Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa...

04/11/23 Ricardo F [email protected]

Faculdade de Ciências Económicas e Empresariais

Universidade Católica Portuguesa

4th session:Corporate Governance

and Financial accounting measures of performance

Performance Evaluation

IMSc in Business Administration

October-November 2007

Ricardo F [email protected]

Session 04 - 2/3304/11/23Performance Evaluation



Corporate Governance Sarbanes-Oxley “Five years under the thumb” Auditing Profession

Financial Performance Measures Earnings per Share





Sarbanes-Oxley

The Sarbanes-Oxley Act of 2002, also known as the Public Company Accounting Reform and Investor Protection Act of 2002 and commonly called SOX or Sarbox; is a United States federal law signed into law on July 30, 2002 in response to a number of major corporate and accounting scandals including those affecting Enron, Tyco International, Peregrine Systems and WorldCom.





TITLE I - “Public Company Accounting Oversight Board (PCAOB)” PCAOB to provide independent

oversight of public accounting firms providing audit services ("auditors"). It also creates a central oversight board tasked with registering auditors, defining the specific processes and procedures for compliance audits, inspecting and policing conduct and quality control, and enforcing compliance with the specific mandates of SOX.





TITLE II - “Auditors Independence”

Establishes standards for external auditor independence, to limit conflicts of interest. It also addresses new auditor approval requirements, audit partner rotation policy, conflict of interest issues and auditor reporting requirements. This title restricts auditing companies from doing other kinds of business apart from auditing with the same clients.





TITLE III - “Corporate Responsibility” This title mandates that senior executives take

individual responsibility for the accuracy and completeness of corporate financial reports. It enumerates specific limits on the behaviours of corporate officers and describes specific forfeitures of benefits and civil penalties for non-compliance. For example, Section 302 implies that the company board (Chief Executive Officer, Chief Financial Officer) should certify and approve the integrity of their company financial reports quarterly. This helps establish accountability.





TITLE IV - “Enhanced Financial Disclosures” Title IV describes enhanced reporting

requirements for financial transactions, including off-balance sheet transactions, pro-forma figures and stock transactions of corporate officers. It requires internal controls for assuring the accuracy of financial reports and disclosures, and mandates both audits and reports on those controls. It also requires timely reporting of material changes in financial condition and specific enhanced reviews by the SEC or its agents of corporate reports.





TITLE V - “Analyst Conflicts of Interest”

Title V defines the codes of conduct for securities analysts and requires disclosure of knowable conflicts of interest.





TITLE VI - “Commission Resources and Authority”

Title VI defines the SEC’s authority to censure or bar securities professionals from practice and defines conditions under which a person can be barred from practicing as a broker, adviser or dealer.





TITLE VII - “Studies and Reports”

Title VII is concerned with conducting research for enforcing actions against violations by the SEC registrants (companies) and auditors.





TITLE VIII - “Corporate and Criminal Fraud Accountability”

Title VIII is also referred to as the “Corporate and Criminal Fraud Act of 2002.” It describes specific criminal penalties for fraud by manipulation, destruction or alteration of financial records or other interference with investigations, while providing certain protections for whistle-blowers.





TITLE IX - “White Collar Crime Penalty Enhancement”

This section is also called the “White Collar Crime Penalty Enhancement Act of 2002.” This section increases the criminal penalties associated with white-collar crimes and conspiracies. It recommends stronger sentencing guidelines and specifically adds failure to certify corporate financial reports as a criminal offence.





TITLE X - “Corporate Tax Returns”

Title X consists of one section, which states that the Chief Executive Officer should sign the company tax return.





TITLE XI - “Corporate Fraud Accountability”

Also known as “Corporate Fraud Accountability Act of 2002” . It identifies corporate fraud and records tampering as criminal offences and joins those offences to specific penalties. It also revises sentencing guidelines and strengthens their penalties. This enables the SEC to temporarily freeze large or unusual payments.





The Certified Public Accountant and the Auditor’s Opinion An audit is an examination of a

company’s transactions and the resulting financial statements

The auditor’s opinion describes the scope and results of the audit and a judgment that the financial statements prepared by management are accurate





Public Accounting Firms

The four largest public accounting firms are Deloitte Touche Tohmatsu Ernst & Young KPMG International PricewaterhouseCoopers

97% of the firms listed on the NYSE are clients of these four firms





Public Accounting Firms

Each firm has annual billings in excess of $1 billion

All firms must follow generally accepted accounting principles (GAAP) The broad concepts and detailed practices

of preparing and distributing financial statements





Sarbanes-Oxley Act

Established the Public Company Accounting Oversight Board to regulate public accounting and to set standards for audit procedures through the issuance of generally accepted auditing standards (GAAS)

Prohibits public accounting firms from providing audit clients with certain non-audit services

Requires rotation every 5 years of the lead audit or coordinating partner and the reviewing partner on an audit





Sarbanes-Oxley Act

Provides regulation of corporate governance Requiring boards to appoint an audit committee

composed only of “independent” directors Requiring CEOs and chief financial officers (CFOs)

to personally sign a statement certifying the appropriateness and fairness of their companies’ financial statements

Increasing criminal penalties for knowingly misreporting financial information





Professional Ethics

Members of the AICPA must abide by a code of professional conduct

The Institute of Management Accountants has a code of ethics for management accounts

Auditors and management accountants have professional responsibilities concerning competence, confidentiality, integrity, and objectivity





Professional Ethics

Ethical standards are personal and depend on the values of the individual

A successful manager must recognize the ethical dimensions of a situation and act with absolute integrity





Professional Ethics

Despite the criticism of accounting ethics, accountants were responsible for revealing the problems in many of the recent corporate scandals

Companies often rely on accountants to safeguard the ethics of the company

WorldCom and Enron whistle-blowers became two of the three 2002 Persons of the Year in Time magazine (Cynthia Cooper of Worldcom and Sherron Watkins of Enron)

04/11/23 Ricardo F [email protected]



Financial accounting measures of performance

Computing Earnings per Share (EPS)





Computing Earnings per Share (EPS)

• Earnings per share indicates the income earned by each share of common stock.

• Reported at the end of the income statement

• Should report intermediate components as well.





EPS on Simple Capital Structure Simple Capital Structure means that there is

only common stock and there is no potential common stock (securities that can potentially be converted into common stock and dilute EPS).

EPS=

Net Income

Weighted Average Number of Shares





Preferred Stock Dividends

Preferred Stock Dividends are compensation not available for common stockholders, therefore they are subtracted from the Net Income.

EPS=Net Income – Preferred Dividends

Weighted Average Number of Common Stock





Weighted Average Number od Shares Outstanding

Weighted by the fraction of the period they are outstanding

Find the equivalent number of whole shares outstanding for the year.





Stock Dividends and Stock Splits

When these happen computation of the average number of shares outstanding needs to be redone.

A stock dividend or split does not change the shareholders’ total investment.





Complex Capital Structure

Dilutive securities are securities that can be converted into common stock (through conversion or exercise) and will dilute earnings per share.





Diluted EPS

Note that:

Only dilutive securities are to be reported! Antidilutive are not considered.

EPS=

Net income- Preferred dividends

-Impact of

Convertibles-

Impact of Option, Warrants, and Other Dilutive

Securities

Weighted Average Shares Outstanding





Diluted EPS – Convertible SecuritiesIf-Converted Method1. Conversion of the convertible securities

as soon as possible (beginning of period or issuance)

2. Elimination of related interest, net of tax.

Logic is that if the convertible securities were converted, then they didn’t produce any interest and net income has to be filtered of this.





Diluted EPS – Options and WarrantsTreasury Stock Method1. Exercise of options or warrants as soon

as possible (beginning of period or issuance)

2. Proceeds from the exercise are used to purchase common stock.

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