. Related Party Transactions Related party transactions occur when a company does business with another entity whose management or operating policies can be controlled or significantly influenced by the company or by some other party in common. There is nothing inherently wrong with related party transactions, as long as they are fully disclosed. If the transactions are not conducted on an arm’s length basis, the company may suffer economic harm, injuring stockholders. The financial interest that a company official might have may not be readily apparent. For example, common directors of two companies which do business with each other, any corporate general partner and the partnerships with which he/she /it does business may be related parties. Family relationships can also be considered related parties, such as all lineal descendents and ancestors, without regard to financial interests. Related party transactions are sometimes referred to as “self – dealing “. While these transactions are sometimes conducted at arm’s length, they often are not. Example: In September 2002, the U.S. Securities and Exchange Commission (SEC) charged former top executives of Tyco International Ltd., including former CEO L.Dennis Kozlowski, with violating U.S. Securities laws by failing to disclose to shareholders hundreds of millions of dollars of low interest and interest-free loans they took from the company, and in some cases, never repaid. Accounting Changes There are generally three types of accounting changes that must be disclosed to avoid misleading the user of financial statements: accounting principles, estimates, and reporting entities. Although the required treatment for these accounting changes varies among the types and across jurisdictions, they are all susceptible to manipulation by the determined fraudster. For example, fraudsters may fail to properly retroactively restate financial statements for a change in accounting principle if the change causes the company’s financial statements to appear weaker. Likewise, they may fail to disclose significant changes in estimates such as the useful lives and estimated salvage values of depreciable assets, or the estimates underlying the determination of warranty or other liabilities. They may even secretly change the reporting entity, by adding entities owned privately by management or excluding certain company – owned units, in order to improve reported results. The notes give additional information about the information in the financial statements. It shall be clear that voluntary disclosures are made to have trust, confidence of the 3 key constituencies for any corporate viz 1. Customers 2. Shareholders 3. Employees. The following five disclosure techniques are used in varying degrees in contemporary financial statements: 1. Parenthetical explanations 2. Notes to the financial statements 3. Cross References 4. Valuation Allowances(sometimes referred to as “contra” amounts ) 5. Supporting Schedules Why do accounting standard setters and regulators regard the distinction between debt and equity as important? Explanation. Accounting standard setters and regulators regard the distinction as important as: • Presentation of Financial Statements viz Balance sheet, Income Statement and Cash Flow Statement; that gives a true and fair position of the state of affairs of a company ; it is of concern for the standard setters that there is absolute clarity in regard to components of Debt and Equity for period to period financial analysis, industry analysis and further that there is harmonization with the International Accounting Standards- International Financial Reporting Standards ; so that analyst across the globe can undertake financial analysis without avoidable time spent in doing adjustments. • Again for processing of financial information submitted to the regulators; it is of importance that there is “clear definition and understanding” of the regulators reporting format so that the aggregate figures of Debt and Equity are separately updated in the relevant data fields and there is minimal queries/resubmissions in view of technical errors in improper understanding of the distinction between debt and equity. • Its their duty and responsibility to ensure that there is compliance with all relevant and requisite “Financial Health Key Indicators”. • They have to ensure that “Preventive Controls - Flags – Alerts” put in place to check if the Company is “geared” within permissible limits keeping the overall capital structure in perspective. • Monetary Authority of Singapore (MAS) compiles a lot of financial and economic intelligence for macro and micro economic management; as such it is of particular concern and interest to the Debt Equity mix employed by the Companies. • For doing financial statement analysis and reviews; the distinction between debt and equity is of primary focus; as based on the Capital Structure mix with clear distinction between debt and equity shall assist the statutory authorities and regulators to make necessary policy adjustments and procedural changes like Credit Policy, Taxation, and Treasury Management. • Too Much Debt: Borrowing too much money to continue operations or to finance new activities can be a major red flag that indicates future problems for a company especially if interest rates start rising. Debt can overburden a company and make it hard for a company to meet its obligations, eventually landing the company in bankruptcy. Examples of Financial Ratios having Debt and Equity Inputs Debt Equity Ratio = Debt/Equity Analysis: Higher the ratio, riskier is the Capital Structure, because of • Higher Interest burden and • Greater chance of insolvency in the long run. More a company borrows, harder it will be for it to pay interest in the years of falling profits. Financial Leverage Refers to the extent to which the firm has fixed financing costs arising from the use of debt capital. A firm with high financial leverage will have relatively high fixed financing cost compared to a firm with low financial leverage. It is sometimes also called Interest-charges leverage, which exists whenever the firm has debt that requires the payment of interest. Financial Leverage and Risk As the company becomes more financially leveraged, it becomes riskier, which leads to: Increased fluctuations in return on equity Should all types of shares issued by companies be treated as equity? Explanation. All shares issued by companies cannot and should not be treated as Equity alone. A Company should have an optimum capital structure with right mix of debt and equity to takes benefits of tax incentives available for loan capital. Below a brief explanation of the Kinds of Capital available other than Equity and benefits/advantages there in are mentioned. Equity Is an ownership “share” in the revenue stream of a corporation’s income once all prior obligations and debts have been satisfied. There are various classes of equity for the individual investor to consider. The primary 3 groups into which equity may be subdivided are • Common stock, • Preferred stock and • Warrants. Common Stock • Represents an ownership in a corporation. • Common stockholders participate in the earnings stream of the corporation through dividends paid and capital gains made on a per share basis. • Owners of common stock are responsible for the election of Board of Directors, appointment of Senior Officers, the selection of an auditor for the corporate financial statements, dividend policy and other matters of corporate governance,. • Investors participate to a greater extent in the fortunes of the firm. Capital gains, through the increase in market price of the firm’s stock, accrue to a greater extent to the holder of common stock than to the holder of preferred stock. • Common stockholders also have a couple of significant rights should the business invested in be wound down ; limited liability to the creditors of the firm and a residual claim on any assets or income derived once all prior claims ( motgages, bondholders, creditors, etc.) have been satisfied. Preferred Stock • Are stock in a company which have a defined dividend, and a prior claim on income to the common stock holder. • Should the company wind up operations, preferred shareholders are paid any obligations owed to them. Should a dividend be suspended by the Board of Directors, for what ever reason, the preferred share usually has a cumulative clause in it allowing that any unpaid dividends must be fully paid before any dividends may be declared and paid to holders of common stock. This means that the preferred share is a relatively more secure investment. The corporate issuing preferred shares may add differing features to the share in order to make it more attractive. These features are similar to those used in the fixed income market and include convertibility into common shares, call provisions, etc. Many have equated preferred shares with a form of fixed income security due to its defined dividend stream. • However, with he added security offered by the guaranteed dividend stream, the holder of preferred shares gives up the right to vote on issues related to corporate governance. Therefore, the preferred holder has little input into corporate policy. Types of Preferred Stock: Cumulative preferred stock - If the dividend is not paid, it will accumulate for future payment. Convertible preferred stock - This type of preferred stock carries the option to convert into a common stock at a prescribed price. Perpetual preferred stock - This type of preferred stock has no fixed date on which invested capital will be returned to the shareholder, although there will always be redemption privileges held by the corporation. Most preferred stock is issued without a set redemption date. Participating Preferred Stock- This type of preferred stock allows the possibility of additional dividend above the stated amount under certain conditions. Why Preferred? A company may choose to issue preferred for a couple of reasons: Flexibility of Payments: Preferred dividends may be suspended in case of corporate problems. Easier to market: The majority of preferred stock is bought and held by institutions. Institutions tend to invest in preferred stock because IRS rules allow U.S. corporations that pay corporate income taxes to exclude 70% of the dividend income they receive from their taxable income. This is known as the dividend received reduction, and it is the primary reason why investors in preferred are primarily institutions. Preferred Stock Pros • Higher Fixed Income payments than bonds or common stock • Lower investment per share compared to bonds • Priority over common stocks for dividend payments and liquidation proceeds • Greater price stability than common stocks • Greater liquidity than corporate bonds of similar quality Warrants: A warrant is a right, exercisable for a stated period of time that allows the holder to purchase a stated amount of shares for a designated price. Companies sometimes give warrants to investors as an “equity kicker” or “equity sweetener” to make investment more attractive to those investors. Treasury Stock: Stock that is repurchased by the Company from the stockholders. How would you treat the cumulative perpetual preferred preference shares of Casino. Justify your view based on any accounting standards or pronouncements that you may have access to. Cumulative preferred stock - If the dividend is not paid, it will accumulate for future payment. Perpetual preferred stock - This type of preferred stock has no fixed date on which invested capital will be returned to the shareholder, although there will always be redemption privileges held by the corporation. Most preferred stock is issued without a set redemption date. Perpetual Cumulative Preferred stock will be included as Tier 2 Capital. This is aligned with the Basel 1 and Basel 2 norms for supplementary capital- as Preferred Stocks are Hybrid Instruments having characteristics of both debt and shareholders equity. How would you treat the cumulative perpetual preferred preference shares of Casino. Ans. Definitions: Cumulative preferred stock - If the dividend is not paid, it will accumulate for future payment. Perpetual preferred stock - This type of preferred stock has no fixed date on which invested capital will be returned to the shareholder, although there will always be redemption privileges held by the corporation. Most preferred stock is issued without a set redemption date. Accounting Treatment Perpetual Cumulative Preferred stock will be included as Tier 2 Capital. This is aligned with the Basel 1 and Basel 2 norms for supplementary capital - as Preferred Stocks are Hybrid Instruments having characteristics of both debt and shareholders equity. It is further stated that on 30th June; it is more than likely that the Company will classify the security as equity. From the particulars given; there is no mention that the preferred stock are convertible in nature. Had that been the case; then it would have been consistent with what has been stated in the Information provided in the case study. In the existing facts either there is a redemption that is exercised; a right that is vested in perpetual preferred stock; and then the security is classified as Equity or there will be need for a board resolution to be passed and then approved in the shareholders meeting; to have the existing cumulative perpetual preferred shares converted to Equity prior to 30th June. References: 1.Association of Certified Fraud Examiners, USA 2.Institute of Management Accountants, USA 3.Association of Chartered Certified Accountants, UK 4.ICWAI- India. 5.All India Management Association, India 6.www.IASB.org Website 7.www.SEC.gov Website 8.www.AICPA.org Website 9. www.FASB.org Website 10.Monetary Authority of Singapore. 11.Doing Business in Singapore-ICSI-India.