1 - TheArtofReadingFinancialStatements-Level1-v1.pdf

Candi Carrera
LEVEL 1
THE ART OF
READING FINANCIAL STATEMENTS
LEVEL 1 - PRACTITIONER

2
All rights reserved – Candi Carrera
Copyright © 2021-2023 Candi Carrera. All rights reserved.
No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical,
including photocopying, recording, or any information storage and retrieval system, without permission in writing from the
publisher. This content and the individual contributions contained in it are protected under copyright by the Publisher
(other than as may be noted herein).
Notices
Knowledge and best practice in this field are constantly changing. As new research and experience broaden our
understanding, changes in research methods and professional practices may become necessary. Practitioners and
researchers must always rely on their own experience and knowledge in evaluating and using any information, methods,
compounds, or experiments described herein. In using such information or methods they should be mindful of their own
safety and the safety of others, including parties for whom they have a professional responsibility.
To the fullest extent of the law, neither the Publisher nor the authors, contributors, or editors, assume any liability for any
injury and/or damage to persons or property as a matter of products liability, negligence or otherwise, or from any use or
operation of any methods, products, instructions or ideas contained in the material herein.
Disclaimer

The Art of Reading Financial Statements for investors
Candi Carrera

Candi Carrera
Financial statements show
where company money came
from, where it went
& where it is now

Candi Carrera
“You have to understand accounting and you have to
understand the nuances of accounting. It’s the
language of business and it’s an imperfect language,
but unless you are willing to put in the effort to learn
accounting – how to read and interpret financial
statements – you really shouldn’t select stocks
yourself”
- Warren Buffett

Candi Carrera
Mycredentials
Who am I to talk about this ?
• Value investor since 1997 with >1M in equity assets & no debt/zero leverage
• Big tech (MSFT) business management background
• Startup mentor since 2010
• Independent board director in Luxembourg (RTO) & Dubai (VC & PE)
• University lecturer since 2020 on Entrepreneurship, Strategic Management,
BigData & AI
• MBA & INSEAD IDP-C
www.linkedin.com/in/candicarrera
www.youtube.com/@36squarecapital

Candi Carrera
My approach writing set of courses about financial statements
• 1st assumption – I continue to see people investing money into
companies without knowing about the company’s situation. I call this
speculation and not investing.
• 2nd assumption - I would have loved somebody teaching me this
approach to read financial statements 25 years ago. This course
shares a non-linear approach in reading financial statements and
grasp the essence of the company being analysed
• 3rd assumption – This course shall complement the investment
courses like The Art of Value Investing & The Art of Company
Valuation to become a better & serious investor

Candi Carrera
• Sharing main reading keys to understand & digest financial statements & financial
reports for investors
• Investors act as financial resource providers
• Intention is to help investors read & analyse financial statements
• Be able to look at companies from the outside-in without insider knowledge
• Why ?
• Financial statements appear complex and long (sometimes on purpose)
• Requires judgment and practice
• People do not know where to start reading and what to look for
• Go into financial statements in a linear/sequential way
• Given the amount of topics to cover
• Course CANNOT be exhaustive
• Complementary to accounting, company valuation & corporate finance courses
• Focus on key topics for investors when reading financial statements & discussing assets, liabilities,
equity, income & cash flow, regulatory & compliance requirements
Trainingpurpose

Candi Carrera
• Due to the breadth & depth of subject, course structured in 2 levels
Practitioner
Expert

Candi Carrera
MultilayeredLearningmethod
Theory requires practice
Source :
Edgar Dale's Cone of Experience, 1969
www.edutechie.ws/2007/10/09/cone-of-experience-media/
www.queensu.ca/teachingandlearning/modules/active/documents/Dales_Cone_of_Experience_summary.pdf
2
3
1
2
3
1 Standard course
Reading real-life reports & answering
questions/assignments
Participating in webinars with Q&A
sessions

Candi Carrera
Tableofcontents
Income
statement
Cash flow
statement
Balance
sheet
What the
company
generates with
its assets
The in- &
outflows of cash
Capital sources
& assets of the
company since
inception
• Probably familiar with financial statements
terms like earnings/income statement and
balance sheet.
• Cash flow statement to lesser extent probably

Candi Carrera
Tableofcontents
Typical order
Income > Cash > Balance sheet
Income
statement
Cash flow
statement
Balance
sheet
What the
company
generates with
its assets
The in- &
outflows of cash
Capital sources
& assets of the
company since
inception
Typical order of 99% of the
people, press, « the street »,
wannabe analysts is of
looking first at Income
Statement, then Cash then
Balance Sheet
Discuss earnings & earnings
per share first, beating
estimates, forecasting next
earnings, …

Candi Carrera
Balance
sheet
Cash flow
statement
Income
statement
Capital sources
& assets of the
company since
inception
The in- &
outflows of cash
What the
company
generates with
its assets
Tableofcontents
I typically read
financial statements
in « reverse » order
starting with balance
sheet.
The lowest interest document
to me is income statement
without neglecting that
revenue & product mix
performance is crucial !
My order
Balance sheet > Cash flow > Income

Candi Carrera
1. Identify & understand accounting standard used IFRS, US GAAP or Local
GAAP
2. Differentiate between 3 main types of financial statements & fundamental
accounting principles
3. Understand & identify main corporate governance elements including
corporate governance 1- or 2-tier model, shareholders & board of directors
4. Understand role of statutory auditor, Identify if audited/unaudited, if audited
identify statutory auditor, tenure of statutory auditor, comments about
statutory auditor’s independence/conflict of interest / related fees and audit
opinion
5. Understand the scope of consolidation (& unconsolidation) of the company
6. Be able to do a vertical analysis of the balance sheet and understand main
resources & capital sources in balance sheet
7. Identify sources of capital including long-term debt, related schedule, cost
to service long-term debt including interest coverage ratio, equity capital
source including potential retained earnings
8. Deepen understanding of value creation for shareholders by understanding
ROIC & WACC
9. Understand profitability of company by analysing revenue segments (if
available) & cash generating assets, understand operating cash flow & working
capital vs financing & investing cash flows
10. Be able to read earnings information including EPS, NOPAT, EBITDA, EBIT &
net income
The Art of Reading Financial Statements
LEVEL 1
Learning Objectives

Candi Carrera
GAAP
corporate governance 1- or 2-tier model, shareholders & board of directors
opinion
6. Be able to do a vertical analysis of the balance sheet and understand main
resources & capital sources in balance sheet
ROIC & WACC
net income
CHAPTER 1
INTRODUCTION TO FINANCIAL STATEMENTS
LANGUAGE
CHAPTER 2
MAIN ELEMENTS OF CORPORATE GOVERNANCE
LINKED TO FINANCIAL STATEMENTS
CHAPTER 3
INVENTORY OF COMPANY RESOURCES & CAPITAL
CHAPTER 4
UNDERSTANDING PROFITABILITY

Candi Carrera
Practicalwork–Companies

Candi Carrera
• Chapter 1
• 1.1 - Determine if financial statements follow IFRS or US GAAP standard
• Chapter 2
• 2.1 - Determine type of legal personality, jurisdiction of incorporation & scope of consolidation
• 2.2 - Determine 1 or 2 tier governance model, find the auditor’s report in annual report, read the opinion, spot any concerns in opinion
• Chapter 3
• 3.1a - Look in latest annual report for the balance sheet. Find the biggest item in balance sheet in assets but also in liabilities side
• 3.1b - Take your favorite company. Download latest balance sheet (assets & liabilities). Put into companion balance sheet Excel file each asset &
liability items. Analyse/interprete % and get sense of what are the main (material) items in terms of assets & liabilities
• 3.2 - Find the amount of outstanding shares & determine if the company has only one class of common shares or potentially multiple
• 3.3 - Look in latest annual report for the cash flow statement. Determine if the company has been paying out cash dividends and/or performing
share buybacks
• 3.4 - Determine the net debt of the company & debt to equity, debt to cash ratio, reimbursement schedule of cash, annual cost to service debt
by determining interest coverage ratio
• 3.5 - Think about products & services and more specifically the cash collection cycle and also potential warranties. Check if the company has any
deferred income & contract/refund liabilities & read the revenue recognition section
• 3.6 - Look at latest balance sheet for long-term lease related assets & liabilities. Look at balance sheet before IFRS 16 / ASC 842 change and
compare with current balance sheet
• 3.7 - Calculate & analyse the cash to total assets ratio for the last 5 years
• Chapter 4
• 4.1 - Take 2 companies you like within SAME industry. Download latest annual report. Compare & comment profitability of both companies
• Chapter 5
• Complex example answering following 10 questions
Listofassignments

Candi Carrera
GAAP
corporate governance 1- or 2-tier model and external regulation
opinion
6. Be able to do a vertical analysis of the balance sheet and understand
material assets & liabilities in balance sheet
ROIC & WACC
net income
LEVEL 1
Learning Objectives

Candi Carrera
Introductiontoentrepreneurship
time
Launch Growth Shakeout Maturity Decline
Renewal phase
( = new revenues)
new cash
new profit
Strategic inflection point
S-Curve of corporate growth
Ideation
Typical milestones/obstacles
1) Incorporating company & overcoming bureaucracy
2) Obtaining financing
3) Hiring & keeping talent
4) Acquiring customers
5) Provide leadership & management to the company
6) Managing competitors & market changes

Candi Carrera
Introductiontoentrepreneurship
time
Launch Growth Shakeout Maturity Decline
Great feeling
• Number 1 prediction of bad performance
is good performance
• REMEMBER : KPIs are backwards looking
Best feeling
Management not even
aware / KPIs &
financials look good
CEO fired
Return on
Equity
« External » causes

Candi Carrera
• In order to deepen knowledge on company strategy
• Masterclass in Entrepreneurship & Strategic Management
• Covers main strategic management tools including Porter 5-forces model, PESTLE, VRIO
analysis tool, Balanced scorecard & Strategic portfolio management tools like BCG
Growth-share matrix
• Complement with Mintzberg emergent strategy perspective & productivity frontier with
strategy stick (WTP, xQ, cost)

Chapter 1
Introductionto
language
History&purpose
Reportingstandards
Financialstatementtypes
Reporting&Accountingprinciples
for Investors

Candi Carrera
• Bookkeepers appeared with barter
• People exchanging goods & services
• Initial purpose : need to record agreements on transactions
• Ancient history
• 7.000 years ago – early accounting records
• Mesopotamia to record lists of expenditures, goods received &
traded
• primitive accounting methods also found in ruins of ancient
Babylonia & Assyria to record growth of crops and herds
• (Accounting) ledger
• book or collection of accounts in which transactions are recorded
History&purpose

Candi Carrera
• Medieval & Renaissance period
• Luca Bartolomeo de Pacioli, 1447-1517, Italian mathematician, Franciscan
friar
• 1494, Summa de arithmetica, geometria, Proportioni et proportionalita
in section titled Particularis de Computis et Scripturis
• did not use term but described double book keeping techniques & post-
closing trial balance
• Double-entry bookkeeping principle
• Double entry bookkeeping principle = Increase or decrease of one side of
equation impacts the other side of equation & helps guarantee accurate
financial records by revealing entry errors
• For any transaction at least 2 accounts are impacted in account ledgers,
with a debit entry recorded against one account and credit entry against
other account
• debit entry represents transfer of value to account
• credit entry represents transfer from the account
• use of debit and credit in a two-column transaction recording format
is the most essential of all controls over accounting accuracy
History&purpose

Candi Carrera
• Double-entry system
• Capital bringer 10MUSD (liability)
• Cash in bank 10MUSD (liability conversion to
asset)
• debit entry represents transfer of value to account
• credit entry represents transfer from the account
Debit Credit Debit Credit
Cash in hand (in kUSD) Equity (in kUSD)
10.000 10.000
560 560
Underlying principle of balance
between total of debt & credits

Candi Carrera
• Accounting involves preparation of information for interested
stakeholders
• internal (management, employees, …)
• external (existing shareholders, potentially new shareholders, creditors, tax authorities, …)
• Purpose of control & decision-making for interested
stakeholders
• consists of simple recording of factual information BUT may require interpretation as well
(shortcomings & imperfections of accounting)
• even financial statements prepared in full compliance with effective accounting
regulations may not be entirely reliable or comparable
• in time
• between various companies
• different standards e.g. IFRS vs US GAAP
• Financial statements constitute simplification of complex
business activities
• NO accounting system perfectly reflects reality
History&purpose

Candi Carrera
• Objective of general purpose financial reporting
• primary users of financial reporting are present & potential investors, lenders and
other creditors
• use information to make decisions about buying, selling or holding equity or debt
instruments, exercising rights to vote on, or otherwise influence, management’s
actions that affect use of company’s economic resources
• … primary users need information about resources of the entity not only to assess
an entity's prospects for future net cash inflows but also how effectively and
efficiently management has discharged their responsibilities to use the entity's
existing resources (i.e., stewardship).
• Need for
• comparability between time periods (e.g. fiscal years), between companies &
industries, between countries & markets
• avoid distortion, incompleteness, bias or misrepresentation impacting decision of
stakeholders
Purpose

Candi Carrera
• Main purpose for companies
• raise money from the public
• use raised capital to fund business growth
• Main purpose for investors
• give entrepreneurs opportunity to lend capital to companies
• hopefully own return on deployed capital depending on asset class
Introduction
Companies Investors
Flow of money
Information
Typical capital sources
• Bonds (Debt)
• Convertible debt (Hybrid)
• Preferred shares (Equity)
• Common shares (Equity)

Candi Carrera
• Securities market divided into 2 categories Primary & Secondary
• Primary market (private)
• Act of selling (offering) originating from corporate issuer to investors
• Low liquidity (illiquid) & low price transparency
• Companies raising capital for first time are making an Initial Public Offering (IPO) or Direct Public Offering (DPO)
• First time company disclosing performance and operations to public
• Carry highest amount of uncertainty and risk for investors
• Secondary market (public)
• Secondary Market involves investor-to-investor sales
• Happening in organized marketplace often referred to as stock market or stock exchange
• High liquidity & price transparency
• New York Stock Exchange, Nasdaq, London Stock Exchange, Frankfurt Stock Exchange, Paris Stock Exchange, …
Introduction
Issuing
company Brokers
Primary market
Lead
underwriter
Secondary market
Group of
investment
banks
Group of
institutional
byers/
primary
buyers
Stock
exchanges/
markets
Sellers Buyers/
Investors

Candi Carrera
• Reporting obligations
• Typical obligations for companies & directors of company
• preparation (by management) of accounts and reports
• approval and signing of accounts and reports
• filing of accounts and reports to central registry (varies per country)
• Primary markets carry basic amount of reporting obligations
• Statutory audit (cf. section) and supplemental requirements are needed for companies matching
certain amount of substance requirements (revenue, balance sheet size, number of employees)
• Highly regulated secondary markets add certain amount of reporting
obligations to avoid information assymetry
• 10Q unaudited quarterly
• 10K audited yearly
• 8K disclosure of major company events in between 10Q & 10K reports
• 3, 4 & 5 forms about company ownership & changes in ownership for officers, directors & >10%
shareholders

Candi Carrera
• Reporting & disclosure obligations
Source :
www.sec.gov/news/press-release/2020-192

Candi Carrera
• Transparency Directive
(2004/109/EC)
• requires issuers of securities traded on regulated
markets within the EU to make their activities
transparent, by regularly publishing certain
information.
• information to be published includes
• yearly and half-yearly financial reports
• major changes in the holding of voting rights
• ad hoc inside information which could affect the price of securities
• Transparency Directive amended
in 2013 by Directive 2013/50/EU
• reduce the administrative burden on smaller
issuers, particularly by abolishing the requirement
to publish quarterly financial reports
Source :
finance.ec.europa.eu/capital-markets-union-and-financial-markets/company-reporting-and-auditing/company-reporting/transparency-
requirements-listed-companies_en

Candi Carrera
• Sources
• For private companies, local/central register of mandatory company filings
• Often requires fee payment and identification of requestor in order to obtain financial
statements of company
• For public companies
• Investor Relations website or section of corporate website
• US Securities & Exchange Commission (SEC) EDGAR (Electronic Data Gathering, Analysis, and
Retrieval) website
https://www.sec.gov/edgar/searchedgar/companysearch
• Europe
• Other markets

Candi Carrera
1

Candi Carrera
1
2

Candi Carrera
1 2

Candi Carrera
Source : investors.3m.com/ir-home/default.aspx

Chapter 1
Introduction to
language
History&purpose
Reportingstandards
Financialstatementtypes
Reporting&Accountingprinciples
for Investors

Candi Carrera
• IFRS - International Financial Reporting
Standards
• International Accounting Standards Board (IASB)
• independent & geodiverse group of experts
• set accounting standard IFRS
• Link https://www.ifrs.org/
• US GAAP - US Generally Accepted
Accounting Principles
• Financial Accounting Standards Board (FASB)
• recognized by U.S. Securities and Exchange Commission as designated accounting
standard setter for public companies
• establishes financial accounting & reporting standards for public and private companies
and not-for-profit organizations that follow Generally Accepted Accounting Principles
(US GAAP)
• Link https://www.fasb.org/home
• Local GAAP
• Often for non-listed companies
• Lux GAAP, Spanish GAAP are examples …
IASB&FASB

Candi Carrera
UnderstandingIFRSvsGAAP
Attribute
IFRS
International Financial Reporting Standards (IFRS)
developed by the International Accounting Standards
Board (IASB)
US GAAP
U.S. Generally Accepted Accounting Principles
established by Financial Accounting Standards Board
(FASB)
Examples
Local vs global
167 juridictions (Feb 2020) around the world including EU,
Asia & South American countries
United States of America
Source :
www.ifrs.org/content/dam/ifrs/around-the-world/adoption/use-of-ifrs-around-the-world-overview-sept-2018.pdf
www.ifrs.org/use-around-the-world/use-of-ifrs-standards-by-jurisdiction/#analysis-of-the-profiles-by-number-of-
domestic-listed-companies
Six jurisdictions use national or regional standards:
Bolivia, China, Egypt, India, Macao SAR & United States

Candi Carrera
Attribute
IFRS
Board (IASB)
US GAAP
(FASB)
Examples
Local vs global
120 countries (Feb 2020) around the world including EU, Asia
& South American countries
Rules vs Principles IFRS has principles that require judgment and interpretation tends to be more rules-based
Balance sheet formatting
• under IFRS begins with non-current assets
• under IFRS, the order is reversed (least liquid to most
liquid)
• current assets are listed first
• GAAP calls for accounts to be listed in the order of
liquidity—or how quickly and easily they can be
converted to cash
Inventory Methods Weighted-average or FIFO, LIFO not allowed Weighted-average, LIFO or FIFO
Inventory Write-Down
Reversals
Considers lower cost or net realisable value. In case of
subsequent recovery in value, inventory can be written up
Considers lower cost or market. In case of subsequent
recovery in value, inventory cannot be written up
Fair Value Revaluations
allows revaluation of the following assets to fair value if fair
value can be measured reliably: inventories, property, plant &
equipment, intangible assets, and investments in marketable
securities. This revaluation may be either an increase or a
decrease to the asset’s value
Under GAAP, revaluation is prohibited except for
marketable securities
Impairment Losses
IFRS allows impairment losses to be reversed for all types of
assets except goodwill
GAAP takes a more conservative approach and prohibits
reversals of impairment losses for all types of assets
Intangible Assets Reporting using cost or reevaluation model GAAP does not allow reevaluation model
Fixed Assets
Under IFRS, these same assets are initially valued at cost, but
can later be revalued up or down to market value
GAAP requires that long-lived assets, such as buildings,
furniture and equipment, be valued at historic cost and
depreciated appropriately
Land bought 30 years
ago
Revenue Will equal cost
Revenue is considered only under the completed contract
method
Extraordinary items IFRS prohibits such classification Allowed under GAAP
2
1
3
4

Candi Carrera
IFRS
Source : www.ifrs.org/issued-standards/list-of-standards/
• International Accounting
Standard (IAS) & International
Financial Reporting Standard
(IFRS) are the same
• IAS represents old accounting
standards

Candi Carrera
• Directive 2013/34/EU
Europeanreportingobligations
Sources :
ec.europa.eu/info/business-economy-euro/company-reporting-and-auditing/company-reporting/financial-reporting_en
eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32013L0034&from=EN

Candi Carrera
USGAAP
Source : asc.fasb.org/section&trid=2208795
Accounting Standards Codification (ASC)

Candi Carrera
• Chart of accounts (CoA)
• index of all financial accounts in general ledger
• organizational tool listing & breaking down all
financial transactions
• In some countries
• charts of accounts is regulated by law
• IFRS does not prescribe chart of accounts
Sources of capital
Equity holders
Share holders
Credit holders
Assets
Assets

Candi Carrera
Spanish National Chart of Accounts
Plan general de contabilidad (PGC)
Luxembourgish Standard Chart of Accounts
Plan comptable normalisé (PCN)
Source : www.icac.gob.es/contabilidad/normativas/nacionales#portada
Source : legilux.public.lu/eli/etat/leg/rgd/2019/09/12/a631/jo

Candi Carrera
USSGL
Source : fiscal.treasury.gov/files/ussgl/tfm-archive/effective-2013-june13/part-1/sec1_chrtacct_2013.pdf

Candi Carrera
Practicalwork
MERCEDES
Automotive
Headquartered in Stuttgart-
Untertürkheim (Germany)

Candi Carrera
Practicalwork
KELLOGG’S
Consumer
Defensive
Headquartered in Battle Creek,
Michigan (USA)

Candi Carrera
• Financial Statements
• Records showing company business activities & financial performance
• Financial statements are simplified representation of company
• Financial statements are prepared on assumption that reporting entity is a going concern & will
continue in operation for foreseeable future
• Defined by IFRS & US GAAP
• Sometimes amended and/or confirmed by national accounting regulations
• Serious investors complement view outside of financial statements
• Public equity / value investors : Net Promoter Score, Competitive/competition analysis, Employee
sentiment (glassdoor), Rating agencies (S&P, Moodys, Fitch), Industry benchmarks, …
• Private equity (PE) : due diligence including legal, customer/supplier, intangible assets review, …
• Venture Capital (VC) : guts feeling, founders profile & vision, management team, problem
addressed, potential market size, …
Thetoolset

Candi Carrera
Terminology

Candi Carrera
• Part 1
• Business
• Risk Factors
• Unresolved staff comments
• Properties
• Legal Proceedings
• Mine Safety Disclosures
• Part 2
• Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities
• Management’s Discussion and Analysis of Financial Condition and Results of Operations
• Quantitative and Qualitative Disclosures about Market Risk
• Financial Statements and Supplementary Data
• Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
• Controls and Procedures
• Other Information
• Part 3
• Directors, Executive Officers and Corporate Governance
• Executive Compensation
• Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
• Certain Relationships and Related Transactions, and Director Independence
• Principal Accountant Fees and Services
• Part 4
• Exhibits, Financial Statement Schedules
Source : www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-bulletins/how-read

Candi Carrera
• When analyzing any firm, investors want to
know
• types of assets owned by company (tangible, intangible, liquid,
illiquid)
• types of claims/liabilities on assets (shareholder claims, 3rd party
claims)
• value of assets (at cost, current/fair value)
• degree of uncertainty about value (linked to current/fair value)
• how good or bad company is at generating cash (first) & profits
(income/earnings)
• Remember
• financial statements & figures in statements are imperfect &
incomplete representation
Measurementbasis

Candi Carrera
• Common use of 3 main financial statement
types
• Balance sheet
• Stock of wealth / wealth accumulation with assets of company &
claims/liabilities on those assets since inception
• also called Statement of Financial Position
Thetoolset
Company creation Today
time
Balance sheet
Since creation
1
Source : asc.fasb.org/section&trid=2122211

Candi Carrera
Thetoolset
time
Balance sheet
Income & cash flow statements
Reporting period
(monthly, quarterly, semestrial, annual, ...)
Since creation
• Common use of 3 main financial statement
types
• Balance sheet
• Stock of wealth / wealth accumulation with assets of company &
claims/liabilities on those assets since inception
• Income/Earnings statement
• Flow of wealth into & out of company (revenue & expenses)
• How much company is making/losing per unit time
• Unit of time can be daily, monthly, quarterly, 27 days, annual, …
• Typical units are monthly, quarterly, semi-annual & annual
• Cash flow statement
• similar to income statement recording company’s cash inflow &
outflows over a specified period of time
3
1
2

Candi Carrera
Practicalwork
3
1 2

Candi Carrera
Practicalwork
3
1
2

Candi Carrera
• Difference between income/earnings & cash
flow
• two different accounting concepts
• time difference between cash movements and business transactions
• in the long-term cash flow & earnings SHALL converge as cash is collected or paid
• income statement
• takes into account some non-cash accounting items such as depreciation resulting
in EBITDA & similar notions (tax advantage for companies investing reducing tax
surface)
• cash flow statement
• strips away all non-cash accounting items
• shows exactly how much actual money the company has generated
• shows performance in managing inflows and outflows of cash
• cash flow provides a sharper picture of a company's ability to pay creditors &
finance growth
Incomevscashflow

Candi Carrera
IncomeapproachedusingDCF/FCFF
Cash flow
statement
(Investing
cash flow)
Income
statement
Car has to be immediately paid to car dealer
(capital expenditure + increases asset side of
balance sheet)
Car as a capital investment can be depreciated
overtime (adding back depreciation in operating
cash flow)
Recurring stream of
revenues
time
time
Cash flow
statement
(Operating
cash flow)
Income
statement
Car is considered a COGS (cost of goods sold/cost
of revenue) as property outside of company
Recurring stream of
revenues
time
time
Car renting
Car purchase

Candi Carrera
3 statements linked together
(Balance sheet & income statement & cash flow)
Incomevscashflow
time
Balance sheet
Reporting period
Since creation

Candi Carrera
Practicalwork
1
2
2
1
3
3
1. Cash position correlates between balance sheet & cash flow
2. Earnings increase and/or decrease total equity
3. Profit before income taxes reconciles with cash flow
3
1 2

Candi Carrera
Practicalwork
1
2
1
3
3
2
3
1
2

Candi Carrera
More than
3 financial statement types

Candi Carrera
• Common use of main financial statement
types
• Balance sheet
• Income statement
• Statement of changes in equity
• Statement of cash flows
• Often not mandatory for companies that prepare
abridged (= shortened) balance sheet, abridged
statement of changes in equity & notes to abridged
Thetoolset
time
Balance sheet
Reporting period
Since creation

Candi Carrera
• Common use of main financial statement
types
• Balance sheet
• Income statement
• Statement of changes in equity
• Statement of cash flows
• Often not mandatory for companies that prepare
abridged (= shortened) balance sheet, abridged
statement of changes in equity & notes to abridged
• Notes to the financial statements
Thetoolset
time
Balance sheet
Reporting period
Since creation
Such an essential reading. You cannot only decide to put your
money into a company without reading the notes

Candi Carrera
• Financial statement types
• Balance sheet / Financial position
• Equity statement
• statement of owner’s equity reports changes in company equity from opening balance to end of period balance
• changes include earned profits, dividends, inflow & withdrawal of equity, movements in treasury stock, net loss, ...
• Comprehensive income statement
• sum of regular income and irregular income called other comprehensive income
• includes realized and unrealized income/losses
• more detailed view of company's net income - not fully reflected by income statement
• Other comprehensive income appears separate from regular income statement and often presented in sequence
of net income
• Examples of other comprehensive income include
Thetoolset
Balance
sheet
focused
Income
focused

Candi Carrera
of net income
Thetoolset
Balance
sheet
focused
Income
focused
3
1b
1
2b
2

Candi Carrera
Practicalwork

Candi Carrera
Practicalwork
1 2 3

Candi Carrera
Practicalwork
2 1
1 1b
1
2

Candi Carrera
Practicalwork
2
2
1
3
3
2
2b
1

Candi Carrera
Practicalwork
1
2
3

Candi Carrera
Practicalwork
1 1b
2
1
2
1

Candi Carrera
Practicalwork
2 2b

Candi Carrera
of net income
• Notes
Thetoolset
Balance
sheet
focused
Income
focused
3
1b
1
2b
2
4

Candi Carrera
• Accompanying notes
• financial statements have to be accompanied by notes that explain information
presented in the financial statements
• Very few people read notes while they provide interesting insights / carry important
information
Thetoolset

Candi Carrera
1. Take your preferred company and
download latest annual report
2. Browse through its financial statements
and find company’s balance sheet, income
statement & cash flow statement
3. Determine if financial statements follow
IFRS or US GAAP standard
Assignment1.1

Candi Carrera
• Financial reports carry explicitly units & currencies
• Investment & analysis mistakes due to wrong usage of units
• personnally have seen students not capturing right currency units & scales when reading
financial reports
• Typical sources of mistakes
• Billion & Million units in
• Financial figures
• Number of outstanding shares
• Foreign currency companies
• analysing companies in foreign currencies (Yen, RMB), students forget to convert between currencies (e.g. Yen to USD
conversion rate of 120:1)
• Depositary securities
• E.g. ADRs
• students make interpretation & valuation mistakes on conversion factor (original share in local market conversion of 4:1)
• When combined, interpretation mistake with order of magnitudes of 1.000+
Aboutunits

Candi Carrera
Aboutunits
1

Candi Carrera
Aboutunits
1
2

Candi Carrera
• Fair presentation
• financial statements shall present fairly the financial position, financial performance and cash flows of an entity
requires the faithful representation of the effects of transactions, other events and conditions
• Going concern
• an entity shall prepare financial statements on a going concern basis unless management either intends to
liquidate the entity or to cease trading, or has no realistic alternative but to do so.
• Accrual basis of accounting
• an entity shall prepare its financial statements, except for cash flow information, using the accrual basis of
accounting
• Materiality and aggregation
• an entity shall present separately each material class of similar items. An entity shall present separately items of
a dissimilar nature or function unless they are immaterial.
• Offsetting (not-offsetting)
• an entity shall not offset assets and liabilities or income and expenses, unless required or permitted by an IFRS.
• Frequency of reporting
• an entity shall present a complete set of financial statements (including comparative information) at least
annually
• Comparative information
• an entity shall present, as a minimum, two statements of financial position, two statements of profit or loss and
other comprehensive income, two separate statements of profit or loss (if presented), two statements of cash
flows and two statements of changes in equity, and related notes
• Consistency of presentation
• an entity shall retain the presentation and classification of items in the financial statements from one period to
the next
Generalfeatures&principles

Candi Carrera
• financial statements shall present fairly the financial position, financial performance and cash flows of an
entity & requires the faithful representation of the effects of transactions, other events and conditions
• Going concern
accounting
annually
the next

Candi Carrera
• Valuation of assets uses 2 measurement bases
• Historical cost measurement reflecting price of transaction or other event
that gave rise to related asset, liability, income or expense
• Current value measurement reflecting conditions at measurement date
• Current value includes fair value, value in use (for assets) & fulfilment value (for liabilities) and
current cost
• one basis might provide more useful information than other under different circumstances
• consider the nature of information that the measurement basis will
produce
• Undervaluation of Land in use (part of PP&E)
• Potential overvaluation of assets (e.g. intangible assets)
Measurementbasis

Candi Carrera
Attribute
IFRS
Board (IASB)
US GAAP
(FASB)
Examples
Local vs global
120 countries (Feb 2020) around the world including EU, Asia
& South American countries
Rules vs Principles IFRS has principles that require judgment and interpretation tends to be more rules-based
Balance sheet formatting
• under IFRS begins with non-current assets
• under IFRS, the order is reversed (least liquid to most
liquid)
• current assets are listed first
• GAAP calls for accounts to be listed in the order of
liquidity—or how quickly and easily they can be
converted to cash
Inventory Methods Weighted-average or FIFO, LIFO not allowed Weighted-average, LIFO or FIFO
Inventory Write-Down
Reversals
Considers lower cost or net realisable value. In case of
subsequent recovery in value, inventory can be written up
Considers lower cost or market. In case of subsequent
recovery in value, inventory cannot be written up
Fair Value Revaluations
allows revaluation of the following assets to fair value if fair
value can be measured reliably: inventories, property, plant &
equipment, intangible assets, and investments in marketable
securities. This revaluation may be either an increase or a
decrease to the asset’s value
Under GAAP, revaluation is prohibited except for
marketable securities
Impairment Losses
IFRS allows impairment losses to be reversed for all types of
assets except goodwill
GAAP takes a more conservative approach and prohibits
reversals of impairment losses for all types of assets
Intangible Assets Reporting using cost or reevaluation model GAAP does not allow reevaluation model
Fixed Assets
Under IFRS, these same assets are initially valued at cost, but
can later be revalued up or down to market value
GAAP requires that long-lived assets, such as buildings,
furniture and equipment, be valued at historic cost and
depreciated appropriately
Land bought 30 years
ago
Revenue Will equal cost
Revenue is considered only under the completed contract
method
Extraordinary items IFRS prohibits such classification Allowed under GAAP
1

Candi Carrera
Modifiedbookvalue-IAS9
Source : www.ifrs.org/issued-standards/list-of-standards/

Candi Carrera
• Fair value accounting & measurement
• also called mark-to-market
• way to measure assets and liabilities appearing on balance
sheet & income statement
• measuring assets and liabilities at fair value may affect
income statement
• Hierarchy of 3 levels of input data for
determining fair value (FAS157, IFRS13)
• Level 1 quoted prices for identical items in active, liquid
and visible markets such as stock exchanges
• Level 2 observable information for similar items in active
or inactive markets (private equity multiples, similar
buildings downtown, …)
• Level 3 unobservable inputs to be used in situations
where markets don’t exist or are illiquid (highly
subjective)
• Impact
• Increase OR decrease in liquidity of company
• Examples
• Level 1 items fair value during bear market ? increase in
book value
• Look out for high level 3 proportion
• CDO during subprime crisis were valued based on Level 1
Assets Liabilities
Tangible
Assets
Equity
Debt
Intangible
Assets
IFRS 9 – Financial instruments
Subcategory of cash & cash equivalents
+ in case of undervaluation
+ in case of undervaluation

Candi Carrera
& requires the faithful representation of the effects of transactions, other events and conditions
• Going concern
accounting
annually
the next

Candi Carrera
• Two accounting methods
• Accrual accounting
• records revenue before receiving payment for goods or services
• expenses are recorded as incurred before payment
• In other words, the revenue earned is recognized on the
company's accounting books regardless of when cash
transactions have occurred
• Cash Accounting
• only records revenue when cash transaction has occurred for
goods and services
Accrual
Has an impact on EPS hence possibility of
overstatement of incomes. I personnally like to hear
from auditors if they have analysed risk of credit
notes on accrued income (reversal)
Look for revenue recognition principles, deferred &
concealed income later in course

Candi Carrera
AccrualsvsDeferrals
• Accruals vs Deferral revenue
• Accural vs Deferral expense
Characteristics Accrued Revenue Deferred Revenue
Definition
Refers earned revenues that have an
impact on financial records
Refers to payment of revenues incurred
during a certain reporting period but is
reported in another reporting period
Objective
Aims at recognizing revenue in the
income statement before payment is
received in cash flow statement
Aims at decreasing revenue in the income
statement while payment already
received in cash flow statement
Results Lead to increase in revenues Lead to decrease in revenues
Characteristics Accrued Expense Deferred Expense
Definition
Refers to already incurred expenses but
not paid yet that have an impact on
financial records
Refers to prepayment of expenses during
a certain reporting period but is reported
in another reporting period
Objective
Aims at increasing costs in the income
statement before payment is done in
cash flow statement
Aims at decreasing costs in the income
statement while payment (cash outflow)
already done in cash flow statement
Results Lead to increase in costs Lead to decrease in costs

Candi Carrera
• Materiality
• auditor shall consider materiality & relationship with audit risk when
conducting audits
• Defined in auditing standard ISA320
• Information is material if its omission or misstatement influences
decisions of stakeholders using financial statements
• Materiality depends on the size of the item or error judged in the
particular circumstances of its omission or misstatement
• materiality provides threshold or cut-off point
• When designing audit plan
• auditor establishes an acceptable materiality level so as to detect
quantitatively material misstatements
• Statutory auditors use often benchmarks (e.g. 5% of total income, 5% of balance
sheet, …)
• Both amount (quantity) & nature (quality) of misstatements need to
be considered
• Material impacts sometimes require restatement of
previous financial statements
• Kraft Heinz restatements
Materiality&fairrepresentation
Thumbrule that I personnally use as
non executive director :
• <5% immaterial
• Between 5-10% requires judgment
• >10% is material

Candi Carrera
Materiality-Assets
Mercedes Mercedes (in %) Kelloggs Kelloggs (in %)
Intangible assets 16.399 5,7% 2.491 13,8%
Property, plant & equipment 35.246 12,3% 3.713 20,6%
Equipment on operating leases 47.552 16,6% 658 3,7%
Equity-method investments 5.189 1,8% 391 2,2%
Goodwill 0 0,0% 5.799 32,2%
Receivables from financial services 53.709 18,8% 0,0%
Marketable debt securities & similar 1.041 0,4% 0,0%
Other financial assets 4.167 1,5% 0,0%
Deferred tax assets 6.259 2,2%
Other assets 911 0,3% 1.462 8,1%
Total non-current assets 170.473 59,7% 14.514 80,7%
Other current assets 7.291 2,6% 226 1,3%
Inventories 26.444 9,3% 1.284 7,1%
Trade/account receivables 10.649 3,7% 1.537 8,5%
Cash & cash equivalents 23.048 8,1% 435 2,4%
Total current assets 115.264 40,3% 3.482 19,3%
Total Assets 285.737 285737 17.996 17996
Interesting to take a step back and look at the proportion, looking specifically at the big numbers to get a first feeling about
the company. Remember that one angle is not enough (cf. analysis of long-term debt schedule for MBG vs K)

Candi Carrera
Materiality-Assets
Mercedes Mercedes (in %) Kelloggs Kelloggs (in %)
Intangible assets 16.399 5,7% 2.491 13,8%
Property, plant & equipment 35.246 12,3% 3.713 20,6%
Equipment on operating leases 47.552 16,6% 658 3,7%
Equity-method investments 5.189 1,8% 391 2,2%
Goodwill 0 0,0% 5.799 32,2%
Other financial assets 4.167 1,5% 0,0%
Deferred tax assets 6.259 2,2%
Other assets 911 0,3% 1.462 8,1%
Total non-current assets 170.473 59,7% 14.514 80,7%
Other current assets 7.291 2,6% 226 1,3%
Inventories 26.444 9,3% 1.284 7,1%
Trade/account receivables 10.649 3,7% 1.537 8,5%
Cash & cash equivalents 23.048 8,1% 435 2,4%
Total current assets 115.264 40,3% 3.482 19,3%
Total Assets 285.737 285737 17.996 17996
Interesting to take a step back and look at the proportion, looking specifically at the big numbers to get a first feeling about
the company. Remember that one angle is not enough (cf. analysis of long-term debt schedule for MBG vs K)
A couple of first reading keys to read if I would be analysing :
1) MBG has around 10% of cash & cash equivalents vs around 2,5% for K
2) MBG has a big portion of financial services receivables 32% if you add short-term & long-term – they are providing
financing/prefinancing to customers which carries intrinsic risks
3) PP&E is higher in terms of ownership for K vs MBG
4) 1 out of 7 dollars in K is linked to intangible assets
1
2
2
4
3

Candi Carrera
• Federal securities laws / Security and Exchange
Commission (SEC)
• mandate publicly-traded companies to provide certain
information to shareholders & general public
• disclosures may occur periodically or as specific events occur
• In US requirements set by Regulation Fair Disclosure (Reg FD)
of 2000 by SEC
• Most important documents / forms to know for investors
• 10-K : contains much more detail than a company's annual
report and includes auditor’s opinion
• 10-Q : comprehensive report of a company's performance to be
submitted quarterly/ The 10-Q is generally an unaudited
report.
• 8-K : report of unscheduled material events or corporate
changes at a company that could be of importance to the
shareholders or the Securities and Exchange Commission
(SEC)
• 3, 4 & 5 forms
• SEC defines corporate insider any beneficial owner of more than 10 percent of a class of
the company's equity securities
• Form 3 is initial filing and discloses ownership amounts
• Form 4 identifies changes in ownership
• Form 5 is annual summary of Form 4 and includes any information that should have
been reported

Candi Carrera
& requires the faithful representation of the effects of transactions, other events and conditions
• Going concern
accounting
annually
• an entity shall present, as a minimum, two statements of financial position, two statements of profit or loss
and other comprehensive income, two separate statements of profit or loss (if presented), two statements
of cash flows and two statements of changes in equity, and related notes
the next

Candi Carrera
1
2
3
Practicalwork

Candi Carrera
• Other general & by experience principles
• Sometimes documented in local financial regulations if not in IFRS & US GAAP
• Substance over form
• presentation of amounts recorded on the balance sheet & profit and loss account may refer to the
substance of operation or of recorded contract
• External auditors are required to attest that companies recognize all business transactions in
compliance with the substance over form concept
• Change in accounting policies
• Accounting policies shall not be modified from one accounting year to another
• Any change requires explanatory note detailing the reason for such changes & should explain impact
on financial situation and results
• Correction of errors
• corrections of errors are recorded in the year when discovered. In principle, they do not lead to the
modification of comparative figures. Appropriate disclosures must be included in the notes to the
annual accounts. (restatements ?)
• Prudence principle
• Somehow linked to fair representation but in some local financial regulations/transcriptions of IFRS,
prudence is explicitly mentioned
• Company shall not overestimate amount of revenues recognized or underestimate amount of
expenses
• Company shall be conservative in recording amount of assets, and not underestimate liabilities

Candi Carrera
• Other general & by experience principles
• Sometimes documented in local financial regulations if not in IFRS & US GAAP
• Substance over form
• presentation of amounts recorded on the balance sheet & profit and loss account may refer to the
substance of operation or of recorded contract
• External auditors are required to attest that companies recognize all business transactions in
compliance with the substance over form concept
• Change in accounting policies
• Accounting policies shall not be modified from one accounting year to another
• Any change requires explanatory note detailing the reason for such changes & should explain
impact on financial situation and results
• Correction of errors
• corrections of errors are recorded in the year when discovered. In principle, they do not lead to the
modification of comparative figures. Appropriate disclosures must be included in the notes to the
annual accounts. (restatements ?)
• Prudence principle
• Somehow linked to fair representation but in some local financial regulations/transcriptions of IFRS,
prudence is explicitly mentioned
• Company shall not overestimate amount of revenues recognized or underestimate amount of
expenses
• Company shall be conservative in recording amount of assets, and not underestimate liabilities

Candi Carrera
• Often driven by changes
in IFRS or US Gaap
standards

Candi Carrera
• Kraft engaged in accounting misconduct
from last quarter of 2015 to end of 2018
• recognizing unearned discounts from
suppliers hence improperly reducing the cost
of goods sold
• resulted in Kraft reporting inflated adjusted
EBITDA of equivalent 208 MUSD
• Required retroactive financial restatements
Financialrestatements
Source : www.sec.gov/news/press-release/2021-174
(1) Interesting to see jump in pretax income from 2015 to 2016.
Probably in 2018 they had to come out with the truth. Tendency
by companies to open floodgates at once with new
management.
(2) 208 MUSD over 3 fiscal years had a material effect of around 2%
on income hence improved EPS
2
1

Chapter 2
Mainelementsof
Corporate
Governance
linkedtofinancialstatements
CorporateLaw
Shareholders
BoardofDirectors
Auditors
for Investors

Candi Carrera
• Corporate law
• often referred to as company and/or company
formation law
• consider 5 basic legal characteristics of a business
corporation
• Legal personality
• Limited liability
• Transferable shares
• Delegated management under board structure
• Investor ownership
• principal function of corporate law is to provide
business enterprises with a legal form that possesses
five core attributes
• often covers launch, growth, maturity or decline of a
business (acquisitions, corporate finance, corporate
restructuring, insolvency, litigation, mergers)
Corporatelaw

Candi Carrera
• Legal personality of a company
• Premise that company is itself a person (moral/legal person vs
physical person) in the eyes of the law
• Company is connection for contracts
• Company serves as common counterparty in numerous contracts with
customers, suppliers & employees
• Most important contribution of corporate law
• permits a firm to serve as a single contracting party that is distinct from
various individuals owning or managing the firm
• Separate patrimony
• involves demarcation of assets distinct from other assets owned by
firm’s owners (the shareholders)
• firm’s rights of ownership over its designated assets include the rights
to use the assets, to sell them, and—of particular importance—to make
them available for attachment by its creditors.
Corporatelaw
Legal personality
Limited liability
Transferable shares
Delegated management
under board structure
Investor ownership

Candi Carrera
• United States
• Limited liability company (LLC, LC, Ltd., or Co.): form of business whose owners enjoy limited liability, but which
is not a corporation
• Corporation (Corp., Inc., or Incorporated): legal entity owned by shareholders and managed by directors and
officers, all of which enjoy limited liability. A corporation can be a public or private company
• India
• Private Limited Company: have 2–200 shareholders; shares held privately and cannot be offered to public. Have
limited liability and registration is mandatory
• Public Limited Company: have more than 200 shareholders. Can be listed or unlisted in share market
• One-person company: type of private company which can have only one director and member
• Unlimited Company – A company, similar to its limited company (Ltd, or Pvt Ltd) counterpart but liability of the
members or shareholders is not limited
• UK
• Private Limited Companies (Ltd or Limited)
• Private company limited by shares, liability is limited to amount, if any, unpaid on the shares held by them. Shares cannot be traded
publicly.
• Private company limited by guarantee. The liability is limited to such amount as the members undertake to contribute to the assets of
the company in the event of its being wound up.
• Public Limited Company (PLC): limited company whose shares may be traded publicly. Requires an authorized
minimum share capital of £50,000 of which it must have allotted shares to the value of at least £50,000 and a
minimum of 25% must be fully paid up prior to starting business
Mostknowntypesofcompanies
Source : en.wikipedia.org/wiki/List_of_legal_entity_types_by_country

Candi Carrera
• Entity shielding
• priority rule
• that grants to creditors of the firm, as security for the firm’s debts, a claim on the firm’s assets that
is prior to the claims of the personal creditors of the firm’s owners
• rule is shared by all modern legal forms for enterprise organization, including partnerships.
• liquidation protection
• provides that the individual owners of the corporation (the shareholders) cannot withdraw their
share of firm assets at will, thus forcing partial or complete liquidation of the firm
• Authority
• rules specifying to third parties who has authority to buy and sell assets in
the name of the firm and enter into contracts bonded by those assets
• board of directors as opposed to individual owners has power to bind firm
in contract
• Procedure
• rules specifying procedures by which both firm and its counterparties can
bring lawsuits on the contracts entered into
Corporatelaw
Legal personality
Limited liability
Transferable shares
Investor ownership
A lawsuit is a civil legal action by one person or entity (the
"plaintiff") against another person or entity (the
"defendant"), to be decided in a court.

Candi Carrera
• Corporate form imposes default term in contracts
between firm and its creditors
• creditors limited to making claims against assets owned by firm itself
• have no claim against assets firm’s shareholders hold in their own names
• Limited liability
• (strong) form of owner shielding
• effectively the opposite of entity shielding described earlier
• Asset partitioning
• entity shielding protects assets of the firm from creditors of the firm’s
owners
• limited liability protects assets of the firm’s owners from claims of
firm’s creditors
Corporatelaw
Legal personality
Limited liability
Transferable shares
Investor ownership

CASE STUDY
Example of asset partitioning
Legal personality
Limited liability
Transferable shares
Investor ownership

Candi Carrera
Assetpartitioning
Private
real estate
100% private
owner

Candi Carrera
Assetpartitioning
Private
real estate
Company A
Other shareholders
80%
100% private
owner

Candi Carrera
Assetpartitioning
Private
real estate
Company A
External creditor
2M claim on
company
assets
Company A
Other shareholders
80%
100% private
owner

Candi Carrera
Assetpartitioning
Private
real estate
Company A
External creditor
2M claim on
company
assets
Company A
Company A assets worth 1.5M
Private real estate of Karen is worth 1M
Claim on company assets is 2M
Other shareholders
80%
100% private
owner

Candi Carrera
Assetpartitioning
Private
real estate
Company A
External creditor
2M claim on
company
assets
Company A
Company A assets worth 1.5M
Private real estate of Karen is worth 1M
Claim on company assets is 2M
Other shareholders
80%
Residual claim of
0.5M on private
assets not
possible
100% private
owner
Shielding mechanism/Asset
partitioning

Candi Carrera
• Share
• indivisible unit of capital, expressing ownership relationship between
company and person or legal entity holding & owning shares
• Share capital refers to all shares of corporation
• Shareholder
• registered by corporation as legal owner of part of capital of
corporation
• referred to as stockholder or equity holder
Transferableshares
Legal personality
Limited liability
Transferable shares
Investor ownership

Candi Carrera
• 1st problem
• “If a company has shareholders, it has to keep a register of who
they are and how many shares they own. It's required by company
law”
• 2nd problem
• “Company needs to continue its business even if owners change”
Corporatelaw
Legal personality
Limited liability
Transferable shares
Investor ownership

Candi Carrera
• 1st problem
• “If a company has shareholders, it has to keep a register of who they are and how many
shares they own. It's required by company law”
• 2nd problem
• Need for shareholder registry & registrar (owner of registry)
• Insourcing allowed
• Outsourced to share registrars
• Institution responsible for tracking & keeping the records of bondholders and shareholders after the issuer provides
securities to the public
• when issuer makes interest payment on bond or dividend payment to shareholders, it refers to list of registered
owners looked after by registrar
Intermediates

Candi Carrera
Intermediates Secondary market
Stock
exchanges/
markets
Seller A
Corp Inc. Buyer B
Share of Corp
Inc.
Broker of
seller A
Broker of
buyer B
Custodian
A
Custodian
B
Clearing
house
Registrar
CSD
• 3rd party registrar example
• Computershare (ASX:CPU) - founded in Melbourne in 1978 and grown since into the world's foremost transfer
agent and registrar

Candi Carrera
• 1st problem
• “If a company has shareholders, it has to keep a register of who they are and how many shares they own. It's
required by company law”
• 2nd problem
• Implies legal transferability of shares in ownership
• basic characteristic of business corporations
• permits firm to conduct business uninterruptedly as identity of owners fluctuates
• different in partnerships, cooperatives and mutuals
• Transferable shares
• do not necessarily mean freely tradable shares without restriction in public markets but just transferable among limited
groups of individuals or with approval of current shareholders or of the corporation
• Terminology
• corporations with freely tradable shares called public corporations
• shares of open corporations may be listed for trading on an organized securities exchange (NYSE, Euronext, LSE, …) making firm a
‘listed’ or ‘publicly-traded’ corporation
• corporations that have restrictions on the tradability of their shares called ‘closed’ or ‘private’ corporations
• Also called ‘unlisted’ corporations
Corporatelaw
Legal personality
Limited liability
Transferable shares
Investor ownership

Candi Carrera
• Example of
transferability clauses
• founder / external investor setup

QUESTION
Give example of public & private
corporation
Legal personality
Limited liability
Transferable shares
Investor ownership

Candi Carrera
• Public
Examples
• Private

Candi Carrera
Consolidation

Candi Carrera
Practicalwork
Fully
consolidated
100% owned
Equity
20-50% owned
Cost
<20% owned
Consolidated
with non-
controlling
interests
>50% owned
4-consolidation methods

Candi Carrera
• Consolidated method (>50%)
• typically 50% or more ownership (aka controlling interest) in another company usually defines it as “subsidiary” and
gives parent company opportunity to include in consolidated financial statements
• Consolidation of below 50% ownership may be allowed if parent company shows that subsidiary’s management is
heavily in control of decision making processes of parent company & management appointment + board of directors
representation
• non-controlling interest appear in balance sheet & income statement for remaining shareholders not part of parent
company
• Equity method (20-50%)
• If company has ownership in subsidiaries but excludes subsidiary in consolidated financial statement reporting it will
usually account subsidiary ownership using equity method or cost method
• With equity method, parent company reports revenue earned by subsidiary on its income statement proportional to
percentage of its equity investment
• When appropriate to use equity method of accounting, investee is often referred to as “associate” or “affiliate” and
not subsidiary
• Cost method (<20%)
• records investment at historical cost or purchase price on parent’s consolidated balance sheet
Consolidatedvsnon-consolidated

Candi Carrera
• CONSOLIDATED method (>50%)
• typically 50% or more ownership (aka controlling interest) in another company usually defines it as “subsidiary” and gives parent
company opportunity to include in consolidated financial statements
• Consolidation of below 50% ownership may be allowed if parent company shows that subsidiary’s management is heavily in
control of decision making processes of parent company & management appointment + board of directors representation
• non-controlling interest appear in balance sheet & income statement for remaining shareholders not part of parent company to
avoid overstatement of equity & earnings to shareholders
If company has ownership in subsidiaries but excludes subsidiary in consolidated financial
statement reporting it will usually account subsidiary ownership using equity method
or cost method
• EQUITY method (20-50%)
• With equity method, parent company reports revenue earned by subsidiary on its income statement proportional to percentage
of its equity investment
• When appropriate to use equity method of accounting, investee is often referred to as “associate” or “affiliate” and not
subsidiary
• COST method (<20%)
• records investment at historical cost or purchase price on parent’s consolidated balance sheet only
Consolidatedvsnon-consolidated

Candi Carrera
Practicalwork
1
1
2

Candi Carrera
Practicalwork
1
2

Candi Carrera
Practicalwork
1
2
All consolidated are
controlling interests
subsidiaries (>50%)

Candi Carrera
Practicalwork
1
Chinese joint-venture at 50% ownership linked to
Chinese gov policies

Candi Carrera
• Consolidated definition in Account policies –
Note 1
Practicalwork
Consolidation table of Kelloggs feels less precise
compared to Mercedes. Does not necessarily mean
that Kelloggs tries to hide something.

Candi Carrera
BerkshireHathaway
Source : www.berkshirehathaway.com/qtrly/3rdqtr21.pdf
Non consolidated investments at fair valuation
(cost method)
Consolidated assets >50% ownership
1
2
2

Candi Carrera
BerkshireHathaway
1

Candi Carrera
BerkshireHathaway

Candi Carrera
Exemptionstoconsolidation
Unconsolidated entities with high ownership
make me nervous !!!

Candi Carrera
Practicalwork
• Enron's financial statements have NOT accurately reflected
underlying economic substance of its activities
• particularly with respect to consolidation of the Special Purpose
Entities(SPEs)
• In particular, it raises questions regarding
• oversight responsibilities of Enron's board of directors
• financial advisers that assisted the company in structuring its SPEs
• banks and other lenders that provided "off balance sheet" financing
• brokers, analysts and other investment advisers that ignored the
warning signs of trouble apparent in Enron's financial reports
2
2

Candi Carrera
Practicalwork
• Enron's financial statements have NOT accurately reflected
underlying economic substance of its activities
• particularly with respect to consolidation of the Special Purpose
Entities(SPEs)
• In particular, it raises questions regarding
• oversight responsibilities of Enron's board of directors
• financial advisers that assisted the company in structuring its SPEs
• banks and other lenders that provided "off balance sheet" financing
• brokers, analysts and other investment advisers that ignored the
warning signs of trouble apparent in Enron's financial reports

Candi Carrera
1. Take your preferred company and
download latest annual report
2. Find in report
1. Type of legal personality
2. jurisdiction of incorporation
3. Scope of consolidation
Assignment2.1

Candi Carrera
Share
Unit of equal parts into which company's
capital/equity is divided entitling the holder to
certain amount of rights

Candi Carrera
• two key elements in ownership of a firm
• right to control firm which generally involves voting in election of directors and voting to
approve major transactions
• right to receive firm’s net earnings / profits
• Power is typically proportional to amount of capital
contributed to the firm
• Other possibilities for shareholders
• Various classes of shares
• Typically class A/B shares with B with fewer or limited voting rights compared to Class A shares
• convertible debentures
• bond giving holder the option to convert into underlying equity instrument (e.g. predetermined price, timing, …)
• In case of liquidation, higher priority to extract residual liquidation value vs pure equity shareholdership
Corporatelaw

Candi Carrera
How much
shares ?
How much
control ?
What classes
of shares ?
How much
per share ?

Candi Carrera
• Articles of constitution/incorporation
• Typically include company's name, type of corporate
structure & classes and number of shares
• most shareholders consider that articles as default
scenario not satisfactory
• Minority shareholders not willing to subject themselves entirely to will
of majority shareholder
• Majority shareholder willing to compel minority shareholder to certain
actions
Shareholderagreement&termsheet
Articles of
constitution/
incorporation
Public

1 - TheArtofReadingFinancialStatements-Level1-v1.pdf

1 - TheArtofReadingFinancialStatements-Level1-v1.pdf

Recommended

Recommended

More Related Content

Similar to 1 - TheArtofReadingFinancialStatements-Level1-v1.pdf

Similar to 1 - TheArtofReadingFinancialStatements-Level1-v1.pdf (20)

Recently uploaded

Recently uploaded (20)

1 - TheArtofReadingFinancialStatements-Level1-v1.pdf