Chapter 2: Accessing and Understanding Financial
Reports
The SEC’s Final Rule on “Interactive Data to Improve Financial
Reporting” has revolutionized the accessibility of financial
reports. In 2009,
the SEC issued this ruling:
“We
are adopting rules requiring companies to provide financial
statement information in a form that is intended to improve its
usefulness to investors. In this format, financial statement
information could be downloaded directly into spreadsheets,
analyzed in a variety of ways using commercial off-the-shelf
software, and used within investment models…” (Securities Act
Release No. 9002, 2009)
Figure 1 summarizes the regulatory structure for financial
reporting:
.
Figure 1:
Regulatory Structure for Financial Reporting
Financial Statements give a detailed summary of a firm’s
transactions over a specific period of time (typically a year,
quarter or half-year).
These statements provide important information about a
wide range of business decisions and therefore serve as a major
source of public and investor confidence in the financial
markets. Their
importance was formally recognized when the US financial markets
suffered a massive loss of investor confidence after the crash
of 1929. The US
Congress enacted two major Securities Acts in 1934 and 1935.
These were designed to restore public and investor
confidence by regulating Financial Statements and the standards
to which they must conform.
This legislation created the Securities and Exchange
Commission (SEC) and provided the SEC with the ultimate
authority over the accounting rules that govern public companies
when preparing their financial statements.
In 1935, the SEC created the Office of the Chief Accountant and
in 1938-1939 the SEC voted to let the private sector take the
lead in establishing Generally Accepted Accounting Principles
(GAAP). In
particular, the SEC let the American Institute of Accountants'
(AIA) Committee on Accounting Procedure (CAP) provide
substantial support to the SEC in relation to accounting
standards. The SEC
could not delegate its authority but it could look to the
private sector for leadership in developing standards.
This informal arrangement persisted for decades and was
only formalized under the Sarbanes-Oxley Act 2002, which permits
the SEC to recognize a private sector body for setting
accounting standards and provide public funding for it.
Management is responsible for preparing the financial statements
and having appropriate internal controls in place.
The independent auditor, hired by management, attests to
the fairness of the presentation and their conformity with the
Generally Accepted Accounting Standards (GAAP).
The Sarbanes-Oxley Act 2002 requires that corporate
executives certify to investors that their internal financial
controls are effective and the auditor also attests to this.
Combined, the regulation creates a system that controls
the financial disclosure process that results in all US publicly
held companies filing a Form 10-K annually with the SEC that
contains the audited financial statements.
Other major filings mandated by the SEC for publicly held
companies are the quarterly unaudited 10-Q forms containing
quarterly financial statements, and 8-K forms required to notify
shareholders of any material events.
Today this formalization of the financial reporting process has
been elevated to new heights with the SEC’s requirement for
Interactive Data Reporting.
This takes the disclosures of a firm to new levels and
has provided a blueprint globally for financial reporting.
We first introduce what Interactive Data Reporting is and
how you can work with this system using Valuation Tutor.
This is followed by a quick overview of financial
reporting requirements and the major statements needed for
financial analysis.
The appendix has a detailed explanation of the items in each of
the major statements as well as a description of the linkages
between the statements.