Reading Financial Reports For Dummies. Lita Epstein

Chapter 18) or reviewed the numbers. A report reviewed rather than audited by a CPA is a much less intensive look at the data and thus, holds less weight.

      Annual reports

      Most small companies must file their annual reports within 90 days of the end of their fiscal year. Companies with over $75 million in assets must file their reports within 60 days. The annual report includes the information presented in the quarterly reports and much more, including a full business description, details about the management team and its compensation, and details about any filings done during the year.

      

Most major companies put a lot of money into producing glossy reports filled with information and pictures designed to make a good impression on the public. The marketing or public relations department, not the financial or accounting department, writes much of the summary information. Too often, annual reports are puff pieces that carefully hide any negative information in the notes to the financial statements, which is the section that offers additional details about the numbers provided in those statements (see Chapter 9). Read between the lines — especially the tiny print at the back of the report — to get some critical information about the accounting methods used, any pending lawsuits, or other information that may negatively impact results in the future.

      Following the rules: Government requirements

      Reports for the government are more extensive than the glossy reports sent to shareholders (see the preceding section). Companies must file many types of forms with the SEC, but I focus on only three of them in this book:

       The 10-K: This form is the annual report that provides a comprehensive overview of a company's business and financial activities.Firms must file this report within 90 days of the end of the fiscal year (companies with more than $75 million in assets must file within 60 days). In addition to the information included in the glossy annual reports sent to shareholders (see the preceding section), investors can find more detailed information about company history, organizational structure, equity holdings, subsidiaries, employee stock purchase and savings plans, incorporation, legal proceedings, controls and procedures, executive compensation, accounting fees and services, and changes or disagreements with accountants about financial disclosures.

       The 10-Q: This form is the quarterly report that describes key financial information about the prior three months. Most companies must file this report within 45 days of the end of the quarter (firms with more than $75 million in assets must file within 40 days). In addition to the information sent directly to shareholders, this form includes details about the company's market risk, controls and procedures, legal proceedings, and defaults on payments.

       The 8-K: This form is a periodic report that accounts for any major events that may impact a company's financial position. Examples of major events include the acquisition of another company, the sale of a company or division, bankruptcy, the resignation of directors, or a change in the fiscal year. When a major event occurs, the company must file a report with the SEC within four days of the event.

      

You can access reports filed with the SEC online at Edgar, which is run by the SEC. To use Edgar, go to www.sec.gov/edgar.shtml.

      Going global

      More companies these days operate across country borders. For years, each country had its own set of rules for preparing financial reports to meet government regulations. Global companies had to keep separate sets of books and report results under different sets of rules in each country in which they operated.

      Today most countries have agreed to accept the International Financial Reporting Standards (IFRS; see Chapter 19) developed by the London-based International Accounting Standards Board (IASB). Beginning in 2002, the U.S. agreed to look at ways to converge the IFRS and the U.S. GAAP (see Chapter 18). The U.S. allows companies based outside its borders to file required reports using either U.S. GAAP or IFRS, but U.S.-based companies must still use GAAP to file their reports. The process of converging U.S. standards with international standards is still a work in process, but the U.S. is now represented on the Accounting Standards Advisory Forum to improve worldwide cooperation among standard setters.

      Staying within the walls of the company: Internal reporting

      Not all of an accounting department's financial reporting is done for public consumption. In fact, companies usually produce many more internal reports than external ones to keep management informed. Firms can design their internal reports in whatever way makes sense to their operations.

      THE ROOTS OF FINANCIAL REPORTING

      Accounting practices can be traced back to the Renaissance, but financial reporting wasn't recognized as a necessity until centuries later.

       1494: Italian monk Luca Pacioli became known as the “father of accounting” for his book Everything about Arithmetic, Geometry and Proportions, which includes a section on double-entry accounting (see Chapter 4). Pacioli warned his readers that an accountant shouldn't go to sleep at night until his debits equal his credits.

       1700–1800: For-profit corporations started to appear in Europe as early as the 18th century. In 1800, only about 330 corporations operated in the U.S.

       1800s: As public ownership of stock increased, regulators realized that some standardized distribution of information to investors was a priority. The New York Stock Exchange was the first to jump into the fray, and in 1853, it began requiring companies listed on the exchange to provide statements of shares outstanding and capital resources.

       1929: Before the stock market crash, equity investing became a passion. People borrowed money to get into the market, paying higher and higher prices for stock. Sound familiar? Not too different from what occurred just before the 2000 crash of technology and Internet stocks.

       1933–1934: Congress created the SEC and gave it authority to develop financial accounting and reporting standards and rules to deter companies from distributing misleading information.

       1973: The Financial Accounting Standards Board (FASB) was created to establish standards for financial accounting and reporting. The SEC recognized the generally accepted accounting principles (GAAP) as the official reporting standards for federal securities laws.

       1984: The FASB formed the Emerging Issues Task Force, which keeps an eye on changes in business operations and sets standards before new practices become entrenched.

       2002: The FASB began work with the International Accounting Standards Board (IASB) to converge international financial reporting systems.

Each department head usually receives a report from the top managers showing the department's expenses and revenue and whether it's meeting its budget. If the department's numbers vary significantly from the amount that was budgeted, the report indicates red flags. The department head usually needs to investigate the differences and report what the department is doing to correct any problems. Even if the difference is increased revenue (which can be good news), the manager needs to know why the discrepancy exists, because an error in the data input could have occurred.

      Reports on inventory are critical, not only for managing the products on hand, but also for knowing when to order new inventory. I talk more about inventory controls