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INTERNATIONAL ACCOUNTING



DEFINITIONAL APPROACHES OF INTERNATIONAL ACCOUNTING
Most accounting students are familiar with financial accounting and managerial accounting, but many have only a vague idea of what international accounting is. Defined broadly, the accounting in international accounting encompasses the functional areas of financial accounting, managerial accounting, auditing, taxation, and accounting information systems. The word international in international accounting can be defined at three different levels.
 The first level is supranational accounting, which denotes standards, guidelines, and rules of accounting, auditing, and taxation issued by supranational organizations. Such organizations include the United Nations, the Organization for Economic Cooperation and Development, and the International Federation of Accountants.
At the second level, the company level, international accounting can be viewed in terms of the standards, guidelines, and practices that a company follows related to its international business activities and foreign investments. These would include standards for accounting for transactions denominated in a foreign currency and techniques for evaluating the performance of foreign operations. At the third and broadest level, international accounting can be viewed as the study of the standards, guidelines, and rules of accounting, auditing, and taxation that exist within each country as well as comparison of those items across countries.
Examples would be cross-country comparisons of (1) rules related to the financial reporting of plant, property, and equipment; (2) income and other tax rates; and (3) the requirements for becoming a member of the national accounting profession.
Clearly, international accounting encompasses an enormous amount of territory— both geographically and topically. It is not feasible or desirable to cover the entire discipline in one course, so an instructor must determine the scope of an international accounting course. This book is designed to be used in a course that attempts to provide an overview of the broadly defined area of international accounting but that also focuses on the accounting issues related to international business activities and foreign operations.
EVOLUTIONARY PATTERN OF A MULTINATIONAL CORPORATION AND ITS INTERNATIONAL ACCOUNTING IMPLICATION
          A multinational corporation is a company that is headquartered in one country but has operations in other countries. 12 The United Nations estimates that there are more than 82,000 multinational companies in the world, with more than
810,000 foreign affiliates. 13 The 100 largest multinational companies account for approximately 4 percent of the world’s GDP. 14 Companies located in a relatively small number of countries conduct a large proportion of international trade and investment. These countries—collectively known as the triad—are the United States, Japan, and members of the European Union. As Exhibit 1.4 shows, 83 of the 100 largest companies in the world are located in the triad.
The largest companies are not necessarily the most multinational. Of the 500 largest companies in the United States in 2000, for example, 36 percent had no foreign operations. 15 In 2008 the United Nations measured the multinationality of companies by averaging three factors: the ratio of foreign sales to total sales, the ratio of foreign assets to total assets, and the ratio of foreign employees to total employees. Exhibit 1.5 lists the top 10 companies according to this measure.
To gain an appreciation for the accounting issues related to international business, let us follow the evolution of Magnum Corporation, a fictional auto parts manufacturer headquartered in Detroit, Michigan. 2 Magnum was founded in the early 1950s to produce and sell rearview mirrors to automakers in the United States.
For the first several decades, all of Magnum’s transactions occurred in the United States. Raw materials and machinery and equipment were purchased from suppliers located across the United States, finished products were sold to U.S. automakers, loans were obtained from banks in Michigan and Illinois, and the common stock was sold on the New York Stock Exchange. At this stage, all of Magnum’s business activities were carried out in U.S. dollars, its financial reporting was done in compliance with U.S. generally accepted accounting principles (GAAP), and taxes were paid to the U.S. federal government and the state of Michigan.
Foreign Direct Investment
Although the managers at Magnum at first were apprehensive about international business transactions, they soon discovered that foreign sales were a good way to grow revenues and, with careful management of foreign currency risk, would allow the company to earn adequate profit. Over time, Magnum became known throughout Europe for its quality products. The company entered into negotiations and eventually landed supplier contracts with several European automakers, filling orders through export sales from its factory in the United States. Because of the combination of increased shipping costs and its European customers’ desire to move toward just-in-time inventory systems, Magnum began thinking about investing in a production facility somewhere in Europe. The ownership and control of foreign assets, such as a manufacturing plant, is known as foreign direct investment. Exhibit 1.1 summarizes some of the major reasons for foreign direct investment. Two ways for Magnum to establish a manufacturing presence in Europe were to purchase an existing mirror manufacturer (acquisition) or to construct a brandnew plant (greenfield investment). In either case, the company needed to calculate the net present value (NPV) from the potential investment to make sure that the return on investment would be adequate. Determination of NPV involves forecasting future profits and cash flows, discounting those cash flows back to their present value, and comparing this with the amount of the investment. NPV calculations inherently involve a great deal of uncertainty.
In the early 1990s, Magnum identified a company in Portugal (Espelho Ltda.) as a potential acquisition candidate. In determining NPV, Magnum needed to forecast future cash flows and determine a fair price to pay for Espelho. Magnum had to deal with several complications in making a foreign investment decision that would not have come into play in a domestic situation. First, to assist in determining a fair price to offer for the company, Magnum asked for Espelho’s financial statements for the past five years. The financial statements had been prepared in accordance with Portuguese accounting rules, which were much different from the accounting rules Magnum’s managers were familiar with. The balance sheet did not provide a clear picture of the company’s.
FINANCIAL STATEMENT
A financial statement (or financial report) is a formal record of the financial activities and position of a business, person, or other entity.
Relevant financial information is presented in a structured manner and in a form easy to understand. They typically include basic financial statements, accompanied by a management discussion and analysis:
1. A balance sheet , also referred to as a statement of financial position, reports on a company's assets , liabilities, and ownership equity at a given point in time.
2. An income statement, also known as a statement of comprehensive income, statement of revenue & expense, P&L or profit and loss report, reports on a company's income , expenses , and profits over a period of time. A profit and loss statement provides information on the operation of the enterprise. These include sales and the various expenses incurred during the stated period.
3. A statement of changes in equity, also known as equity statement or statement of retained earnings , reports on the changes in equity of the company during the stated period.
4. A statement of cash flows reports on a company's cash flow activities, particularly its operating, investing and financing activities.
For large corporations, these statements may be complex and may include an extensive set of footnotes to the financial statements and management discussion and analysis. The notes typically describe each item on the balance sheet, income statement and cash flow statement in further detail. Notes to financial statements are considered an integral part of the financial statements.
Financial statements of any company is basically the summarized financial reports which provide the operating results and financial position of companies, and the detailed information contained therein is useful for assessing the operational efficiency and financial soundness of a company. The financial statements to be discuss extensively in the work would be basically the Income Statement and Balance Sheet. The information contained in each of these statements therefore requires proper analysis and interpretation of such information for which a number of techniques (tools) have been developed by financial experts. For a company to keep on as a going concern in a world of high competiveness it primary objectives must not be challenge negatively which are profitability and solvency. According to Hermanson et al, (1992), profitability is the ability of a business to make profit, while solvency is the ability of company to pay her debts as they fall due. However, the achievement of these objectives requires efficient management of all factors of production (resources) of the company her managerial functions which include planning, coordinating, staffing, controlling, forecasting and decision making. It should be noted that the strength and weakness of the business must be identifies and adequate measures that will be applied. Accounting provides us the basic information that will foaster the detail analysis of companies performances as it is the principal subject that is concerned with all process involved in collecting, recording, grouping, classifying and summarizing financial data with some intention of preparing financial statement/report to assist various financial users in analyzing and taking crucial decision for efficient and effective operation. (Wole, 2011).
PURPOSES OF FINANCIAL STATEMENTS
"The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions." [2] Financial statements should be understandable, relevant, reliable and comparable. Reported assets, liabilities, equity, income and expenses are directly related to an organization's financial position.
Financial statements are intended to be understandable by readers who have "a reasonable knowledge of business and economic activities and accounting and who are willing to study the information diligently."
Financial statements may be used by users for different purposes:
Owners and managers require financial statements to make important business decisions that affect its continued operations.
Financial analysis is then performed on these statements to provide management with a more detailed understanding of the figures. These statements are also used as part of management's annual report to the stockholders.
Employees also need these reports in making collective bargaining agreements (CBA) with the management, in the case of labor unions or for individuals in discussing their compensation, promotion and rankings.
Prospective investors make use of financial statements to assess the viability of investing in a business. Financial analyses are often used by investors and are prepared by professionals (financial analysts), thus providing them with the basis for making investment decisions.
Financial institutions (banks and other lending companies) use them to decide whether to grant a company with fresh working capital or extend debt securities (such as a long-term bank loan or debentures) to finance expansion and other significant expenditures.
Consolidated financial statements
Consolidated financial statements are defined as "Financial statements of a group in which the assets , liabilities, equity, income , expenses and cash flows of the parent (company) and its subsidiaries are presented as those of a single economic entity ", according to International Accounting Standard 27 "Consolidated and separate financial statements", and International Financial Reporting Standard 10 "Consolidated financial statements".
Government financial statements
The rules for the recording, measurement and presentation of government financial statements may be different from those required for business and even for non-profit organizations. They may use either of two accounting methods : accrual accounting, or cost accounting, or a combination of the two (OCBOA). A complete set of chart of accounts is also used that is substantially different from the chart of a profit-oriented business.
Personal financial statements
Personal financial statements may be required from persons applying for a personal loan or financial aid . Typically, a personal financial statement consists of a single form for reporting personally held assets and liabilities (debts), or personal sources of income and expenses, or both. The form to be filled out is determined by the organization supplying the loan or aid.
Audit and legal implications
Although laws differ from country to country, an audit of the financial statements of a public company is usually required for investment, financing, and tax purposes. These are usually performed by independent accountants or auditing firms. Results of the audit are summarized in an audit report that either provide an unqualified opinion on the financial statements or qualifications as to its fairness and accuracy. The audit opinion on the financial statements is usually included in the annual report.
There has been much legal debate over who an auditor is liable to. Since audit reports tend to be addressed to the current shareholders, it is commonly thought that they owe a legal duty of care to them. But this may not be the case as determined by common law precedent. In Canada, auditors are liable only to investors using a prospectus to buy shares in the primary market. In the United Kingdom , they have been held liable to potential investors when the auditor was aware of the potential investor and how they would use the information in the financial statements. Nowadays auditors tend to include in their report liability restricting language, discouraging anyone other than the addressees of their report from relying on it. Liability is an important issue: in the UK, for example, auditors have unlimited liability.
In the United States, especially in the post- Enron era there has been substantial concern about the accuracy of financial statements. Corporate officers (the chief executive officer (CEO) and chief financial officer (CFO)) are personally responsible for fair financial reporting allowing those reading the report to have a good sense of the organization.
Standards and regulations
Different countries have developed their own accounting principles over time, making international comparisons of companies difficult. To ensure uniformity and comparability between financial statements prepared by different companies, a set of guidelines and rules are used. Commonly referred to as Generally Accepted Accounting Principles (GAAP), these set of guidelines provide the basis in the preparation of financial statements, although many companies voluntarily disclose information beyond the scope of such requirements.
Recently there has been a push towards standardizing accounting rules made by the International Accounting Standards Board ("IASB"). IASB develops International Financial Reporting Standards that have been adopted by Australia , Canada and the European Union (for publicly quoted companies only), are under consideration in South Africa and other countries . The United States Financial Accounting Standards Board has made a commitment to converge the U.S. GAAP and IFRS over time.
Inclusion in annual reports
To entice new investors, public companies assemble their financial statements on fine paper with pleasing graphics and photos in an annual report to shareholders , attempting to capture the excitement and culture of the organization in a "marketing brochure " of sorts. Usually the company's chief executive will write a letter to shareholders, describing management's performance and the company's financial highlights.
In the United States, prior to the advent of the internet, the annual report was considered the most effective way for corporations to communicate with individual shareholders. Blue chip companies went to great expense to produce and mail out attractive annual reports to every shareholder. The annual report was often prepared in the style of a coffee table book .
Notes to financial statements
Notes to financial statements (notes) are additional information added to the end of financial statements that help explain specific items in the statements as well as provide a more comprehensive assessment of a company's financial condition. Notes to financial statements can include information on debt , going concern criteria, accounts , contingent liabilities or contextual information explaining the financial numbers (e.g. to indicate a lawsuit).
The notes clarify individual statement line-items. For example, if a company lists a loss on a fixed asset impairment line in their income statement, notes could corroborate the reason for the impairment by describing how the asset became impaired. Notes are also used to explain the accounting methods used to prepare the statements and they support valuations for how particular accounts have been computed.
In consolidated financial statements, all subsidiaries are listed as well as the amount of ownership (controlling interest) that the parent company has in the subsidiaries. Any items within the financial statements that are evaluated by estimation are part of the notes if a substantial difference exists between the amount of the estimate previously reported and the actual result. Full disclosure of the effects of the differences between the estimate and actual results should be included.
Management discussion and analysis
Management discussion and analysis or MD&A is an integrated part of a company's annual financial statements. The purpose of the MD&A is to provide a narrative explanation, through the eyes of management, of how an entity has performed in the past, its financial condition, and its future prospects. In so doing, the MD&A attempt to provide investors with complete, fair, and balanced information to help them decide whether to invest or continue to invest in an entity.
The section contains a description of the year gone by and some of the key factors that influenced the business of the company in that year, as well as a fair and unbiased overview of the company's past, present, and future.
MD&A typically describes the corporation's liquidity position , capital resources, results of its operations, underlying causes of material changes in financial statement items (such as asset impairment and restructuring charges), events of unusual or infrequent nature (such as mergers and acquisitions or share buybacks ), positive and negative trends, effects of inflation , domestic and international market risks, [8] and significant uncertainties.
Moving to electronic financial statements
Financial statements have been created on paper for hundreds of years. The growth of the Web has seen more and more financial statements created in an electronic form which is exchangeable over the Web. Common forms of electronic financial statements are PDF and HTML. These types of electronic financial statements have their drawbacks in that it still takes a human to read the information in order to reuse the information contained in a financial statement.
More recently a market driven global standard, XBRL (Extensible Business Reporting Language), which can be used for creating financial statements in a structured and computer readable format, has become more popular as a format for creating financial statements. Many regulators around the world such as the U.S. Securities and Exchange Commission have mandated XBRL for the submission of financial information.
The UN/CEFACT created, with respect to Generally Accepted Accounting Principles, (GAAP ), internal or external financial reporting XML messages to be used between enterprises and their partners, such as private interested parties (e.g. bank) and public collecting bodies (e.g. taxation authorities). Many regulators use such messages to collect financial and economic information.
CONTENT OF FINANCIAL STATEMENTS
Structure
The income statement (statement of income, statement of earnings, or statement of operations) reports the accountant's primary measure of performance of a business, revenues less expenses during the accounting period. While the term profit is used widely for this measure of performance, accountants prefer to use the technical terms net income or net earnings. Maxidrive's net income measures its success in selling disk drives for more than the cost to generate those sales.
A quick reading of Maxidrive's income statement (Exhibit 1.3 ) indicates a great deal about its purpose and content. The heading identifies the name of the entity, the title of the report, and the unit of measure used in the statement. Unlike the balance sheet, however, which reports as of a certain date, the income statement reports for a specified period of time (for the year ended December 31, 2009). The time period covered by the financial statements (one year in this case) is called an accounting period. Notice that Maxidrive's income statement has three major captions, revenues, expenses, and net income. The income statement equation that describes their relationship is
Elements
Companies earn revenues from the sale of goods or services to customers (in Maxidrive's case, from the sale of disk drives). Revenues normally are reported for goods or services that have been sold to a customer whether or not they have yet been paid for. Retail stores such as Wal-Mart and McDonald's often receive cash at the time of sale. However, when Maxidrive sells its disk drives to Dell and Apple, it receives a promise of future payment called an account receivable, which later is collected in cash. In either case, the business recognizes total sales (cash and credit) as revenue for the period. Various terms are used in income statements to describe different sources of revenue (e.g., provision of services, sale of goods, rental of property). Maxidrive lists only one, sales revenue, in its income statement.
Income Statement
Expenses represent the dollar amount of resources the entity used to earn revenues during the period. Expenses reported in one accounting period may actually be paid for in another accounting period. Some expenses require the payment of cash immediately while some require payment at a later date. Some may also require the use of another resource, such as an inventory item, which may have been paid for in a prior period. Maxidrive lists five types of expenses on its income statement, which are described in Exhibit 1.3 . These expenses include income tax expense, which, as a corporation, Maxidrive must pay on pretax income. 2
Net income or net earnings (often called “the bottom line”) is the excess of total revenues over total expenses. If total expenses exceed total revenues, a net loss is reported. 3 We noted earlier that revenues are not necessarily the same as collections from customers and expenses are not necessarily the same as payments to suppliers. As a result, net income normally does not equal the net cash generated by operations. This latter amount is reported on the cash flow statement discussed later in this chapter.
1. Learning which items belong in each of the income statement categories is an important first step in understanding their meaning. Without referring to
Exhibit 1.3 , mark each income statement item in the following list as a revenue (R) or an expense (E).
2. During the period 2009, Maxidrive delivered disk drives for which customers paid or promised to pay amounts totaling $37,436,000. During the same period, it collected $33,563,000 in cash from its customers. Without referring to Exhibit 1.3 , indicate which of these two amounts will be shown on Maxidrive's income statement as sales revenue for 2009. Why did you select your answer?
3. During the period 2009, Maxidrive produced disk drives with a total cost of production of $27,130,000. During the same period, it delivered to customers disk drives that had cost a total of $26,980,000 to produce. Without referring to Exhibit 1.3 , indicate which of the two numbers will be shown on Maxidrive's income statement as cost of goods sold expense for 2009. Why did you select your answer?
After you have completed your answers, check them with the solutions at the bottom of the page.
1. E, E, R, E (reading down the columns).
2. Sales revenue in the amount of $37,436,000 is recognized. Sales revenue is normally reported on the income statement when goods or services have been delivered to customers who have either paid or promised to pay for them in the future.
3. Cost of goods sold expense is $26,980,000. Expenses are the dollar amount of resources used up to earn revenues during the period. Only those disk drives that have been delivered to customers have been used up. Those disk drives that are still on hand are part of the asset inventory.
FINANCIAL ANALYSIS Analyzing the Income Statement: Beyond the Bottom Line Investors such as Exeter and creditors such as American Bank closely monitor a firm's net income because it indicates the firm's ability to sell goods and services for more than they cost to produce and deliver. Investors buy stock when they believe that future earnings will improve and lead to a higher stock price. Lenders also rely on future earnings to provide the resources to repay loans. The details of the statement also are important. For example, Maxidrive had to sell more than $37 million worth of disk drives to make just over $3 million. If a competitor were to lower prices just 10 percent, forcing Maxidrive to do the same, its net income could easily turn into a net loss. These factors and others help investors and creditors estimate the company's future earnings.
FINANCIAL ANALYSIS Interpreting the Cash Flow Statement
Many analysts believe that the statement of cash flows is particularly useful in predicting future cash flows that may be available for payment of debt to creditors and dividends to investors. Bankers often consider the Operating Activities section to be most important because it indicates the company's ability to generate cash from sales to meet its current cash needs. Any amount left over can be used to pay back the bank debt or expand the company. Stockholders will invest in a company only if they believe that it will eventually generate more cash from operations than it uses so that cash will become available to pay dividends and expand.
1. During the period 2009, Maxidrive delivered disk drives to customers who paid or promised to pay a total of $37,436,000. During the same period, it collected $33,563,000 in cash from customers. Without referring to Exhibit 1.5 , indicate which of the two amounts will be shown on Maxidrive's cash flow statement for 2009.
2. Your task here is to verify that Maxidrive's cash balance decreased by $156 during the year using the totals for cash flows from operating, investing, and financing activities presented in Exhibit 1.5 . Recall the cash flow statement equation:
After you have completed your answers, check them with the solutions at the bottom of the page.
Self-Study Quiz Solutions
1. The firm recognizes $33,563,000 on the cash flow statement because this number represents the actual cash collected from customers related to current and prior years' sales.
2. EXHIBIT 1.6 Relationships Among Maxidrive's Statements
Relationships Among the Statements
Our discussion of the four basic financial statements focused on what elements are reported in each statement, how the elements are related by the equation for each statement, and how the elements are important to the decisions of investors, creditors, and others. We have also discovered how the statements, all of which are outputs from the same system, are related to one another. In particular, we learned:
1. Net income from the income statement results in an increase in ending retained earnings on the statement of retained earnings.
2. Ending retained earnings from the statement of retained earnings is one of the two components of stockholders' equity on the balance sheet.
3. The change in cash on the cash flow statement added to the beginning-of-the-year balance in cash equals the end-of-year balance in cash on the balance sheet.
Thus, we can think of the income statement as explaining, through the statement of retained earnings, how the operations of the company improved or harmed the financial position of the company during the year. The cash flow statement explains how the operating, investing, and financing activities of the company affected the cash balance on the balance sheet during the year. These relationships are illustrated in Exhibit 1.6 for Maxidrive's financial statements.
UNDERLYING ASSUMPTIONS ON THE PREPARATION OF FINANCIAL STATEMENT
Detail financial information of a company is always provided in the annual financial statements of a company which can be use to evaluate the performances of companies. however, it should be noted Bat financial statements are not means to an end and not end in themselves. Thus, the use of financial statements in evaluating companies performances is not easy owing to the following problems
i.        As a result of the compressed (summarized) nature of financial information contained in financial statements, they need to be analyzed and interpreted by means of financial ratios to enable management and relevant stakeholders make decision and as well to know the performances of companies.
ii.       Many users of financial statements are not knowledgeable about accounting ratios and how the ratios can be applied to financial statements to assist than have proper evaluation insight as to know the performances of companies.
iii.      Despite the immense benefits of financial statements analysis through the use of ratios there are lots of weaknesses or limitations associated with it uses.
We have learned a great deal about the content of the four basic statements. summarizes this information. Take a few minutes to review the information in the exhibit before you move on to the next section of the chapter.
1 A corporation is a business that is incorporated under the laws of a particular state. The owners are called stockholders or shareholders. Ownership is represented by shares of capital stock that usually can be bought and sold freely. The corporation operates as a separate legal entity, separate and apart from its owners. The stockholders enjoy limited liability; they are liable for the debts of the corporation only to the extent of their investments. Chapter Supplement A discusses forms of ownership in more detail.
2 This example uses a 25 percent rate. Federal tax rates for corporations actually ranged from 15 percent to 35 percent at the time this book was written. State and local governments may levy additional taxes on corporate income, resulting in a higher total income tax rate.
3 Net losses are normally noted by parentheses around the income figure.
4 Other corporations report these changes at the end of the income statement or in a more general statement of stockholders' equity,.
5 Net losses are subtracted.
6 Alternative ways to present cash flows from operations
Notes
At the bottom of each of Maxidrive's four basic financial statements is this statement: “The notes are an integral part of these financial statements.” This is the accounting equivalent of the Surgeon General's warning on a package of cigarettes. It warns users that failure to read the notes (or footnotes) to the financial statements will result in an incomplete picture of the company's financial health. Notes provide supplemental information about the financial condition of a company without which the financial statements cannot be fully understood.
There are three basic types of notes. The first type provides descriptions of the accounting rules applied in the company's statements. The second presents additional detail about a line on the financial statements. For example, Maxidrive's inventory note indicates the amount of parts, drives under construction, and finished disk drives included in the total inventory amount listed on the balance sheet. The third type of note provides additional financial disclosures about items not listed on the statements themselves. For example, Maxidrive leases one of its production facilities; terms of the lease are disclosed in a note. Throughout this book, we will discuss many note disclosures because understanding their content is critical to understanding the company.
A few additional formatting conventions are worth noting here. Assets are listed on the balance sheet by ease of conversion to cash. Liabilities are listed by their maturity (due date). Most financial statements include the monetary unit sign (in the United States, the $) beside the first dollar amount in a group of items (e.g., the cash amount in the assets). Also, it is common to place a single underline below the last item in a group before a total or subtotal (e.g., land). A dollar sign is also placed beside group totals (e.g., total assets) and a double underline below. The same conventions are followed in all four basic financial statements.
FINANCIAL ANALYSIS
Management Uses of Financial Statements
In our discussion of financial analysis thus far, we have focused on the perspectives of investors and creditors. Managers within the firm also make direct use of financial statements. For example, Maxidrive's marketing managers and credit managers use customers' financial statements to decide whether to extend credit for purchases of disk drives. Maxidrive's purchasing managers analyze parts suppliers' financial statements to see whether the suppliers have the resources to meet Maxidrive's demand and invest in the development of new parts. Both the employees' union and Maxidrive's human resource managers use Maxidrive's financial statements as a basis for contract negotiations over pay rates. The net income figure even serves as a basis for calculating employee bonuses. Regardless of the functional area of management in which you are employed, you will use financial statement data. You also will be evaluated based on the impact of your decisions on your company's financial statement data.
Statement of Cash Flows
At the bottom of each of Maxidrive's four basic financial statements is this statement: “The notes are an integral part of these financial statements.” This is the accounting equivalent of the Surgeon General's warning on a package of cigarettes. It warns users that failure to read the notes (or footnotes) to the financial statements will result in an incomplete picture of the company's financial health. Notes provide supplemental information about the financial condition of a company without which the financial statements cannot be fully understood.
There are three basic types of notes. The first type provides descriptions of the accounting rules applied in the company's statements. The second presents additional detail about a line on the financial statements. For example, Maxidrive's inventory note indicates the amount of parts, drives under construction, and finished disk drives included in the total inventory amount listed on the balance sheet. The third type of note provides additional financial disclosures about items not listed on the statements themselves. For example, Maxidrive leases one of its production facilities; terms of the lease are disclosed in a note. Throughout this book, we will discuss many note disclosures because understanding their content is critical to understanding the company.
A few additional formatting conventions are worth noting here. Assets are listed on the balance sheet by ease of conversion to cash. Liabilities are listed by their maturity (due date). Most financial statements include the monetary unit sign (in the United States, the $) beside the first dollar amount in a group of items (e.g., the cash amount in the assets). Also, it is common to place a single underline below the last item in a group before a total or subtotal (e.g., land). A dollar sign is also placed beside group totals (e.g., total assets) and a double underline below. The same conventions are followed in all four basic financial statements.
FINANCIAL ANALYSIS Management Uses of Financial Statements
In our discussion of financial analysis thus far, we have focused on the perspectives of investors and creditors. Managers within the firm also make direct use of financial statements. For example, Maxidrive's marketing managers and credit managers use customers' financial statements to decide whether to extend credit for purchases of disk drives. Maxidrive's purchasing managers analyze parts suppliers' financial statements to see whether the suppliers have the resources to meet Maxidrive's demand and invest in the development of new parts. Both the employees' union and Maxidrive's human resource managers use Maxidrive's financial statements as a basis for contract negotiations over pay rates. The net income figure even serves as a basis for calculating employee bonuses. Regardless of the functional area of management in which you are employed, you will use financial statement data. You also will be evaluated based on the impact of your decisions on your company's financial statement data.


REFERENCES
"IFRS 10 — Consolidated Financial Statements" . www.iasplus.com . IAS Plus (This material is provided by Deloitte Touche Tohmatsu Limited (“DTTL”), or a member firm of DTTL, or one of their related entities. This material is provided “AS IS” and without warranty of any kind, express or implied. Without limiting the foregoing, neither Deloitte Touche Tohmatsu Limited (“DTTL”), nor any member firm of DTTL (a “DTTL Member Firm”), nor any of their related entities (collectively, the “Deloitte Network”) warrants that this material will be error-free or will meet any particular criteria of performance or quality, and each entity of the Deloitte Network expressly disclaims all implied warranties, including without limitation warranties of merchantability, title, fitness for a particular purpose, non-infringement, compatibility and accuracy.). Retrieved 2013-11-29.
"Presentation of Financial Statements" Standard IAS 1, International Accounting Standards Board. Accessed 24 June 2007.
"The Framework for the Preparation and Presentation of Financial Statements" International Accounting Standards Board. Accessed 24 June 2007.
Alexander, D., Britton, A., Jorissen, A., "International Financial Reporting and Analysis", Second Edition, 2005, ISBN 978-1-84480-201-2
FASB, 2001. Improving Business Reporting: Insights into Enhancing Voluntary Disclosures . Retrieved on April 20, 2012.
MD&A & Other Performance Reporting
Nico Resources Management's Discussion and Analysis
PepsiCo Management's Discussion and Analysis