Overview of the Financial Reporting Environment

Hi and welcome back to the introduction to financial accounting course in this session. We will gain familiarity with accounting rules and standards and especially with the financial reporting process that entails understanding and embedding. Who are the preparers of financial statement. Who is in charge of double checking on them and who are the users of financial information and for which purposes they are going to use financial statements. Now, let’s focus on the accounting rules and the standard setting process. Who makes the accounting rules? It’s a quite tricky question because there is a parallel process in place.

On the one hand we have the international accounting standards boards namely the IASB who issues the International Financial Reporting Standards otherwise known as IFRS which have been widely adopted worldwide by nearly 120 countries As of 2019. The IFRS standards must be endorsed locally because there is a supranational body issuing them. On the other hand we have local gaps who are generally accepted accounting principles and each jurisdiction has its own set of accounting rules. Now these gaps are embedded into the institutional system to regulate companies dealings. And the main targets of the local GAAPS would be small and privately held firms or government and not for profit entities. And it is Vis-a-vis the IFRS that is dedicated to large listed companies.

The relevance of the adoption of IFRS worldwide is witnessed by

some figures and numbers: for instance the diffusion of IFRS worldwide can be seen on this slide. As you can notice that nearly 87 percent of countries worldwide are adopting IFRS. Where has the remaining 13 percent is merely adopting local GAAPS. When we look at the relevance of IFRS worldwide and see the breakdown by GDP we can notice that in countries where IFRS are adopted for all companies account for 47 percent of the GDP worldwiden whereas in other countries accounting for 45 percent of the worldwide GDP there is no difference. And this can be explained by the fact that countries like the US or China are not de facto in endorsing IFRS standards.

Also if you look at the breakdown by the number of listed companies you would notice that for 56 percent of companies listed on any stock exchange worldwide the IFRS are required. Whereas - and here it is quite clear in the diagram in the U.S. China and Japan accounting for 31 percent of leasing companies worldwide. These IFRS are not fully endorsed. Now let let’s move on to the financial reporting process. The financial reporting process is a multi-faced process because it goes throughout the year. It stops at the end of the year. And then there are ex-post controls and there are significant differences in terms of regulation across countries. But by and large you can rely on the diagram below.

If you look at the internal constituencies, you would notice that shareholders management and the board of directors or the audit committee are involved. These are internal parties where has the external parties would be the regulator like the SEC in the US who can free sense ask companies to reinstate financial statements if there is a breach in the regulation, or you can rely on external auditors like PWC or EY which work closely with companies throughout the year so that they can ensure a smooth financial reporting process. Now which are the tasks of three different actors? In some countries like in Italy shareholders approve financial statements. It is not so in many other countries though. Then the management and the CFO.

Well these are key actors in certain countries for instance in the US. What happened in the US the CEO and the CFO are legally responsible for signing off the accounts and then in some countries again like Italy. We don’t have an audit committee as part of the Board of Directors whereas we have something called collegio sindacale which is a statutory body which is made of independent professionals from the company who overlooked the financial reporting process now let’s have a look at the financial statement which we see as a package because it’s made of different documents.

The first one is the balance sheet that tells us what is the financial position of the firm and compare its assets and liabilities with the remaining value being accrued as equity. Second, we have the income statement the income statement reveals the performance of the firm by comparing revenues and expenses that accrued throughout the year. And we have the cash flow statement that tells us what these the dynamics of cash flow, meaning what are the cash means and the cash shouts that accrued to the company in the period. Last, we have the statement of stockholders equity that tells us what is the change in the stockholders wealth.

So what is the wealth of the owners of the company as a result of the paid in capital and potentially distribution of dividends. Who uses financial statement and for which purposes Financial statement exists because they must be

useful to someone: they don’t exist in a vacuum. So the first class of users are the current shareholders or potential investors. These can be hedge funds pension funds. It can be retail investors. These people make buy or sell decisions. Now imagine yourself wanting to buy a stock of a company or if you

want to price securities: financial statements are your starting point. Then we have rating agencies and analysts. Now the rule of these two constituencies is making an assessment and evaluation of the underlying company financials and they tell us whether the company will be profitable in the future whether its income is sustainable in the near future. And the issue of valuation of the stock then we have a serious of what we call stakeholders at

large: like regulators for instance like funding bodies, tax authorities or even competitors. Now these subjects have each a specific purpose. For instance you might be interested in assessing the sustainability of the company whether they are polluting or not whether they are generating outputs that are of higher value than inputs or if you want to assess impact which is something that is gaining momentum. Let’s turn now to a taxonomy of corporate communication. Well we normally like to think that it’s all about financial statements. balance sheet and income statement. Well they are extremely important but there is a lot more out there. For instance management earnings forecasts or MEFs.

If these are forecast about the future issued by the managers prior to the end of the fiscal year. These are quite different from earnings announcement point two because earnings announcement are seen released by managers but they basically pre-empt the information that will be released in financial statements. So there is a higher degree of certainty vis-a-vis the MEFs We then have corporate governance report and executive remuneration. And it is increasing steadily over time. So companies tell us who are the board members how many times they’ve met how much executives are earning whether they have stock options whether they have grand and so on and so forth. The financial statement always starts with the chairperson address or a letter to the shareholder.

The letter to shareholder is a summary of what happened throughout the year to the company. It’s usually based on textual rather than numbers. And it’s a nice screenshot of how the company went during the year. Additional layers of information which are more specific on internal self dealing or related party transactions. Now a companies that are involved with intra group transactions with other companies that the union must disclose what kind of transactions they have finalized. And last, we have social and environmental reporting or CSR report that tell what the company has been doing in terms of social impact consumption on natural resources and so on and so forth. Now let’s have a look at the recent trends in corporate communication.

Corporations are increasingly providing voluntary information in addition to what is required mandatorily. For instance there is a lot of information around

corporate social responsibility: meaning what is the impact of company operations on the environment. What has been done in terms of promoting social welfare? but not just. An increasingly common report is the so-called sustainability report. This goes well beyond financial and economic performance. In fact that is a triple bottom line in which companies assure that their operations are long term viable and are sustainable in the future. And last we have governance report that are becoming increasingly common or to some extent mandatory in certain countries. And they tell us who are the owners of the firm who are the board members which feature and characteristics that have which background they have. And they also have to disclose potential conflicts of interest.

We are done for this video by now. And I will see you at the next video.