Excessive pressure on management, such as unrealistic profit or other performance goals, can also lead to fraudulent financial reporting. The legal requirements for a publicly traded company when it comes to financial reporting are, not surprisingly, much more rigorous than for privately held firms. And they became even more rigorous in with the passage of the Sarbanes-Oxley Act.
This legislation was passed in the wake of the stunning bankruptcy filing in by Enron, and subsequent revelations about fraudulent accounting practices within the company. Enron was only the first in a string of high-profile bankruptcies. Serious allegations of accounting fraud followed and extended beyond the bankrupt firms to their accounting firms.
The legislature acted quickly to fortify financial reporting requirements and stem the decline in confidence that resulted from the wave of bankruptcies. Without confidence in the financial reports of publicly traded firms, no stock exchange can exist for long.
The Sarbanes-Oxley Act is a complex law that imposes heavy reporting requirements on all publicly traded companies. Meeting the requirements of this law has increased the workload of auditing firms.
In particular, Section of the Sarbanes-Oxley Act requires that a company's financial statements and annual report include an official write-up by management about the effectiveness of the company's internal controls. This section also requires that outside auditors attest to management's report on internal controls.
An external audit is required in order to attest to the management report. Private companies are not covered by the Sarbanes-Oxley Act. However, analysts suggest that even private firms should be aware of the law as it has influenced accounting practices and business expectations generally.
The preparation and presentation of a company's financial statements are the responsibility of the management of the company. Published financial statements may be audited by an independent certified public accountant. In the case of publicly traded firms, an audit is required by law. For private firms it is not, although banks and other lenders often require such an independent check as a part of lending agreements.
During an audit, the auditor conducts an examination of the accounting system, records, internal controls, and financial statements in accordance with generally accepted auditing standards. The auditor then expresses an opinion concerning the fairness of the financial statements in conformity with generally accepted accounting principles.
Four standard opinions are possible:. The financial statements are the responsibility of the company's management; the audit was conducted according to generally accepted auditing standards; the audit was planned and performed to obtain reasonable assurance that the statements are free of material misstatements, and the audit provided a reasonable basis for an expression of an opinion concerning the fair presentation of the audit.
The audit report is then signed by the auditor and a principal of the firm and dated. May-June Kwok, Benny K. Accounting Irregularities in Financial Statements. Gower Publishing, Ltd. Taulli, Tom. Ross Publishing, Taylor, Peter. Top Stories. Top Videos. Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.
This number tells you the amount of money the company spent to produce the goods or services it sold during the accounting period. The next section deals with operating expenses. Marketing expenses are another example. Depreciation is also deducted from gross profit. Depreciation takes into account the wear and tear on some assets, such as machinery, tools and furniture, which are used over the long term. Companies spread the cost of these assets over the periods they are used.
This process of spreading these costs is called depreciation or amortization. After all operating expenses are deducted from gross profit, you arrive at operating profit before interest and income tax expenses. Next companies must account for interest income and interest expense.
Interest income is the money companies make from keeping their cash in interest-bearing savings accounts, money market funds and the like. On the other hand, interest expense is the money companies paid in interest for money they borrow. Some income statements show interest income and interest expense separately. Some income statements combine the two numbers. The interest income and expense are then added or subtracted from the operating profits to arrive at operating profit before income tax.
Finally, income tax is deducted and you arrive at the bottom line: net profit or net losses. Net profit is also called net income or net earnings. This tells you how much the company actually earned or lost during the accounting period. Did the company make a profit or did it lose money? Most income statements include a calculation of earnings per share or EPS.
This calculation tells you how much money shareholders would receive for each share of stock they own if the company distributed all of its net income for the period.
To calculate EPS, you take the total net income and divide it by the number of outstanding shares of the company. This is important because a company needs to have enough cash on hand to pay its expenses and purchase assets. While an income statement can tell you whether a company made a profit, a cash flow statement can tell you whether the company generated cash.
A cash flow statement shows changes over time rather than absolute dollar amounts at a point in time. The bottom line of the cash flow statement shows the net increase or decrease in cash for the period. Generally, cash flow statements are divided into three main parts. Each part reviews the cash flow from one of three types of activities: 1 operating activities; 2 investing activities; and 3 financing activities.
For most companies, this section of the cash flow statement reconciles the net income as shown on the income statement to the actual cash the company received from or used in its operating activities.
To do this, it adjusts net income for any non-cash items such as adding back depreciation expenses and adjusts for any cash that was used or provided by other operating assets and liabilities. Breaking News. In the proposal, the 10 elements of financial statements to be applied in developing standards for public and private companies and not-for-profits are: Assets; Liabilities; Equity net assets ; Revenues; Expenses; Gains; Losses; Investments by owners; Distributions to owners; and Comprehensive income.
The new chapter would: Clearly identify the right or obligation that gives rise to an asset or a liability. Eliminate terminology that makes the definitions of assets and liabilities difficult to understand and apply.
Clarify the distinction between liabilities and equity between revenues and gains and expenses and losses. I Accept Show Purposes. Your Money. Personal Finance. Your Practice. Popular Courses. Key Takeaways The information found on the financial statements of an organization is the foundation of corporate accounting. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear.
Investopedia does not include all offers available in the marketplace. Related Articles. Partner Links. Related Terms Financial Statement Analysis Financial statement analysis is the process of analyzing a company's financial statements for decision-making purposes. How the Indirect Method Works The indirect method uses changes in balance sheet accounts to modify the operating section of the cash flow statement from the accrual method to the cash method. Reading Financial Performance Financial performance measures how well a firm uses assets from operations and generates revenues.
Read how to analyze financial performance before investing. What Are Considered Business Activities? Business activities are activities a business engages in for profit-making purposes, such as operations, investing, and financing activities.
Comprehensive Income Definition Comprehensive income is the change in a company's net assets from non-owner sources.
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