Part 1
Financial reporting entails the production of financial statements which disclose the financial status of a company to the interested parties. Usually, financial reporting targets the external stakeholders, such as the shareholders, potential investors, customers, government employees among others. However, financial reporting is also used by the management of the organization to improve the corporate governance. Shareholders are extremely interested in the financial status of a company. The investors need to understand how the company is making an effort to maximize their wealth and create value from the resources they have injected into the company. Such information can only be provided by producing financial statements which capture this information. The most common financial statement utilized in the process of financial reporting include the statement of financial position also referred to as the Balance sheet, the statement of compressive income or simply the income statement, the statement of cash flows and the statement of changes in equity. The accompanying notes also form an integral part of the financial statements, and they have therefore become a crucial part of the financial reporting process.
Similarly, financial values have only become relevant, not sufficient when it comes to assessing the value created by an organization. Intangible and tangible assets all play a big role in the value creation process. For example, the identifiable assets of Nike Inc. grew from $8793.5 Million in 2005 to $ 9869.6 Million in 2006 (Pratt and Hirst 62). The shareholders can view this as value creation to the company. Reporting these values can, therefore, be essential in determining the extent to which the company using both the public and private resources to do so. Reporting the earnings per share is another essential way of reporting value creation to the shareholders. Earnings per share indicate the amount of profits attributable to each and very shareholders. As noted earlier, the shareholders are only interested in the returns that the company is giving them. EPS is, therefore, an important indicator of value creation. It can either be done through the reporting of basic or diluted earnings per share. For example, according to the consolidated statement of comprehensive income of Home Depot Inc. and subsidiaries , the basic earnings per share (EPS) has been increasing gradually from 2005 to 2007, from$ 2.27 in 2005, $2.73 in 2006 to $2.80 in 2007 (Pratt and Hirst 28). It is a good indicator to the shareholders that the management of the company has been doing value creation.
Part 2
The cases presented have shaped my understanding of financial reporting. For instance, the case “Exploring the Nile Inc. and Manchester United Plc. Financial Statements” presents a lot to learn from. Frist, the value created by a business from its operations will highly depend on the context in which the business is operating. Therefore, there will be different financing, operating and investing activities for different business depending on whether the firm is a service firm, merchandising firm, distributor among others. In this connection, therefore, one would expect Nike Inc. and Manchester United Plc. to report different operating, financing, and investing activities. In the Manchester United PLC consolidated profit and loss account, one will not expect to have sales of the kind of business does not allow such a business organization to sell anything. However, one expects Nike Inc. to record sales in its consolidated statement of financial position as sales is an integral part of the distribution business. True to this, Nike Inc. indicated $14, 954.9 million as revenues in 2006 (Pratt and Hirst 61). When doing financial reporting, we, therefore, need to establish a base of comparability as some investors may be interested in the returns posed by the two companies. Similarly, the two companies are acting in different lines of business and; hence, serving different markets. The effect of this is that the companies will be subjected to different market Betas, which in turn implies that the returns of the companies may be even harder to compare. The question posed to the accountants, and any member interested in the two companies would, therefore, be; how we can make the value creation between the two companies comparable? The earnings per share become the most secure place to turn to. The basic earnings per share will give a comparison between the return per share of the Nike Inc. and the corresponding return per share of Manchester United plc. Through this, the shareholders can now say that our counterparts in the other company were able to earn this much while we earned this much. The decision of potential investors, as well as the current shareholders, can, therefore, be more informed. One needs to remember that the main aim of financial reporting is to provide financial information to stakeholders with the sole aim of making informed decisions.
Unlike the past days when the shareholders were only interested in the financial figures and values in the financial statements, the issue of value creation has become an important factor among the shareholders. The shareholders are seeking to understand if their company is potentially able to do sustainable value creation both now, that is in the short term, in the medium and long term. If the company is not potentially able to do this, then the shareholders feel that the company is not in a position to maximize their wealth. Financial reporting has therefore undergone a paradigm shift in ensuring that it captures value creation measures in its financial statements. Value creation can only take place within the context of business transactions. Different companies will, therefore, create value through different ways depending on the different context of the business. Some assets owned by companies may be difficult to report as they may be hard to value. A good category of such assets is most of the intangible assets such as goodwill. In most instances, accountants will only be in a position to value goodwill during exchange transactions, which in case it doesn’t occur, it will only lie in the hands of the prudent accountant to subjectively determine it. For example, Manchester United PLC indicated that their intangible assets valued 78, 233 pounds in 2004 (Pratt and Hirst 65). It can only be determined subjectively according to the fair market value.
Similarly, the case "Home Depot Inc., Kingfisher Plc and Value Creation" also presents a lot that can be learned regarding financial reporting and value creation. The amount of profit indicated cannot explicitly show the amount of value directly attributable to the shareholders. Overtime, most shareholders have noted that accountants and managers of organizations tend to use figures to hide the real value of the business. It might be done by opting to use an accounting principle that overstates profits by underestimating the expenses and overestimating the revenues. In 2007, Kingfisher PLC indicated a profit of 338.4 million pence, with a basic EPS of 14.4 p. while in 2006, it reported a profit of 139.0 million pence with a basic EPS of 6.0p (Pratt and Hirst 30). It indicates that the profit figure may have little to offer regarding determining the exact value created by a company.
Work Cited
Pratt, Jamie, and D. Eric Hirst. Financial Reporting for Managers: A Value-Creation Perspective. New Jersey: John Wiley & Sons, 2009. Print
