1. FINANCIAL
REPORTING

2. PRESENTED TO:
Sir. ISHTIAQ AHMED
GROUP MEMBERS:
1. QASIM RAZA
2. M. USMAN AHMED
MSBA-I
NUML, ISLAMABAD
Qasimraza555@gmail.com

3. A financial reporting is a formal
record of the financial activities
of the business, person or other
entity.
(Wikipedia Dictionary)
The process of preparing the
corporation's financial statement
in accordance with generally
accepted accounting principles
(GAAP). The statement prepared
includes: an income statement, a
balance sheet, and a statement of
cash flows.
(Real Estate Dictionaries)

4. Annual Report for a Company
For legal and necessity reasons,
companies publish a formal report at the
end of each financial year. This annual
documents has three broad sections:
Directors report, financial statements
and audit report.
Director’s Report Financial
Statements Audit Report

5. The first section of the annual report, called Directors Report, is a narrative , often in the
form of a letter from the company’s chairman to it’s share holders giving three important
pieces of information:
Firstly, a comment on the performance of the company during the year to which the report
relates. This part is often referred to as OFR, i.e. operational and financial review.
Secondly, an assessment of what lies in the immediate future .
Thirdly, a statement about the company’s policies, principles and strategies developed to
meet the challenges of the future.

6. Narrative Part of Annual Report:
The narrative part of annual report is prepared with great care.
Professional writers and designers are hired to touch it up to ensure its acceptability and
appeal to the shareholders.
A number of graphs , charts and photographs are inserted.
Only those issues are talked about which the management feels will be of interest of and
appreciated by the shareholders.
Sadly, over recent era this report has become to lose a considerable part of its credibility.
As more and more investors tend to look at it as a public relations exercise rather than a
serious attempt to give meaningful information to shareholders.

7. The second section of the report comprises of four financial statements, namely;
A Balance Sheet
An Income Statement
A Funds Flow Statement
A Statement showing movement in equity
Each statement is accompanied with a large number of notes providing explanations Of items
therein.
Notes of accounts are considered in to be as important as the account themselves as they provide
an insight into the company's accounting policies and manner of treating various financial items.

8. Example:
The method of computing and providing depreciation on fixed assets is a
very important issue as it can have a significant impact on profit for the period under
review. Hence, financial Analyst go through these notes as minutely as the financial
statements themselves.

9. 1.INCOME STATEMENT:
This statement shows the profit or loss made by the company in the year
under report. While the statement may not be so clearly demarcated, it is
common for an Income Statement to have the following three distinct
parts;
1. Trading Accounts:
This part shows the sales revenue earned by the company, the total of
direct costs incurred to earn that revenue, and the resultant gross
profit earned by the company.

10. 1.INCOME STATEMENT: (Cont…)
2. Profit & Loss account:
This starts with the figures for gross profit to which are added all
incidental incomes, arriving at the figure of gross operating profit. From
this figure is deducted the total of all other expenses (overheads) to arrive
at the year’s net profit figure.
3. Profit & Loss Appropriation Account:
This part show how the profit earned during the year is being used. From
the figure of net profit for the year, deductions of applicable
corporation tax is shown to arrive at the Profit After Tax for the year.

11. 1.INCOME STATEMENT: (Cont…)
To this figure is added the un-appropriated profit brought forward from
the previous year to arrive at the profit available for appropriation .The
appropriations made in the year (e.g transfer to reserves, write off of
intangible assets, recommendations to proposed dividends, payments of
interim dividends etc) are then listed, totaled and the total deducted from
the figure of profit available for appropriation, to arrive at the un-
appropriated profit carried forward to the next financial year.
Profit & Loss Appropriation Account

12. 2. CASH FLOW STATEMENT:
The statement show movement in funds, generally taken to mean cash and near cash
items, over the year. It should be appreciated that definition of accounting net profit is
“an increase in net assets (or equity) of a company arising out of its operations”. An
increase in net asset does not necessarily mean an increase in cash. A number of
expenses not even paid in cash (e.g. Depreciation), or may have been booked but not yet
paid (e.g. accruals). On the other hand, a number of incomes may not be received in cash
(e.g. appreciation in value of fixed assets, or accrued incomes) and may yet be credited
to the year’s profits. At the same time, a part of cash earned out of the year operations
may have been used to increase the level of certain assets (e.g. increase in stocks), or to
retire debt , while some cash may have been received (e.g. from shares issues or loan
proceeds) without passing through the income statements.

13. 2. CASH FLOW STATEMENT:
KFC
Statement of Cash flow
Dec 31, 2011
Cash Cash
1. Operating Activities:
Cash collection from customers 2,50,000
Cash payments to suppliers (85,000)
Cash payments for salaries (45,000) 1,20,000
Net cash flow provided by operating activities 1,20,000
2. Investing Activities:
Sale of equipment 30,000
Purchase of equipment (36,000) (6,000)
Net cash flow used by investing activities (6,000)
3. Financing Activities:
Cash payment of dividend (35,000)
Retirement of Common Stock (25,000) (60,000)
Net cash flow used by financial activities (60,000)
Total Net change in cash 54,000

14. 3. Balance Sheet:
This statement shows the assets and liabilities of the company at the end of the financial year. It is
customary in the Pakistan to first show the Liabilities side and then the Asset side. The Liabilities side
shows the equity and long term liabilities. The Asset side shows the total of fixed assets, intangible
assets, investments and working capital. Hence, each side of the balance sheet shows the total of capital
employed.
Capital Employed:
= Equity + Long term Liabilities
= (Fixed Assets + Intangible Assets+ Investments) +Working Capital
= Noncurrent assets + Working Capital
Equity: The total of equity of a company comprises of it’s paid up share capital, reserves and
un-appropriated profits.

15. 3. Balance Sheet: (Cont…)
Long Term Liabilities: These are obligation of a company that are payable after
considerable time, at least one year after the date of the current balance sheet.
Fixed Assets: These are assets that a company uses to conduct its business with e.g. Land,
Buildings, Plant, Machinery, Equipments, Vehicles, furniture and fittings etc.
Non-Tangible Assets: These assets have no physical form but have value to the company,
as they are capable of improving its profitability. e.g. copyrights, goodwill, trademarks,
franchise, licenses, royalties, etc.
Investments: These are financial assets held by the company. A company may own shares
and bonds of other company or organization. It could be of two types
•Long-term Investments
•Short term investments

16. 3. Balance Sheet: (Cont…)
Working Capital: This is the excess of current assets over current liabilities at any given
moment of time. It is shown on the assets side of the balance sheet.
Current Assets: These are the assets that are expected to be sold, consumed or converted
into cash during the normal operating cycle of a company or within one year if the operating
cycle of the company is shorter than one year.
Current Liabilities: It is an obligation that must be discharge by a company within normal
operating cycle or within its normal operating cycle, or within one year whichever is longer.
Capital Employed: Total of each side of balance sheet represents company’s capital
employed.

17. 3. Balance Sheet:

18. 4. Statement of Owners Equity:
Equity of a company comprise of three parts: Paid up share capital,
Reserve and un-appropriated profit. Statement shows how these
items increased and decreased over a financial year under report.
Increase in share capital come from fresh issue of shares, while
decrease come from redemption of shares.

19. Notes to the Financial Statements:
Notes accompanying the set of financial statements published by a
company provide the following additional information:
1.An explanation of accounting methods or policies used. For example,
companies are generally free to choose the method of computing
depreciation on their fixed assets. While Ali Ltd. calculate depreciation on
its plant and machinery using the staright line method, Bakr Ltd. may well
opt to write down its plant and machinery using the diminishing balance.

20. 2. Greater details regarding certain figures in the financial statements. For
example, In income statement only one figure of cost of goods sold is given.
Details of the various figures making up the cost of good sold during the year are
given in Notes to the accounts.
3. Statutory disclosures. The law require company to disclose certain
information in their annual accounts. For example, details of remuneration paid
to directors and senior managers must be disclosed.
4. Changing in accounting policies, methods or nature of business during the
year. If a company changes any of its accounting policies, or start a new line of
business , or abandons a part of its operations, or if there is any significant
change in the manner in which company conducts its business, information
about such changes must be given in the Notes to the accounts.

21. 5. Details of off-balance sheet items. Certain information may be
important for the users of the financial statements but it may not have a
rightful place within the body of any particular financial statement.

22. The Need for Publishing Financial Statements;
Financial statements published by a company at the end of every financial year serve
three main purposes:
1. The Information Function:
A large number of people have an interest in the affairs of company. The persons are
called stakeholders and include shareholders, lenders, suppliers, customers, managers,
employees, prospective investors, relevant governmental departments and the public at
large. Their only source of information about the financial performance and health of the
company is the annual report published by the company. These statements therefore
serve to provide vital information to all those who have an interest in the well being of
the company.

23. 2. The Control Function:
On the basis of information contained in the financial statements, shareholders can
control the conduct of directors who manage the company. These financial statements
when compared with others from similar companies can also help the investors set
important benchmark for measuring the efficiency of the managers.
3. The Planning function:
Financial statements of one year provide a basis on which to plan or budget for the next
one or next few years. Detailed analysis of financial statements helps to set target and
make attainable plans in light of already achieved standards.

24. Limitation of Financial Statements:
Financial statements are very useful source of information to all those people who have
an interest, or stake in the company. However, financial statements suffer from some
inherent defects. These are briefly discussed below, along with some adviice on how to
minimize the impact of these problems.
1. Most balance sheets show values of assets, in particular the fixed assets, at cost less
accumulated depreciation. These values may be vastly different from the prevailing
market value of these items.
2. Accounting policies of companies differ even within an industry. e.g. one company
may not treat a sale as a sale till the goods are paid for by the customer, while
another company may book a sale as soon as items are delivered to the customer.

25. Limitation of Financial Statements: (Cont…)
3. Financial statements contain absolute figures. For the purpose of evaluating financial
performance or position, it is often necessary to compare one company’s figures with
those of other companies, or the average of the industry.
4. Certain assets and/or liabilities may not be shown in the financial statements. E.g.
Contingent liabilities are often shown only in notes to the accounts. Similarly, a company
may opt not to show a disputed receivable amount in its balance sheet till it is actually
received.

26. Stakeholders interest in financial statements:
1. Shareholders use them for deciding how they should vote at the various issues put up for
voting at the annual general meeting. These include approval of dividends, approval of
directors remuneration etc.
2. Investor use them for making investment decisions like should they continue to hold the
shares of this company, should they sell them off, or buy more of them.
3. Investment analysts use them for rating the company as well as its instruments like
shares and bonds.
4. Major investor use them for making acquisitions, merger or de-merger decision.
5. Creditors particularly the long term lenders, use them for assessing the credit worthiness
or risk-weight of the company.
6. Employees use them for negotiating better terms of employment with the company.
7. Management use them as a basis of planning for the future.
8. Government, particularly its various tax departments, use them for computing the
company’s tax liability for income tax, capital gains tax, sales tax etc.

27. Qualities of Financial Statements:
A good set of financial statements should have the following qualities:
1. Each statement should be clear and understandable.
2. The statements should be reliable.
3. The statements should be honest.
4. The statements should contain all the disclosures required by the various regulatory
bodies.

28. Responsibility for the health of financial Statements:
The parties related to and sharing responsibility for financial statements are;
1. The management, who keeps the books, chooses the accounting policies, maintains
the books of accounts, prepares the financial statements and facilitates the external
auditor.
2. The board who oversee the preparation of accounts, prepare the directors report,
ensure that all due legal disclosures are made, present the financial statements to the
shareholders, and file them with KSE and SECP.
3. Audit committee who liaises with the internal and external auditors and recommends
the financial statements to the Board.
4. External Auditor who examines the accounting and related records as well as the
financial statements and gives a formal opinion on them.

29. Audit Committee’s Role:
The audit committee is the part of Board of directors. It is assigned the specific
responsibility by the board to ensure that financial statements produced by the
management and audited by the external auditors are worthy of board’s
recommendation for approval by the shareholders. In order to achieve this
objective , the audit committee takes the following steps;
1. It review the internal control processes of the company. It approves all of the
company’s procedure manuals which provides them the opportunity to
understand how the company carries out its various activities.
2. It review the reports of the internal auditor. In this way, committee is able to
understand and evaluate the efficiency of company’s accounting systems and
policies.
3. It plays the pivotal role in selection of external auditor, carrying out the vetting
process, and negotiating their terms and conditions.

30. Audit Committee’s Role: (Cont…)
4. It maintain liaison with the external auditors and reviews all his communication with
the company.
5. It can go direct to the chairman or the shareholders if it feels that executive directors
are in any way impeding its work.

31. Misleading Financial statements:
Statements are said to be misleading if;
1. They are not consistent with the accounting records on which they are purportedly
based.
2. They are not based on accounting policies.
3. They do not comply with applicable accounting standards and GAAP.
4. They do not disclose the true profit or loss made by the company, meaning they do
not include all the expenses and incomes, or state them at correct accounts.
5. They do not include all the assets and liabilities in the balance sheet.
6. They do not value the assets and liabilities of the company correctly.
7. They do not provide adequate information or disclosure to help a user understand or
evaluate them meaningfully.

32. Consequences of unreliable Financial Statements:
As stated earlier, a lot of people related with the company make a number of their decisions
on the basis of its financial statements. For Example:
1. Creditors make decision about extending more term or calling back their existing loans
on the strength of the financial statements.
2. Investors decide about buying more shares, or selling off their present holding in light of
the information contained in the financial statement.
3. Shareholders approves the dividends or expansion program according to what the
financial statements say.
4. Management draws their future plans and employees make their long term decisions
under the influence of financial results.
All these decisions would prove wrong if the financial statements are not reliable,
accurate or honest. It is therefore important that the financial statements have the highest
degree of integrity.

33. Misleading financial statements:
There are essentially three aspects of misstatements:
1. Over-statement of Profits:
a. To meet the expectation of general public or investors.
b. To maintain the share price. A decline in profits often leads to reduction in share
price at the stock exchange.
c. To meet contractual obligations with creditors. Some lender lay down very strict
conditions in the loan agreements.
d. To maintain its image of rising profit.
e. To prepare the company for a higher price if a merger or sale of the company is in
the offing.

34. Under-statement of Profits:
a. To save corporation tax.
b. To avoid having to pay dividends.
c. To smoothen the earnings trend. Hence, a company may under-state its profit by
creating unnecessary provisions, or writing off some non-tangible assets.
Misstatement of Financial Position:
This means stating assets or liabilities at incorrect values. Assets may over-stated in
balance sheet through provision of inadequate depreciation, stocks may be over-valued,
insufficient provisions for doubtful debts may be made to overstate the trade debtors etc.
Some assets may be deliberately misclassified, i.e. a fixed asset may be show as current
assets or vice versa. Similarly, some liabilities may be understated or not shown in the
balance sheet at all.

35. Creative Accounting:
“A systematic and intention misrepresentation of the true income and financial position of an
entity to achieve certain objectives.” This involves using such accounting policies and
techniques that assist in misstating the financial statements.
The Role of External Auditor:
Stakeholders attach a lot of importance to external auditor’s report because;
1. External auditor is appointed by shareholders, not management.
2. He is independent, not a part of the company’s management.
3. He is competent to examine the accounts and financial statements and give an opinion
there-on. Only professionally qualified persons can get a license to act as external
auditors to a company.
4. He is believe to have a high degree of integrity as he belongs to a profession that is
strictly regulated by a professional body.

36. The Audit Report:
This report is given by the external auditors after they have examined the accounting
records, supporting evidence and financial statements prepared on the basis of such
records at the end of year. It essentially gives the auditors opinion on the financial
statements, generally covering the following areas:
a. Step taken by the external auditor to form his opinion on the financial statements;
b. Auditor’s opinion on whether or not:
o The book of account have been properly kept and are complete in all necessary aspects;
o The financial statements are in accordance with the accounting records;
o The financial statements give a true and fair view of company’s profit for the year
ended and its financial position at the end of the year;
o The financial statements provide all the disclosures required by relevant laws.

37. Types of Audit Reports:
1. Unqualified Report: If the external auditor is fully satisfied with the state of affairs, he
gives a clean or unqualified repot which indicate that the financial statements are by and
large very much in order.
2. Qualified Report: If the external auditors find some minor irregularities in the accounts
or the financial statements which do not materially affect the year’s profit or financial
position at the year end, he may give a qualified report, indicating areas about which he
is dissatisfied.
3. Adverse Report: If the external auditors finds too many errors and misstatements in
the accounts, or if the accounts have not been properly kept, and the financial statements
give materially incorrect profit and financial statements are not reliable.
4. Disclaimer: If the external Auditors finds hat the book of accounts or supporting
documents are inadequate for the purpose of preparing meaningful financial statements,
he may give a disclaimer., which indicates that he was not able to form any opinion on
the accounting records and/or financial statements due to inadequate records and
evidence.

38. Independence of External Auditor:
Financial statements are used by various stakeholders for making a number of decisions. The
decisions would not prove to be correct if the financial statements are not accurate. With that
much importance being attached to the audit report, it is essential that that external auditor
must be independent and allowed to do his work independently.
The following are some of the means used to ensure the independence of external auditors:
1. The firm performing the external audit should not be given any other professional work.
If an audit firm earns a large percentage of its total revenue from a particular company
through fees for audit, accounting, tax, procedure consultancy, financial advisory
services etc. It is likely that its independence may be impaired.
2. Auditor should be rotated frequently so that familiarity does not lead to loss of
independence.
3. There should be no relationship between the partners of an audit firm and company’s
directors.

39. Membership of External Auditors:
1. All the external auditors are members of Pakistan Institute of Charted Accountants
(ICAP).
2. This body strictly regulate the conduct of its members, providing them with
comprehensive code of conduct and monitoring their work.
3. In addition, SECP also monitor the conduct of audit firms in Pakistan.
4. There are also several international professional bodies which issues standards/
guidelines for accounting and auditing practices.
5. ICAP is a member of most of these international professional bodies and makes it
compulsory for its own members to follow the internationally recognized standards
and guidelines.

40. International Bodies:
Some of these international bodies/ standards are:
1. Accounting standards from IFAC
2. Ethical Standards for ESB
3. Audit Standards from APB (UK)
4. Accounting and Audit Review Board (UK)
5. Public Company Accounting Oversight Board (Sarbanes-Oxley Act) in USA