Understanding Business Accounting For Dummies, 2nd Edition (61 page)

Management's responsibility statement:
A short statement that management has primary responsibility for the accounting methods used to prepare the financial statements and for providing the other disclosures in the financial report.

Independent auditor's report:
The report from the accounting firm that performed the audit, expressing an opinion on the fairness of the financial statements and accompanying disclosures. (Chapter 15 discusses the nature of audits.) Public companies are required to have audits; private businesses may or may not have their annual financial reports audited depending on their size.

Company contact information:
Information on how to contact the company, the Web site address of the company, how to get copies of the reports filed with the London Stock Exchange, SEC, the stock transfer agent and registrar of the company, and other information.

Managers of public corporations rely on lawyers, auditors, and their financial and accounting officers to make sure that everything that should be disclosed in the business's annual financial reports is included and that the exact wording of the disclosures is not misleading, inaccurate, or incomplete. This is a tall order. The field of financial reporting disclosure changes constantly. Laws, as well as authoritative accounting standards, have to be observed. Inadequate disclosure in an annual financial report is just as serious as using wrong accounting methods for measuring profit and for determining values for assets, liabilities, and owners' equity. A financial report can be misleading because of improper accounting methods or because of inadequate or misleading disclosure. Both types of deficiencies can lead to nasty lawsuits against the business and its managers.

The Accounting Standards Board provides guidance on how the Companies Act requires balance sheets and profit and loss accounts to be laid out. To access their guidance, go to
www.frrp.org.uk
and click on ‘ASB', ‘Technical', and ‘FRSSE'.

Keeping It Private versus Going Public

Compared with their big brothers and sisters, privately-owned businesses provide very little additional disclosures in their annual financial reports. The primary financial statements and footnotes are pretty much all you'll get.

The annual financial reports of publicly-owned corporations include all, or mostly all, of the disclosure items listed earlier. Somewhere in the range of 3,000 companies are publicly owned, and their shares are traded on the London Stock Exchange, NASDAQ, or other stock exchanges. Publicly-owned companies must file annual financial reports with the Stock Exchange, which is the agency that makes and enforces the rules for trading in securities and for the financial reporting requirements of publicly-owned corporations. These filings are available to the public on the London Stock Exchange's Web site (
www.londonstockexchange.com
) or for US companies on the Securities Exchange Commission's (SEC's) EDGAR database at the SEC's Web site -
http://www.sec.gov/edgar/searchedgar/cik.htm
.

Both privately-held and publicly-owned businesses are bound by the same accounting rules for measuring profit, assets, liabilities, and owners' equity in annual financial reports to the owners of the business and in reports that are made available to others (such as the lenders to the business). These ground rules are called
generally accepted accounting principles
(GAAP) and are mentioned many times in this book. There aren't two different sets of accounting rules - one for private companies and another one for public businesses. The accounting measurement and valuation rules are the same for all businesses. However,
disclosure
requirements and practices differ greatly between private and public companies.

Publicly-owned businesses live in a fish bowl. When a company goes public with an
IPO
(initial public offering of shares), it gives up a lot of the privacy that a closely held business enjoys. Publicly-owned companies whose shares are traded on national stock exchanges live in glass houses. In contrast, privately-owned businesses lock their doors regarding disclosure. Whenever a privately-owned business releases a financial report to its bank in seeking a loan, or to the outside non-management investors in the business, it should include its three primary financial statements and footnotes. But beyond this, they have much more leeway and do not have to include the additional disclosure items listed in the preceding section.

A private business may have its financial statements audited by a professional accounting firm. If so, the audit report is included in the business's annual financial report. The very purpose of having an audit is to reassure shareholders and potential investors in the business that the financial statements can be trusted. But as we look up and down the preceding list of disclosure items we don't see any other absolutely required disclosure item for a privately held business. The large majority of closely-held businesses guard their financial information like Fort Knox.

The less information divulged in the annual financial report, the better - that's their thinking. And we don't entirely disagree. The shareholders don't have the liquidity for their shares that shareholders of publicly-held corporations enjoy. The market prices of public companies are everything, so information is made publicly available so that market prices are fairly determined. The shares of privately-owned businesses are rarely traded, so there is not such an urgent need for a complete package of information.

A private company could provide all the disclosures given in the preceding list - there's certainly no law against this. But usually they don't. Investors in private businesses can request confidential reports from managers at the annual shareholders' meetings, but doing so is not practical for a shareholder in a large public corporation.

Nudging the Numbers

This section discusses two accounting tricks that business managers and investors should know about. We don't endorse either technique, but you should be aware of both of them. In some situations, the financial statement numbers don't come out exactly the way the business wants. Accountants use certain tricks of the trade - some would say sleight-of-hand - to move the numbers closer to what the business prefers. One trick improves the appearance of the
short-term solvency
of the business, in particular the cash balance reported in the balance sheet at the end of the year. The other device shifts profit from one year to the next to make for a smoother trend of net income from year to year.