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Financial Reporting Theory Week 6 Presentation
Dennis Chow
Ivan Chan
Rita Lam
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All new disclosure should appear in the Management Discussion &
Analysis Statement
Mandatory? All?
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What is a Management Discussion and Analysis Statement (MD&A)?
Purpose:
• information relevant to an assessment of the financial condition
• results of operations of the company
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Scope of Disclosures in MD&A
Relevant
Reliable
Material
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• “those matters which there is substantial likelihood that a reasonable investor would attach importance in determining whether to buy or sell the securities registered”
• Certainty -- Determined by MGT or evaluated objectively for the consequences
Material defined by SEC:
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Talking with CEOs
• Mr Richard Li• Chief Executive Offic
er of
Pacific Century CyberWorks Limited
(PCCW)
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• Mr Steven A. Ballmer • Chief Executive Offic
er of Microsoft Incorporation
Talking with CEOs
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Present Application of MD&A
In Hong Kong,
• Reference for Disclosures in Annual Report of Hong Kong Exchange and Clearing Ltd
– may disclose (Not restricted) e.g.:• description of the business done and
intended to be done • general development of last 5 years • Corporate government practice
Voluntary !!!
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In United States,• SEC Regulation S-K – Required three aspects for disclosure:
Basic Information Covered:i) Liquidityii) Capital Resourcesiii) Results of Operation
Present Application of MD&A
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Our Standpoint
Oppose Voluntary disclosure Oppose Voluntary disclosure besides basic requirements in besides basic requirements in
MD&AMD&A
I) Redundancy
II) Expose the virtues and evade from the bad
III) Cost & Benefit
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Basic thinking process:
I. Redundancy in MD&A
Receiving Information
Interpretation Judgment
Digest & Understand
Reading Annual Report
Predict the performance of the company
Quantity of Information
---will affect “decision-making effectiveness”
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The reason of mentioning the process of thinking, as we have found:
• Decision-making effectiveness of readers has decreased by redundant disclosed information in MD & A.
Let’s see example: MD & A of Giordano Ltd
I. Redundancy in MD&A (cont’d)
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I. Redundancy in MD&A (cont’d)
5. Geographical Classification
6. Divisional Classification
P/L
CF statement
1. Turnover of the company 2. Gross Margin3. Distribution and Administrative Cost
4. Cash Flow
8. Liquidity and Capital Resources
9. Human Resources
7. Outlook
Notes to Account
Meet the required content in MD & A
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I. Redundancy in MD&A (cont’d)
5. Geographical Classification
6. Divisional Classification
P/L
CF statement
1. Turnover of the company 2. Gross Margin3. Distribution and Administrative Cost
4. Cash Flow
8. Liquidity and Capital Resources
9. Human Resources
7. Outlook
Notes to Account
Meet the required content in MD & A
Conclude:
If we add too much voluntary disclosure information to MD & A, it will cause information repetitions and redundancy.
decrease understandability of MD & A
decrease decision-making effectiveness
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• Chairman of Ernst & Young,US, NJ.Groves conducted a survey in 1994
• Try to quantify the excessive disclosures in annual report.
I. Redundancy in MD&A (cont’d)
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I. Redundancy in MD&A (cont’d)
Collect & measure the total no of pages -- annual report, footnotes, MD&A of 25 companies in USA.e.g. AT&T, Coca-Cola, IBM, etc
reflect the increasing redundancy problem
Increasing total no of pages
Basic assumption:
• Not all information disclosed is useful.
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I. Redundancy in MD&A (cont’d)
Collect & measure the total no of pages -- annual report, footnotes, MD&A of 25 companies in USA.e.g. AT&T, Coca-Cola, IBM, etc
reflect the increasing redundancy problem
Increasing total no of pages
Basic assumption:
• Not all information disclosed is useful.
Conclusion:
The redundancy problem in MD & A become serious as the new disclosure increase from year to year
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II. Expose the virtues and evade from the bad
• Focus of MD&A– focus specifically on MATERIAL events and
uncertainties known to management – would cause reported financial information not
to be necessarily indicative of future operating results or of future financial condition
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• Focus : material
• However: “Material” is left to the judgment of company management
1. Agency Theory
2. Need not to be audited
3. Company interest to divert investors’ attention
Expose the virtues and evade from the bad
II. Expose the virtues and evade from the bad
(cont’d)
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1. Agency TheoryJohn K. Courtis (1996) “Agency theory posits that management would
be motivated to disclose items of information which have the potential to show the company and its management in a certain light”
E.g. Repeat the profits made
II. Expose the virtues and evade from the bad
(cont’d)
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2. Credibility of Un-audited Information
• something about forecast
• judgment by management
• arbitrary disclosure may mislead users
• tend to disclose positive price-sensitive information
II. Expose the virtues and evade from the bad
(cont’d)
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3. Diversion of Attention from Important Matters
Product-line Profit(loss) Prospect
Ladies 50M 100M
“…The Company has an outstanding performance in Ladies’ cloth, it is expected that our business have a good prospect…
II. Expose the virtues and evade from the bad
(cont’d)
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• Diversion of Attention from Important Matters
Product-line Profit(loss) Prospect
Ladies 50M 100M
Men (30M) -
Child (50M) -
Total (30M) -
II. Expose the virtues and evade from the bad
(cont’d)
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• Handsome• Strong Body• Good Temper• U-grade• 2M salary per year• Own 2 flats and 1 car• Tender to you
• Such an all-rounded man
• Excellent qualification
Be my valentine
I DO
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I Should have done an
AUDIT on your marital
status
Conclusion: Let’s Back to Basic
Too many unnecessary information are meaningless
“Oppose Voluntary disclosure besides basic requirement”
ProfileName: D. ChowAge: 25Sex: MMarital Status:
MARRIED
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III. Cost & Benefit
Every Information is Money!!!!
Company’s burden increase
Information disclose increaseManagement spent
time
Admin cost
increase
Reasons: 1. Time spent on sorting information
--Directors spent a lot of time to discuss which info should be disclosed
2. Administration cost will be increased
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III. Cost & Benefit (cont’d)But the benefit generated from the increased disclosed info in MD & A is not so great as you think!!!!
In Boeing’s MD&A
--- technical terms---describe the production process in the Research & Development --- Model of the military(e.g F/A-18 Super Honet, F-22 Raptor, AH-64 Apche, V-22 Osprey)
Example:
Boeing --- military aerospace products (e.g helicopters, tanks) manufacturers in US
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III. Cost & Benefit (cont’d)But the benefit generated from the increased disclosed info in MD & A is not so great as you think!!!!
In Boeing’s MD&A
--- technical terms---describe the production process in the Research & Development --- Model of the military(e.g F/A-18 Super Honet, F-22 Raptor, AH-64 Apche, V-22 Osprey)
Example:
Boeing --- military aerospace products (e.g helicopters, tanks) manufacturers in USthe increased disclosed information
cannot help investors to predict the performance of the company!!!!!!!
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Conclusion• MD&A is good• But be precise• Avoid redundancy• Avoid expose the virtues and evade from the
bad• Avoid Cost over Benefit
Provide information relevant to the assessment for the financial condition and results of operation, and stick to the basic requirement
don’t disclose all
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~ The End ~Thank you ^_^