Chapter 3: Financial Reports- Statement of Income, Comprehensive Income and Changes in Equity
Material Weaknesses Found in Financial Reporting Oversight
In 2014, Penn West Petroleum Ltd., a Calgary-based oil company, was tasked with restating more than two years of financial statements in response to an internal investigation that uncovered material weaknesses in its internal controls over financial reporting. The impact of the restatement was a reduction in cash flow by $145 million and an increase in its operating costs by $367 million–no small sums, to be sure!
The investigation was undertaken after the discovery of misclassifications in its accounting records regarding its capital spending, operating costs, and royalty payments. The investigation found that operating expenses were recorded to property, plant, and equipment, and significant amounts of operational expenses were reclassified to royalties' assets. The company claimed that these errors originated with some former employees who were no longer with the company. When news of the scandal reached investors' ears, fears escalated, resulting in large numbers of shares being sold off in the stock market. In the aftermath, investors launched $400 million in class-action lawsuits in Canada and the U.S., alleging that the company and some of its former top executives were negligent in not ensuring that adequate internal controls regarding financial reporting were in place.
It is unknown whether the misclassifications were due to management bias, intended to deceive, or if they were due to human error and poor judgment. Either way, the financials prior to restatement were making the company look better than it was.
Penn West implemented new internal controls to ensure that this never happens again. A key component of the change relates to its journal entries, to ensure any transactions that are to be capitalized (versus being expensed) are done so only after passing a strict oversight process.
(Source: Jones, 2014)
After completing this chapter, you should be able to:
- Describe the statement of income, the statement of comprehensive income, and the statement of changes in equity and their roles in accounting and business.
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Identify the factors that influence what is reported in the statement of income, statement of comprehensive income, and the statement of changes in equity.
- Explain the factors that influence the choice of accounting year-end.
- Explain how changes in accounting estimates, changes due to correction of accounting errors, and changes in accounting policy affect the income and equity statements.
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Identify the core financial statements and explain how they interconnect together.
- Explain the differences between IFRS and ASPE regarding the income and equity statements.
- Describe the various formats used for the statement of income and the statement of comprehensive income, and identify the various reporting requirements for companies following IFRS and ASPE.
- Describe the various formats used to report the changes in equity for IFRS and ASPE companies, and identify the reporting requirements.
- Identify and describe the techniques used to analyze income and equity statements.
Introduction
Financial reports are the final product of a company's accounting processes. These reports, combined with thoughtful analysis, are intended to "tell the story" about the company's operations, its financial performance for the reporting period, and its current financial state (resources and obligations) including its cash position for that period. Is it good news or bad news for management, investors, and creditors who are the company's stakeholders? Did the company meet its financial goals and objectives for the fiscal year? The answers depend not only on the outcome of the actual operations reported in the financial statements, but also on their accuracy and reliability, as the opening story about Penn West explained. As discussed in Chapter 2, financial statements consist of a set of core reports that identify the company's resources (assets), claims to those resources (liabilities and investor's equity), and information about the changes in these resources and claims (performance). A key activity after the financial statements are prepared is to accurately analyze and evaluate the company's performance and determine if it met its objectives for the reporting period. This chapter will discuss financial statements that report net income, comprehensive income, and changes in equity and their ability to tell the story about the company's performance for the reporting period.
Chapter Organization