Multilingual Financial Reporting Glossary for the Conference Interpreter (DE-EN-ES-IT-FR)

Master

Reference

Multilingual Financial Reporting Glossary for the Conference Interpreter (DE-EN-ES-IT-FR)

CRISP, Edward Maxwell, PANTANI, Francesca

Abstract

This paper presents a multilingual financial glossary for the conference interpreter who is preparing to work in meetings whose agendas contain discussion of the financial reports of companies. The vocabulary used in three types of financial reports (balance sheets, cash flow statements, profit and loss--or income--statements) are presented in five languages (English, French, German, Italian and Spanish). There is also introductory and explanatory material for the uninitiated. Likewise, we discuss some extra linguistic and semantic field material, both in the form of explanations and glossaries.

CRISP, Edward Maxwell, PANTANI, Francesca. Multilingual Financial Reporting Glossary for the Conference Interpreter (DE-EN-ES-IT-FR). Master : Univ. Genève, 2012

Available at:

http://archive-ouverte.unige.ch/unige:26753

Disclaimer: layout of this document may differ from the published version.

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Multilingual Financial Reporting Glossary for the Conference Interpreter (DE-EN-ES-IT-FR)

Mémoire réalisé en vue de l'obtention de la

Maîtrise (Ma) universitaire en interprétation de conférence

par

CRISP, Edward Maxwell et PANTANI Francesca

Directeur du mémoire

Jury

SAND, Peter

Niveau de diffusion dans l'archive Public

Résumé

This paper presents a multilingual financial glossary for the conference interpreter who is preparing to work in meetings whose agendas contain discussion of the financial reports of companies. The vocabulary used in three types of financial reports (balance sheets, cash flow statements, profit and loss--or income--statements) are presented in five languages (English, French, German, Italian and Spanish). There is also introductory and explanatory material for the uninitiated. Likewise, we discuss some extra linguistic and semantic field material, both in the form of explanations and glossaries.

KEYWORDS: multilingual glossary, financial statements, financial reports, accounting, interpreting, balance sheet, cash flow statement, profit and loss statement, income statement

Genève, 4 février 2011, Signature :

2

3

Contents

CONTENTS ...3

T ^{ABLE OF} F ^IGURES ... 5

INTRODUCTION ...6

PART I FINANCIAL STATEMENTS ...7

1.1 A PPLICABILITY ... 7

1.2. C LASSIFICATION BY SCOPE AND FREQUENCY ... 9

1.2.1 Difference between Financial Statements and Budget ... 10

1.3 P ^{RIVATE VS} . PUBLIC SECTOR ... 10

1.4 A CCOUNTING POLICIES ... 12

1.4.1 Historic Framework ... 12

1.4.2 Anglo-American vs. Continental Accounting System . 13 1.4.3 US GAAP and the FASB vs. IAS/IFRS and the IASB ... 14

1.5 C OMPOSITION ... 16

1.5.1 Balance sheet ... 17

1.5.2 Income Statement (or Profit and Loss Account) ... 20

1.5.3 Statement of Changes in Equity ... 21

1.5.4 Cash Flow statement... 22

1.5.5 Notes to the Financial Statements ... 22

1.5.6 Interim reports ... 23

1.5.7 The interlocking nature of financial reports ... 23

PART II TARGET AUDIENCE ... 25

2.1 I NTERNAL STAKEHOLDERS ... 26

2.2 E XTERNAL S TAKEHOLDERS ... 27

PART III APPROVAL AND PUBLICATION ... 30

3.1 A ^UDITING S ^TANDARDS ... 30

3.1.1 Historical framework ... 30

3.1.2 US GAAS vs. ISA ... 31

3.2 P ^{ROCESS TO} P ^UBLICATION ... 32

PART IV A LINGUISTIC APPROACH TO FINANCIAL REPORTING

... 34

4

4.1 F IGURATIVE MODELS OF FINANCIAL REPORTING . ... 34

4.2 U SE OF FIGURATIVE LANGUAGE IN FINANCIAL REPORTING DISCOURSE . ... 37

4.3 S ^YNONYMS , J ^ARGON , D OUBLESPEAK AND OTHER ANIMALS ... 38

4.3.1 Synonyms ... 39

4.3.2 Jargon ... 40

4.3.3 Double Speak ... 42

PART V MULITLINGUAL DEFINITIONS ... 44

5.1 M ULTILINGUAL DEFINITIONS OF THE THREE DOCUMENTS EXPLORED IN THIS PAPER ... 45

5.2 U NDERLYING CONCEPTS USED IN FINANCIAL REPORTS ... 48

5.3 P RINCIPAL CONCEPTS USED IN FINANCIAL REPORTS ... 51

5.4 S OME TERMS OFTEN USED DURING DISCUSSIONS OF FINANCIAL REPORTS BUT NOT NECESSARILY FIGURING THEREIN ... 62

PART VI GLOSSARY TABLES ... 70

6.1 M ETHODOLOGY ... 70

6.2 B ^ALANCE S ^HEET ... 71

6.2.1 Balance Sheet Assets ... 71

6.2.1 Balance sheet liabilities ... 75

6.3 P ROFIT AND LOSS ( INCOME ) STATEMENT ... 80

6.4 C ASH FLOW STATEMENT ... 85

CONCLUSION ... 93

BIBLIOGRAPHY ... 94

INDEX ... 96

5 Table of Figures

Figure 1 Multilingual names for companies ... 8

Figure 2 Some definitions of financial accounting ... 12

Figure 3 Anglo-Saxon vs. Continental Accounting ... 13

Figure 4 Balance sheet breakdown ... 18

Figure 5 Equivalances in balance sheets ... 19

Figure 6 Simplified income statement ... 20

Figure 7 Relationship amongst financial statements ... 24

Figure 8 Different types of Stakeholders ... 26

Disclaimer: The information contained in this document is intended for pedagogical purposes only. It is also principally aimed at language trainees and/or professionals. It is therefore not intended to be taken as advice on financial investment.

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INTRODUCTION

When we want to check up on the health of a company, we most frequently turn to that company‘s financial statements. This set of documents and the figures they contain are produced using the company‘s accounts and records, then approved during the Shareholders‘ Annual General Meeting (AGM). Financial Statements are usually found at the end of the Annual Report, which begins with the Chief Executive Officer‘s (CEO‘s) opening ―Letter to Shareholders‖ and the business review section.

At first sight, the contents may inspire dread in the trainee conference interpreter, as they contain highly specific terminology, vocabulary that is likely to be unfamiliar to those who don‘t live and work in this section of the business environment. This is made worse when we look further afield and cross national borders, as each country and region has its own regulatory frameworks for issuing financial statements. Each of these different systems is, at best, a byzantine maze of principles, guidelines and best practices.

Financial statements are based on a continuous work-in-progress. Companies change continuously, evolving with market and economic conditions, which are direct consequences of the changing needs of our society. So, if you have a sound understanding of business and/or economics, you should be able to study these documents and with reasonable diligence get an idea of how well a company is doing, especially if you do so regularly over time and across industry sectors. With this experience, certain pieces of information become more relevant, depending on whom the listener/reader is, and so an interpreter cannot afford to stray too far from the currently accepted terms when working with financial statements.

As time is often of essence when it comes to releasing a company‘s financial information, we aim to provide the interpreter with a quick guide and reference to these documents. First, we look at the paths financial statements have taken leading them to their current format. We will also look at the kind of information presented, why it is important, and how that changes when we move between different groups of people. Then, we describe the key terms, also known as reported items, and attempt a clear explanation of each in simple language. Finally we present multi-lingual reference glossaries.

The aim then is to provide a quick vade mecum for preparing ahead of accounting meetings, AGMs, financing exercises etc. This guide does not cover the financial statements of financial-sector companies (e.g. banks, hedge funds, etc.). Whilst at first glance the reports may look similar, and even contain similar terms, the activities of the company treat money also as a product/service, making the reporting of their activities yet more complex. Therefore, deposit-taking institutions, such as banks, building societies, credit unions, trust companies, mortgage loan companies, insurance companies, pension and investment funds and so on, are excluded. Likewise, we do not include government, civil- society, non-governmental and international organisations either, as their activities are not oriented around profit. (For more detail see Part 1.4)

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PART I FINANCIAL STATEMENTS 1.1 Applicability

We produce financial statements to broadcast the health of a business. In principle, all companies are required by law to produce them, irrespective of the kind of company, if for no other reason than for calculating how much tax they

owe. They are based on a business‘ accounts, i.e. their business transaction records.

When we talk about the kind of business, we usually refer to a sole proprietorship, a partnership or a private or public company (or corporation). The first is a small business based on the activities of one person who owns and runs his or her own business.

Classic examples of this include shopkeepers, plumbers, electricians and so on. A partnership is made up of two or more individuals who set up, own and manage a firm together. Many professional businesses, such as audit and law firms, are organised

in this way. They are not limited to small companies however; most of the world‘s most famous investment banks – Goldman Sachs, Morgan Stanley, JPMorgan – started off as partnerships before later becoming public companies. A company, then, is a kind of business which is not necessarily set up, owned and managed by the same people.

When a company is first established, its ownership (shares) can be held either privately by a small group people in some way related to those running it or publically by a large number of people, investors or shareholders,‘ whose only relation to the company is this investment.

Companies often grow in this way, starting life as a partnership, reaching a point where they need more money to expand and turning to others for this. After turning to people they know, including banks, they have the option of selling a small stake in their companies to the general public. This process is called an Initial Public Offering, often referred to as ‗floating‘ a company.

Financial statements:

documents regularly produced by companies, attesting

to the conditions

within the company

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The crucial difference between sole proprietorships and partnerships on the one hand and companies on the other is the concept of ‗limited liability.‘ Shareholders of a company cannot be held personally responsible for any of its debts, unlike sole proprietors and partners.

Given this lack of liability, there is a clear need for publishing financial reports, so those who invest in the company can do so in full knowledge of its health. Figure 1 (below) shows the different names under which public and private limited liability companies go in the 27 EU member states.

Figure 1 EU-member-state names for public and private limited liability companies

Country Public Companies Private Companies

Limited Partnership General Partnerships Austria Aktiengesellschaft Gesellschaft mit

beschränkter Haftung

Belgium Société anonyme/

naamloze vennootschap

Société de personnes à responsabilité limitée/

personenvennootschap met beperkte

aansprakelijkheid

Société en commandite par actions /

commanditaire vennootschap op aandelen Bulgaria акционерно дружество дружество с ограничена

отговорност командитно

дружество с акции

Cyprus

Δημόζιες εηαιρείες περιοριζμένης εσθύνης με μεηοτές ή με εγγύηζη

ιδιωηικές εηαιρείες περιοριζμένης εσθύνης με μεηοτές ή με εγγύηζη

Czech Republic Společnost s ručením

omezeným Akciová společnost

Denmark Aktieselskaber Kommanditaktieselskaber Anpartsselskaber Estonia Aktsiaselts Osaühing

Finland Osakeyhtiö/Aktiebolag

France Société anonyme Société en commandite par actions

Société à responsabilité limitée

Germany Aktiengesellschaft Kommanditgesellschaft auf Aktien

Gesellschaft mit beschränkter Haftung Greece ανώνσμη εηαιρία εηαιρία περιωριζμένης

εσθύνης εηερόρρσθμη καηά

μεηοτές εηαιρία Hungary Részvénytársaság Korlátolt felelősségű

társaság

Ireland

Public companies limited by shares or by guarantee

Private companies limited by shares or by guarantee

Italy Società per azioni Società in accomandita per azioni

Società a responsabilità limitata

Latvia Akciju sabiedrība Sabiedrība ar ierobežotu atbildību

Lithuania Akcinės bendrovės Uždarosios akcinės bendrovės

Luxembourg Société anonyme Société en commandite par actions

Société à responsabilité limitée

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Country Public Companies Private Companies

Malta

Kumpanija pubblika — Public limited liability company

Kumpannijaprivata — Private limited liability company

Soċjeta in akkomandita bil-kapital maqsum f'azzjonijiet — Partnership en commandite with the capital divided into shares

Poland Spółka akcyjna Spółka z ograniczoną

odpowiedzialnościa Spółka komandytowo- akcyjna

Portugal

Sociedade anónima, de responsabilidade limitada

Sociedade em comandita por açcões

Sociedade por quotas de responsabilidade limitada

Romania Societate pe acțiuni Societate cu răspundere

limitată Societate în comandită

pe acțiuni Slovakia Akciová spoločnosť Spoločnosť s ručením

obmedzeným Slovenia Delniška družba Družba z omejeno

odgovornostjo

Komanditna delniška družba

Spain Sociedad anónima Sociedad comanditiara por acciones

Sociedad de responsabilidad limitada Sweden Aktiebolag

The Netherlands Naamloze vennootschap

Besloten vennootschap met beperkte

aansprakelijkheid

UK

Public companies limited by shares or by guarantee

Private companies limited by shares or by guarantee Source: (European Council, 1978)

1.2. Classification by scope and frequency

There are different kinds of financial statements. It is important to distinguish between reports based on consolidated and unconsolidated accounts. The former offers an overview of the business at group level. Companies often invest (become part owners) in other companies, which then become known as subsidiaries. This is known as owning a stake in a company and inextricably links the two firms, often making it necessary to consider all their activities and financial results in one set of documents. Unconsolidated accounts describe the financial situation of a company irrespective any other companies in which it may be involved financially. So, in principle, for a company with no subsidiaries, there is no such thing as a consolidated set of accounts. Once a company has controlling or minority stakes (see box) in other entities that operate as part of the same business, two sets of statements should be produced.

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1.2.1 Difference between Financial Statements and Budget

When released as part of a company‘s annual reports, the information contained in financial reports is of great value. Similarly, quarterly, or interim, announcements of a company‘s earnings also fuel the

financial community‘s activity, as they wait with bated breath to see how the company is doing. As we said, in these cases, time is of the essence and heated buying and selling of the company‘s shares often follows on the stock exchange. By contrast, another document, the annual budget, fails to make the front-pages.

A company‘s annual budget is merely an internal document. It is seldom available to investors or the general public. It constitutes an irreplaceable tool for directing the company towards its annual targets, but it is usually limited to the specific situations within the divisions of a company. Annual budgets can refer to a business‘ given regions, divisions, product lines, projects, clients etc.

It is a crucial component of planning. The company‘s managers need to ensure the company will not go beyond its financial limits, or to know systems are in place, which either prevent overspending or set off warning signals beforehand.

Once a period ends, it also serves to check revenue and expenditure projections for reliability. Nevertheless, the budget is usually forward-looking. This is the main distinction from financial statements, which offer a glimpse of the major events and activities of the past fiscal year, an overview at a certain point in time or the business activity over a chosen period.

1.3 Private vs. public sector

As mentioned in the introduction, we are focusing on companies. Now that you have a little background, we can briefly look at some of the reasons why private and public sector finances must be considered separately. A company needs to generate profit if it is to survive.

Its financial statements gauge its ability to do this. Governments and non-profit organizations, let‘s say the Red Cross for example, are almost never judged on profit. Their annual reports are most likely valued more for their content describing their humanitarian actions than for

Controlling stake: a percentage of a company

large enough to veto decisions

Minority stake: a percentage not large enough to veto decisions

Budget: allocation of funds to specific present future and

projects

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any financial aspects, barring any crisis. The main aim of the organization is the achievement of charitable aims, the provision of public services and so on. Supply and demand, shareholder profit and such considerations bear very little if any relation to the activities of public sector and non-profit organisations.

Furthermore, public sector entities rely on donations, almost entirely unrelated to the services provided. Fluctuations may occur, yet never be reflected in the quantity or quality of services provided. Similarly, these donations might not reflect demand or satisfaction levels.

In the private sector, however, we can clearly identify these factors. If the price of a good or service is constant and a company is doing more business, there is a clear indication that the company is successfully satisfying a societal need. As time passes, this may turn into higher levels of production and an investor may foresee a bright future for the company and commit more resources to it.

This logic does not necessarily apply to public-sector organizations. They are judged more on the current availability of funds, which is not the same as an ability to generate funds. Their funds may come from, amongst other things, donations, country contributions, sales-related taxes, individual income, property taxes, state monopoly excises etc. In addition to that, they are obliged to provide a minimum level of service to the community irrespective of the actual needs and might not respond promptly to demand fluctuations. The exception to this rule is, of course, investment in sovereign debt, whereby an investor would look at the data for a national economy much in the same way as they would scrutinize a company‘s performance, but economic data is very much a different kettle of fish to company accounts.

This difference is compounded in the light of accounting regulations. Let us take the matching concept for example. This is a central notion in financial accounting. It states that expenditures must correspond to incomes (hence the idea of a ‗balance‘ sheet). This is a challenge for companies in the broadest sense of the word, yet does not apply in the same way to governments and not-for-profits. Businesses attempt to match the costs of specific goods or services with the revenues that they generate. Governments and not-for-profits, however, can sometimes do no more than associate overall revenues with the broad categories of expenditures they are intended to cover (Granof, 2006). It is for these reasons that we associate budgets with government entities and NGOs, quite rightly so, as the budget is the culmination of a political process. It is this political process that demonstrates the organization‘s ability to generate income.

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1.4.1 Historic Framework

As you probably will have seen by this stage, the terms accounting and accounts and reporting and reports are used relatively broadly. It is hard to escape the distinction between documents and processes, but it would also be useful to draw a line between accounting and reporting. To begin, and at the risk of oversimplifying, we could say accounting is a process with no other aim than to continue compiling data. Reporting then is the periodical collation, analysis and presentation of that data.

In fact, there is no single definition of accounting. Over the years some have tried to pinpoint the nature and aim of accounting practices. The United States of America has the longest list of such attempts, some of which are shown in Figure 2 (below).

Generally it is safe to say that accounting describes a company‘s activity. With time this has broadened from pure financial information to include non-financially quantifiable information¹, ensuring a comprehensive reference.

Reports rely on a reliable accounting system. Accounts serve the company whether reported or not, just think of the incriminating records kept by clandestine organisations, such as that run by Al Capone. Reports, however, most often serve those outside the company. Yet both are subject to regulation, which itself has evolved as the result of legal, social and economic circumstances.

Figure 2 Some definitions of financial accounting

Accounting Body Definition

American Institute of Certified Public Accountants (1)

Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the result thereof

American Accounting Association (2) Accounting refers to the process of identifying measuring and communicating economic information to permit informed judgment and decisions by users of the information

American Institute of Certified Public Accountants (3)

Accounting is a service activity. Its function is to provide quantitative information, primarily financial in nature as it talks about economic entities that is intended to be useful in making economic decisions and in making reasoned choices among alternative courses of action

(1) (American Institute of Certified Public Accountants, 1953) (2) (American Accounting Association, 1966)

(3) (American Institute of Certified Public Accountants, 1970)

1 This information is presented in a section called Notes to the Financial Statements.

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1.4.2 Anglo-American vs. Continental Accounting System

As you may know, the Anglo-American (or Anglo-Saxon if you prefer) and Continental (or Roman) legal systems are vastly different. As an interpreter this is hard to ignore. Interestingly, accounting is one area most affected by this difference, increasingly so given the existence of multinational companies and in a globalized world.

Each region and country has so-called generally accepted national accounting principles. A study of these reveals legal frameworks have been shaped over time by economic pressures, short- and medium-term fiscal goals, abuses of the system and fraud scandals and so on. Let‘s take a quick example: the invention of the corporation was a direct response to the economic pressures of the industrial revolution. As industrialization gathered steam, no pun intended, so did business. To keep apace of this, business owners found they could sell part of their company. This transaction provided them with financing in return for a promise of future returns. As a result of this, national legislators saw the need to protect or promote specific interest groups, different categories of investors and trade partners. This varied naturally from sector to sector and therefore from country to country. For example, a country like Germany would have adopted provisions favouring small and medium sized enterprises (SMEs) and shaped accounting standards around those provisions, whilst a country like Italy might have opted merely to simplify reporting requirements for companies operating in specific sectors. Figure 3 shows the most relevant aspects of Anglo-American and Continental accounting systems.

Accounting rules must therefore be seen as a mechanism, liable to change with the times to stabilize the business environment in response to events.

Figure 3 Fundamental characteristics of Anglo-Saxon and Continental Accounting

Accounting System Continental Anglo-Saxon

Economic and Social Environment

Predominant Source of Financing Banking sector Welfare state Civil Law

Accounting and Taxation strongly interconnected

Financial markets

Culture Individualistic

Judicial System Common Law

Fiscal System Accounting independent from

Taxation

Accounting objectives

Main users Creditors, Tax authorities,

Investors

Investors

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Accounting System Continental Anglo-Saxon

Predominant Accounting Principles Prudence True and Fair View

Publication scope Limited Significant

Accounting and Valuation Options

Significant Limited

Operating Profit calculation ruled by

Prudence Profit distribution limitations

Creation of hidden reserves

True and fair view No limitation to profit distribution

No hidden reserves

Relation between Accounting and Taxation Mutual influence

Belgium, Germany, France, Greece, Italy, Japan, Portugal, Switzerland

Independent

Countries Australia, UK, Ireland, Canada,

New Zealand, The Netherlands, Singapore, USA

Source : (Glaum & Mandler, 1996)

1.4.3 US GAAP and the FASB vs. IAS/IFRS and the IASB

As the world has become so much more interdependent, it comes as no surprise that in recent years we have seen conscious efforts to harmonize the two dominating systems:

 US General Accepted Accounting Principles (US GAAP) as promulgated by the Financial Accounting Standard Board (FASB); and

 International Accounting Standards (IAS)/International Financial Reporting Standards (IFRS)² as defined by the International Accounting Standards Board (IASB).

They differ in their very nature. The Continental IAS/IFRS dictate the principles ruling accounting practices but do not limit how information is interpreted so strictly. In contrast, the US GAAP standards adopt a more prescriptive approach, generally avoiding the interpretation of standards. This gives room for maneuverer to those who operate under this system, including the official interpretive body, the International Financial Reporting Interpretations Committee (IFRIC). On the other hand, the strong regulatory and legal environment in US

2 International Accounting Standards (IAS) were developed by the International Accounting Standards Committee (IASC) from 1973 to 2000. In 2001 the IASC underwent a major restructuring and changed its name to International Accounting Standards Board (IASB). Similarly, IAS were renamed as International Financial Reporting Standards (IFRS). Since then, the IASB has amended some IAS, has replaced some of them with new IFRS and has adopted or proposed certain new IFRS on topics for which there was no previous IAS. The denomination IAS still applies to revised standards issued before 2001.

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markets has led FASB to include guidance for implementation and industry-specific interpretations. It goes beyond the purpose of this essay to describe the specific differences between US GAAP and IAS/IFRS.

The European Union (EU) adopted the International Accounting Standards (IAS) Regulation in June 2002. It requires all companies registered in the EU to prepare their financial statements in accordance with IFRS, as of 2005³:

―These standards should, wherever possible and provided that they ensure a high degree of transparency and comparability for financial reporting in the Community, be made obligatory for use by all publicly traded Community

companies‖ (European Parliament and the Council of the European Union, 2002).

EU legislators have always aimed to consolidate widely accepted accounting principles and the specificities of the EU single market. Although some argue against this, saying ―to attempt further harmonization at the European level is merely to introduce an unnecessary, artificial, and distracting middle layer into the wider movement toward greater international harmonization and comparability‖ (Alexander & Archer, 1995, p17). Be that as it may, the EU‘s reforms introduced in the 1970s and early 1980s were very much needed and are key to understanding today‘s regulatory framework.

In 1971, the first of these reforms was embodied in the Fourth Directive (as amended 1978). It was originally based on German civil law, an example of Continental law. It underwent significant amendments in 1974 when the UK and Ireland, whose systems are Anglo-American, joined what was then the European Economic Community (EEC). Within the Fourth Directive, in article 31, we can find the principles that should guide the accountant in compiling financial statements.

The Fourth Directive was followed up with the Seventh Directive (1983). This latter directive applied and broadly extended the provisions of the former to the preparation and publication of consolidated accounts. It took a longwinded and excruciating procedure before this was adopted in 1983. This was due to the co-existence of de jure and de facto (see box) approaches within the EEC. One of the most important issues related to groups of companies (specifically, defining the relationship between a parent company and subsidiaries and the subsequent accounting requirements and methods).

3 Where IAS were not to be applied, the 4th and 7th Company Law Directives (78/660/EEC and 83/349/EEC), also known as the Accounting Directives, would continue to be the basis of EU accounting requirements.

de jure: concerning law, officially created through legal

means

de facto: concerning fact, brought about through convention and/or customary practices

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The Fourth and Seventh Directives were subsequently integrated by further legislation, following changes in the markets and new EU Member States. This is a good example of how frameworks responded to changes in a conscious effort to harmonise accounting and reporting activities.

In December 2004 the EC Transparency Directive expanded the use of IFRS by requiring it use by non-EU companies wishing to be registered within the EU for investment purposes. Exceptions to this are made where the Committee of European Securities Regulators (CESR) agrees national accounting standards are equivalent to IFRS⁴.

1.5 Composition

We turn now to look at the reports themselves. As we mentioned earlier, all firms are obliged to keep track of their business activity. However, not all are obliged to make this information public. Those which must are subject to disclosure requirements for publicly listed companies (PLCs). Nevertheless, the same accounting principles are applied by those private companies not subject to such requirements. The situation is different and the criteria simplified, for sole proprietorships and partnerships. We will focus on those companies obliged to disclose their financial reports.

In the interest of transparency and fairness, accounting rules ensure that companies‘

financial statements comply with not only statutory requirements but also accounting standards. Accounting standards contain guidance as to how certain matters should be dealt with in a company‘s financial statements. A guideline known as IAS 1 sets out the general requirements for presenting financial statements as well as information on how to structure them and on minimum content requirements. IAS 1 was recently revised to help investors, creditors and interested parties to:

(a) understand an entity‘s present and past financial position;

(b) understand the past operating, financing, and other activities that caused an entity‘s financial position to change and the components of these changes; and

(c) use that financial information (along with information from other sources) to assess the amounts, timing, and uncertainty of an entity‘s future cash flows. (European Commission, 2008)

In particular, this revision of IAS 1 addressed the issue of what constitutes a complete set of financial statements and the requirements needed to present information comparable with previous reports. This includes new titles for sections within financial statements (for example 'statement of financial position' instead of balance sheet). While, these will be used in the

4 In 2005 CESR published its final technical advice to the EC on equivalence between Canadian, Japanese and US GAAP and IFRS. The Committee reached the conclusion that companies following the three above-mentioned GAAP willing to observe additional disclosure requirements for specific reporting items were exempted from adopting IFRS. However, there was no final decision as to what additional disclosures might be deemed necessary.

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accounting standards, they are not mandatory in the statements themselves. As you may be beginning to see, there is a plethora of quasi-synonyms, so we must always bear in mind that these sorts of amendments do occur and immediately adopt the new terms.

A complete set of financial statements is made up of:

(1) a balance sheet (also known as statement of financial position) (2) an income statement (also known as profit and loss account) (3) a statement of changes in equity

(4) a statement of cash flows

(5) notes, comprising a summary of accounting policies and other explanatory notes The above mentioned documents provide information about the financial position, financial performance and cash flows of an entity. In turn, minimum disclosure requirements apply to each component, as we will see below.

1.5.1 Balance sheet

The balance sheet is a snapshot of the firm. This is a convenient means of organising and summarising what a company owns (assets),

what a company owes (liabilities) and the difference between the two (equity) at a given point in time. Figure 4 (below) illustrates how this can be conceptualised. The left-hand side lists assets and the right-hand side shows liabilities and equity.

Assets are classified as either current or fixed. Fixed assets have relative long lives.

They can be either ‗tangible,‘ such as a lorry or a personal computer, or ‗intangible,‘ such as royalties or patents. Current assets can be converted into cash within 12 months. An important component of current assets is usually a firm‘s stock (the term inventory often causes less confusion), which would normally be sold on to customers within a year. Another example might be accounts receivable (the money owed to the firm by its customers).

As liabilities represent the eventual loss of an asset, they mean a reduction in the ability to provide value. Liabilities are also classified according to the period during which this change may occur, current or long-term.

For example, any amount of money owed and to be paid within 12 months is called a current liability. Debt that is not due in the coming year is classified as long term liability.

Asset: a resource capable of providing

value.

Liability: a commitment to transfer an asset to

another entity.

18

The difference between the total value of assets and of liabilities is known as shareholders’ equity, also referred to as common equity or owners’ equity. So, if we were to sell all the company‘s assets and pay off all its debts, this is the sum with which investors would be left. This remainder will unlikely correspond to their initial investment in the company; in fact, if this situation did arise, it would be the exception not the rule.

Figure 4 Balance sheet breakdown showing assets and liabilities

Over the page, Figure 5 shows another representation of the balance sheet, this time showing the equivalent items that must always ‗balance.‘ We are also introduced to the idea of Net Working Capital. This is the difference between current assets and current liabilities.

Simply put, it is the amount of cash a company will have ‗in hand,‘ taking into account not only the conversion of current assets into value, but also the loss of value inherent in its obligations to others. A healthy company should have a positive figure for Net Working Capital.

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Figure 5 Equivalences in balance sheets

Minimum items on the face of the statement of financial position should include:

(IFRS, 2007)

(a) property, plant and equipment (e.g., a shipping company has many ships)

(b) investment property (e.g., a piece of land held and forecast as increasing in value) (c) intangible assets (e.g., a trademark)

(d) financial assets (e.g., investment in other companies) (e) biological assets (e.g., a forest, vineyard, stock of fish) (f) inventories (e.g., a stationery producers stock of stationery) (g) trade and other receivables (e.g., money owed by a customer)

(h) cash and cash equivalents (e.g., bank accounts, savings accounts, cheques, treasury bills, foreign currency accounts)

(i) assets held for sale (e.g., a ship, trademark, etc.)

(j) trade and other payables (e.g., money owed to suppliers)

(k) provisions (e.g., amount of money needed to repair goods sold under warranty) (l) financial liabilities (excluding amounts shown under (k) and (l)) (e.g., A futures

contract to buy a commodity at a certain price)

(m) liabilities and assets for current tax (i.e., tax owed or due)

(n) deferred tax liabilities and deferred tax assets (i.e., tax owed or due in the future) (o) liabilities included in disposal groups (e.g., a mortgage loan of a company held for sale)

(p) non-controlling interests (i.e., a less than 50% holding of shares in a company)

(q) issued capital and reserves attributable to owners of the parent (i.e., money invested into a company by a stockholder/s)

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1.5.2 Income Statement (or Profit and Loss Account)

In contrast to the balance sheet, the Income Statement shows revenues and expenses incurred by the company over a period of time, be it a quarter, a semester or a full year. If we think of the balance sheet as a photograph, we can consider the income statement as video footage capturing all the events that affected the elements portrayed in our picture. Figure 6 (below) gives a simplified version of an income statement; please refer to Part V glossaries for definitions of the terms included therein.

At this stage we are still looking at things in a simplified way, in reality each company has many different operations, many of which are spread over different timespans.

Whereas the balance sheet has a holistic approach to value, the income statement goes into detail showing which elements of the business are bringing in money and which are letting it escape. So the balance sheet has two columns (or sections depending on how it is laid out) with equal totals, and the income statement has one total, which should come in somewhere under the totals on the balance sheet (how much varies greatly on the company, industry and so on). For this reason, income statements usually have negative numbers, often expressed as such by being place in brackets.

Figure 6 Simplified income statement

______________________________________________________________________

_________________________________________________________________________

Minimum items on the face of the statement of comprehensive income should include: (IFRS, 2007)

(a) revenue (b) finance costs

(c) share of the profit or loss of associates and joint ventures (d) tax expense

Net sales

minus Cost of goods sold minus Depreciation/Amortisation

= Earnings before Interest and Taxes (EBIT) minus Interest paid

= Taxable Income minus Taxes

= Net Income

Including: Dividends

Addition to retained earnings

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a. the post-tax profit or loss of discontinued operations and

b. the post-tax gain or loss recognized on the disposal of the assets or disposal group(s) constituting the discontinued operation

(f) profit or loss

(g) each component of other comprehensive income classified by nature (h) share of the other comprehensive income of associates and joint ventures (i) total comprehensive income

The following items must also be disclosed in the statement of comprehensive income as allocations for the period: (IFRS, 2007)

(a) profit or loss for the period attributable to non-controlling interests and owners of the parent

(b) total comprehensive income attributable to non-controlling interests and owners of the parent

1.5.3 Statement of Changes in Equity

The third most important component of Financial Statements is the Statement of Changes in Equity. This refers to the variation in retained earnings. Retained earnings are the portion of net income not distributed to shareholders as dividends (investors‘ share in the profits).

Minimum items on the face of the statement of changes in equity should include:

(IFRS, 2007)

(a) total comprehensive income for the period, showing separately amounts attributable to owners of the parent and to non-controlling interests

(b) the effects of retrospective application, when applicable, for each component (c) reconciliations between the carrying amounts at the beginning and the end of the

period for each component of equity, separately disclosing:

o profit or loss

o each item of other comprehensive income

o transactions with owners, showing separately contributions by and

distributions to owners and changes in ownership interests in subsidiaries that do not result in a loss of control

The following amounts may also be presented on the face of the statement of changes in equity, or they may be presented in the notes: (IFRS, 2007)

o amount of dividends recognised as distributions, and o the related amount per share

22 1.5.4 Cash Flow statement

The Cash Flow statement reflects the company‘s ability to pay. As with the income statement, it takes a number of the same variables seen in the balance sheet to break down the parts of the business through which there is difference in incoming and outgoing cash. Up until now we have been looking at money and value as opposed to cash. There is value in a product waiting to be sold, but for that value to be realized, a buyer is needed. This age old problem led to the creation of currency, and accounting distinguishes between cash and value.

You will regularly see ‗cash‘ followed by ‗and cash equivalents.‘ Cash equivalents refer to any document (securities) that can readily be sold for cash, e.g., Treasury bills, commercial papers, etc. (n.b.: non-cash transactions such as depreciation, amortisation and write-offs are excluded). The cash flow statement therefore shows a company‘s ability to be able to pay off debts independently of their sales performance. Again we will see negative figures in amongst the figures, in brackets as the norm.

Cash flows statements must distinguish between operating, investing and financing activities (IFRS, 2007). They are therefore often broken down as follows:

 Operating activities - the main revenue-producing activities of the entity that are not investing or financing activities. Operating cash flows include cash received from customers and cash paid to suppliers and employees

 Investing activities - the acquisition and disposal of long-term assets and other investments that are not considered to be cash equivalents

 Financing activities - activities that alter the equity capital and borrowing structure of the entity

1.5.5 Notes to the Financial Statements

Finally, and as their name suggests, the Notes to the Financial Statements complement the information included in the four previous documents. As we alluded to earlier, information in this section is primarily non-numerical. The IFRS (2007) prescribes that the notes to the financial statements should present information about the specific accounting policies used, as well as any additional information relevant to gaining a comprehensive overview of the business. Other variables that you might find there include financial risk management, intended acquisitions, outstanding lawsuits, effects of business combinations, segment/geographical information.

23 1.5.6 Interim reports

Financial reports are usually an annual exercise. A good number of companies also provide interim reports, most typically for each quarter or half-year. Often they contain the same kinds of information as annual reports, but minimum disclosure requirements are set forth in a separate guideline (IFRS, 2007). This guideline specifies the content of an interim financial report should conform to International Financial Reporting Standards, but does not mandate:

 which entities should publish interim financial reports,

 how frequently, or

 how soon after the end of an interim period.

Such matters will be decided by national governments, securities regulators, stock exchanges, and accountancy bodies. For the sake of simplicity, these interim requirements are not going to be outlined in further detail. (Key to electronic files: itsnotbalancesheet)

1.5.7 The interlocking nature of financial reports

As you may have gathered by now, a lot of the information used in each report is the same on all reports. What changes significantly between them is not the name and numbers but the layout. This simplifies the interpreter‘s task considerably, although it is naturally best to double check by cross referencing the documents you have to hand. We include the following Figure 7 (over) taken from Tracy (2009), showing how the three principal documents interact.

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Figure 7 The interlocking nature of balance sheets, cash flow and income statements

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PART II TARGET AUDIENCE

We began the last chapter by saying that these reports are useful for assessing a company‘s ‗health.‘ As with this metaphor, often a person‘s health is of interest not only to patient and doctor but also to many others, think of insurance companies, employers, relatives and loved-ones, health services and so on. In business, this is the same. In this part, we will look at the potential audience. As we do this we must also ask, why are they interested and what interests them specifically.

The balance sheet can be an invaluable tool for making informed decisions. By looking at the relative size of accounts payable (i.e., how much the company owes to its suppliers), a potential supplier can see how promptly the firm pays its bills. The company‘s potential creditors would probably examine its liquidity and degree of financial leverage, helping them decide whether the company is a good investment. Managers within the firm can track cash and inventory kept on hand, as it is part of their role to ensure neither is sitting around in large quantities lying idle.

As you can see in Figure 8 (over) we can define two large groups within the potential audience. A general term for those who have some vested interest in a company is stakeholders. In this respect, it is vital to stress the difference between stakeholders and shareholders. A stakeholder is not necessarily a shareholder, but a shareholder is by definition a stakeholder.

Stakeholders refer to a broadly defined group having an interest in and/or being affected by the company‘s operations, such as employees, customers, local communities, suppliers and governments.

Shareholders, which are also called stockholders in American English, are a type of stakeholders. Their interest in the company is above all financial. They can be natural or legal persons (natural persons are individuals and legal persons are companies, pension funds, non- profit organizations etc.) and they own a percentage of the company (i.e. shares or stock) by virtue of a capital investment.

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Figure 8 Different types of Stakeholders

2.1 Internal stakeholders

Managers: Although shareholders own the company, they do not involve themselves in its day-to-day operation. Instead, they vote to elect a board of directors who make decisions concerning the company‘s general course. Typically, some board members are drawn directly from the upper echelons of the company management, although there are often non-executive directors amongst them, i.e., directors who are not employed by the firm to work there. The members of a board of directors represent the shareholders. It is their role to appoint the top management, or executive officers, who in turn are mandated with acting in the shareholders‘

best interest.

For managers, financial statements offer a good tool to keep an eye on their management. Just like board members, those entrusted with the responsibility of steering the company, can use them to check that those they hired are on track to meet expectations.

Managers are usually very focused on financial reporting, as changes in the figures contained therein are an objective measure of their performance. In many cases where targets have been set, they will also decide the remuneration a manager receives.

Employees: Employees all work for the same company and their coordinated effort should contribute to achieving a common goal, but as employees have individual tasks, it

Managers

Internal Stakeholders

Employees

Banks/Lenders

External Stakeholders

Shareholders/

Investors

Suppliers/

Trade

creditors

Government

Local Communities

Customers

Company

27

means they often struggle to get an overall picture of the company. Companies are complex and everybody is focused on the targets set for their own division or department. Strategic decisions and guidelines cascade through the hierarchy on a regular basis, but that is not enough to assess the health of a company. In addition, there are so called ‗cost‘ departments whose activities do not generate revenue for the company (e.g. human resources, security, premises, etc.).

In some companies, and to a greater extent in some contracts, shares of the company are awarded to employees either on a performance basis (as with managers) or simply as part of a salary package (which could also include pension contributions and so on). Employees with such considerations will likely want to monitor how the company is doing, even if it is just out of the curiosity generated by gambling cash from their pay packet on the odds of a future windfall.

The more forward-looking employee may also be hedging his or her own future.

Companies have strengths and weaknesses, market shares and short-term objectives swing significantly from sector to sector, business to business and even within the same company.

Problems in one part of the company might not be naturally communicated to those working in profitable divisions. Employees belonging to business units that operate at a loss are therefore in a position to see bankruptcy coming long before the others.

Hence a good understanding of financial statements can prove worthy: it is the key to solving this intricate puzzle and understand how each and every employee is contributing to the business‘ continuity, and ultimately how the company is performing as a whole.

2.2 External Stakeholders

Shareholders/Investors: This group of stakeholders comprises governmental, public and private entities as well as individuals. They have ‗lent‘ the company their money and so should naturally be concerned that it is being put to

profitable use. They analyse the reports to identify measures of risk and return to make investment decisions. These decisions require estimates of the future, be it a month, a year or a decade and as with most things in life, future predictions are made on the basis of past and present trends. General- purpose financial statements, which describe the immediate past, provide a good starting point for projecting future earnings and cash flows etc. For long-term investments, it is crucial to determine the long-term earning power of the company, often

Risk: the probability an investment will lead

to profit (cf. high vs.

low)

Return: the profit earned from an

investment

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Banks/Lenders: As with shareholders and investors, lenders are mostly interested in making credit decisions. As part of their investment and credit strategies, such companies employ what is known as diversification. Lenders often invest in companies in different industries, sectors, and even within the same

market, as each company presents a unique risk profile. Lenders need to assess whether a company can keep up with repayments of money borrowed at a given interest rate. They turn to its financial reports to do this.

Suppliers/Trade Creditors: This group has a similar interest to that of lenders, although they have a more short-term horizon and so focus in on elements such as liquidity, as their own survival might hang in the balance should a payment be missed or delayed.

Customers: The general public needs to be informed about companies‘ activities, even more so if we consider that spending habits contribute to their survival. Sustainability and business ethics become increasingly topical and companies have the duty to provide as much information as possible about the materials they use, the ethical approaches they do or do not use in manufacturing and business processes as well as their general attitude towards society. There is also a growing trend of environmental reporting, often focusing on such items as carbon neutrality.

Government: public authorities can use the financial statements of national companies to help their own projections for the fiscal year, double-check company tax returns against publicly available documents and shape future fiscal policies. Moreover, governments also act as strategic investors by taking up majority or minority stakes in companies deemed of significant interest to the state.

Local Communities: Financial statements offer detailed information about the impact of business activities on the territory. As with the general public, they may sift through the Notes for information on plans for future expansion or on Corporate Social Responsibility programs. Civil society will also use information contained in these pages when planning civil disobedience campaigns. Citizens can use it should they want to undermine the company‘s profitability through targeted consumer spending initiatives. Financial statements offer very clear revenue breakdowns by country, product, brand etc., often used to the advantage of lobbyists and boycotters.

Diversify: spreading risk across

investments

basket)

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We can build on the internal-external dichotomy by distinguishing two types of financial reporting, management and financial, each destined for different end users and end uses.

A management report is used by internal decision makers to make informed decisions on operations, investments and financing activities (related to specific divisions and/or lines of business). It can refer to the company as a whole but is never intended for the general public. Typical examples of management accounting reports include Client Profitability Analysis, Product Profitability Analysis, Sales and Financial Forecasting, Annual Budgeting, Cost and Resource Allocation.

Financial reports are used primarily by external stakeholders such as investors, creditors, financial analysts, regulatory authorities etc. The exception to this rule is internal stakeholders, such as employees, who may find information is presented more clearly to the public than to staff.

Earlier we discussed the relationships between shareholders, directors and managers but did not evoke the concept of accountability. In most companies, each stakeholders group bears a different responsibility. Managers are in charge of running and steering the business, setting short terms goals as well as long-term strategies, if they err in doing this they are held accountable by the board of directors. On the next level up, directors of the board are held accountable by shareholders and, ultimately, to other stakeholders, such as governments and civil society. Nevertheless, external stakeholders must rely on the information held in financial reports to monitor their investment.

For the purpose of this work, we will continue our exploration of financial accounting documents.

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PART III APPROVAL AND PUBLICATION 3.1 Auditing Standards

3.1.1 Historical framework

As we mentioned earlier, companies are subject to rules and guidelines in their compiling and presenting of financial reports. It is inevitably the responsibility of someone to monitor companies from time to time, or as needs be, to ensure that they are complying with rules and guidelines. This process is known as auditing and is essentially a double-check of the company‘s accounts plus investigation where deemed necessary. Auditing is carried out for a variety reasons, including but not limited to suspicion of dubious accounting practices and ahead of potential mergers, investments etc., then often known as due diligence (see box on next page).

The auditing world is heavily concentrated. Four accountancy and professional services firms, usually referred to as ―the Big Four‖, dominate the

industry:

 PricewaterhouseCoopers

 Deloitte Touche Tohmatsu

 Ernst & Young

 KPMG (Klynveld Peat Marwick Goerdeler)

Before 1989, there were a larger number of smaller firms, but following a series of mergers the number of big players dropped from 8 to 5. Then, in 2002, came the demise of Arthur Andersen, forced to withdraw from business in the wake of the Enron scandal⁵.

The Big Four share the global market more or less equally. In 2007 market share ranged from 22% to 28% with two firms having almost equal shares of about 25%. This is a recent

5 The firm was indicted for obstruction of justice for shredding documents related to the audit on the 2001 Enron scandal. The resulting conviction, since overturned, still effectively meant the end for Arthur Andersen. Most of its country practices around the world were sold to members of what is now the Big Four.

Auditing: the professional

review of a company by a

third party