CORPORATE REPORTING AND ANALYSIS

By
Dr. S.A.S. ARUWA1, CNA
____________________________________________________________________
Being a paper presented at ANAN Practitioners Forum
at Mainland Hotel, Lagos on 3rd August, 2010
____________________________________________________________________
Abstract
Good corporate reporting is generally an indication of competitiveness and superior
corporate governance. Good reports show initiative and effort on the part of the
preparers. Significant changes in the corporate external reporting environment have
led to proposals for fundamental changes in corporate reporting practices. A variety
of new information types are been demanded, in particular forward-looking, nonfinancial and soft information. Openness and transparency in annual reporting on an
unprecedented scale may be inevitable with the adoption of International Financial
Reporting Standards (IFRS) and Nigerias commitment to adopt IFRS; Nigerian
companies will have no alternative but to bring themselves up to speed. One way is
to ensure that companys reports actually reflect good governance.
INTRODUCTION
Good corporate reporting is generally an indication of competitiveness and superior
corporate governance. Good reports show initiative and effort on the part of the
preparers. The better reports always address all the required relevant information
concisely, and disclose thoroughly the measures taken including on activities,
corporate policy, strategic plans, the companys prospects and current initiatives to
protect the environment, (Pushpanathan, 2010:15).
In recent times the demand for financial disclosure of listed companies has
dramatically increased and the failures of large companies listed on the most
important stock exchanges have placed extra pressure on listed companies and
standard setters for the increase in the quality of corporate reporting.
Significant changes in the corporate external reporting environment have led to
proposals for fundamental changes in corporate reporting practices. Recent influential
reports by major organizations have suggested that a variety of new information types
be reported, in particular forward-looking, non-financial and soft information.
1

Dr. Aruwa is a Senior Lecturer and Head of Department of Accounting, Nasarawa State University, Keffi-Nigeria.

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It cannot be stressed enough that companies should be more open if they want to
improve. For example, significant related party disclosures involving holding
companies, subsidiaries, associated companies and joint ventures, as well as other
director-related transactions ought to be disclosed in a transparent manner in the
annual reports. The more relevant information it shares with its stakeholders, the
better a companys corporate governance is likely to be.
Openness and transparency in annual reporting on an unprecedented scale may be
inevitable with the adoption of International Financial Reporting Standards (IFRS) and
Nigerias commitment to adopt IFRS; Nigerian companies will have no alternative but
to bring themselves up to speed. One way, of course, is to ensure that companys
reports actually reflect good governance.
A recent study by the design agency Bostock & Pollitt (2006) found that companies
have two main reasons for producing an annual report. The first is to meet the
governments regulatory requirements. The second is to market the company to key
stakeholders. Corporate reports are viewed as follows:
It provides a balanced overview of our results and financial position at the end of
the year and satisfies all regulatory requirements.
It achieves the primary regulatory requirements. The second is to market the
company to key stakeholders.
It is a legal requirement but it also enables you to get your message out to key
stakeholders It forms a branding exercise also.
It achieves the primary regulatory purpose when signed off by the auditors and
regulators.
It achieves our statutory obligation for filing.
is to give stakeholders a view of business, what drives it, what affects it, how we
measure ourselves going forward.
It is a communications piece to stakeholders raising the key issues for the business
and addressing how management will address these issues going forward.

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Companies want to meet their legal requirements. They also want to communicate
with their key stakeholders. The law provides a framework within which companies
are free to find their own solutions.
When the corporate reporting agency Black Sun (2006) analyzed the FTSE-100 annual
reports published for the year ending December 2005, they found evidence of
significant change:
95% of companies discussed their corporate strategies, up from 75% a year
before
40% provided business objectives or targets, up from 16%
the percentage of firms discussing values and principles rose from 30% to 66%
the proportion disclosing Key Performance Indicators (KPIs) almost doubled
from 19% to 36%.
Many criticisms have been leveled against financial reporting. However, these
criticisms may simply be the symptoms of a financial reporting expectations gap,
comprising of the much discussed audit expectations gap as well as a financial
statements expectations gap. Only once the limitations of the financial statements
are recognized can the real debate regarding the corporate communication of
performance and risk begin.
Statement of Accounting Standards (SAS) 1 (Disclosure of Accounting Policies), SAS 2
(information to be disclosed in Financial Statements), SAS 10 and 15 (on Banks and
Non-Bank financial Institutions), and SAS 18 (on Statement of Cash flows) directly
provide guidance on the Information content of corporate reports in Nigeria.
The International Accounting Standards (IAS) 1 prescribes a complete set of financial
statements to include:
a) statement of financial position as at the end of the period;
b) an statement of comprehensive income for the period;
c) a statement of changes in equity for the period:
d) a statement of cash flows for the period;
e) notes, comprising a summary of significant accounting policies and other
explanatory information; and
f) when an entity applies an accounting policy retrospectively or makes a
retrospective restatement of items in its financial statements, or when it
reclassifies items in its financial statements, a statement of financial position as at
the beginning of the earliest comparative period.
SAS 2 prescribes that Financial Statements should include the following:
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a)
b)
c)
d)
e)
f)
g)

Statement of Accounting policies

Balance Sheet
Profit and Loss Account or Income Statement
Notes to the Accounts
Statement of Cash flows
Value Added Statement
Five year Financial Summary

This paper provides the knowledge, judgment and perspective necessary to be both
proficient and insightful at understanding, interpreting, and analyzing the information
contained in corporate financial statements and their accompanying nonfinancial
information.
TRANSFORMATIONS IN CORPORATE FINANCIAL REPORTING
Throughout its history, financial reporting has evolved continuously. As a service
activity, the practice of accounting responds to changes in the context in which it
operates. Changes in manufacturing industry brought about by the Industrial
Revolution (especially the rapid increase in the scale of business activity) were
responsible for much of the early development of financial accounting.
Related significant influences include the emergence of the corporate form (and
hence the divorce of ownership from control), the development of active markets for
shares, the formation of Professional Accounting associations, and the regulation of
accounting and auditing practices (Ryan, Scapens and Theobald, 1992). In recent
times, the professional bodies have sought to monitor the environment, identify key
changes, and develop strategies to accommodate these changes. Changes in
accounting practice are highly pragmatic, drawing upon academic research in a
selective manner.
However, the pace of change has not been uniform. It is possible that the
technological revolution may mark a further period of intense change in the course of
development of corporate reporting practices. The rapid developments in information
and communications technology, in particular, have led to the transformation of the
global infrastructure. We now have global capital markets, widespread electronic
commerce, and short-term strategic corporate alliances. Business is increasingly
flexible and consumer-driven, rather than producer-driven.
Allied to this there has, since the late 1980s, been a steep rise in the market value of
companies relative to the book value of their assets (i.e., the valuation ratio) (Higson,
1998). This appears to be due, in large part, to the growing importance of service and
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knowledge-based companies relative to traditional manufacturing companies. Soft

assets, in particular human capital and intellectual property, are critical to these
companies. In recent years, management practices have embraced the use of a
balanced scorecard, which recognizes that corporate value depends on a range of
critical success factors, with accounting measures lagging behind non-financial
performance indicators (Kaplan and Norton, 1996).
In relation to business information, there is no longer any significant technological or
cost constraint on the amount of information that can be disseminated. Moreover,
sophisticated, user-friendly software agents provide the user with effective decisionsupport facilities. The Internet provides an efficient means of electronic information
dissemination to external parties, potentially on a real-time basis.
Given these far-reaching changes in the general environment, business practices, and
business information technology, it is not surprising that the relevance of the
traditional corporate reporting model is being called into question. Five key features
of the traditional corporate reporting model are coming under attack. The arguments
being presented by critics are as follows.
First, the fundamental entity and going-concern assumptions upon which the current
reporting model is based are undermined by short-term strategic alliances. This is
because companies are no longer relatively stable groupings of the factors of
production. The term virtual organization is increasingly used to refer to such
transient organizations comprising soft assets.
Second, the periodic nature of current reporting sits uncomfortably with the real-time
nature of modern information flows. Third, the high degree of information
aggregation is no longer necessary or desirable, since large quantities of information
can now be conveyed cheaply and reliably. Moreover, sophisticated software agents
support search and analysis by users, thus reducing the problem of information
overload.
Fourth, the historical, backward-looking perspective of the traditional model is not
fully consistent with the manufacturing and commercial flexibility now required for
company survival and success. As the pace of change quickens, the past becomes a
less useful predictor of the future. This signals the need for more forward-looking,
strategic information. Finally, the traditional model, rooted in financial information,
is shown to be incomplete and partial when set against the broad range of financial
and non-financial performance measures now widely accepted as useful indicators of
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corporate success. Non-financial information relating to critical success factors such

as customers, employees, and products is needed.
As a consequence of this misfit between the traditional corporate reporting model
and the modern business world, various organizations around the world have begun to
examine the future of corporate external reporting. The two countries that have been
at the forefront of this debate are the US and the UK. The American Institute of
Certified Public Accountants (AICPA) (1994) report represents a significant point in the
development of this debate. Although not a turning point, this report marks the start
of the latest phase in the ongoing discussion.
One of the most influential documents worldwide has been the report of The Special
Committee on Financial Reporting set up by the American Institute of Certified Public
Accountants (AICPA, 1994), known as The Jenkins Report, and formally titled
Improving Business Reporting A Customer Focus. This report proposes a
comprehensive model of business reporting that includes a broader, integrated
range of information.
The principal information categories are: financial and non-financial data;
managements analysis of this data; forward looking information; information about
management and shareholders; and background company information. These five
broad categories encompass ten distinct elements shown as follows:
Information Categories Proposed by AICPA (1994)
1. Financial and non-financial data:
Financial statements and related disclosures
High level operating data and performance
management uses to manage the business

measurements

that

2. Managements analysis of financial and non-financial data

Reasons for changes in the financial, operating, and performance-related
data, and the identity and past effect of key trends.
3. Forward-looking information
Opportunities and risks, including those resulting from key trends
Managements plans, including critical success factors
Comparison of actual business performance to previously disclosed
opportunities, risks, and managements plans.
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4. Information about management and shareholders

Directors, management, compensation, major
transactions and relationships among related parties

shareholders,

and

5. Background about the company

Broad objectives and strategies
Scope and description of business and properties
Impact of industry structure on the company
Flexible auditor involvement with business reporting is recommended, whereby the
elements of information on which auditors report, and the level of auditor
involvement with those elements, are mutually agreed by the company and the users
of its business reporting. It is recognized that a different (lower) level of assurance
will be appropriate for some elements.
Wallman (1995) proposes a piecemeal, partial solution to the critical issues faced by
financial reporting, including additional reporting of soft assets and business risks and
on-line access to large sections of the companys management information system.
Subsequently, Wallman (1996) proposes an integrated, comprehensive solution to
these problems. This model, to be contrasted with the current black and white
model, defines a spectrum of disclosure based on the extent to which items meet
existing recognition criteria, i.e., whether an item: meets the definition of the
element; is measurable with reliability; and is relevant. The core would broadly
correspond to current financial statements. Information in the layers outside the core
would increasingly raise definitional, reliability and measurement concerns (e.g.,
regarding intellectual capital) and be subject to a lesser degree of attestation. To
fully exploit developments in information technology, Wallman (1997) proposes a
disaggregated, user-controlled access model.
The AICPA set up The Special Committee on Assurance Services (The Elliott
Committee) in 1994, with a final report appearing in late 1996 (AICPA, 1996). A new
concept of professional service was developed (assurance services) to serve as the
foundation for new opportunities for the accountancy profession. Assurance is defined
broadly as independent professional services that improve the quality of information,
or its context, for decision makers, a definition which embraces both the reliability
and relevance of information. Based on this definition, assurance services encompass,
but are not confined to, attestation services. Attestation services require the issuance
of a written report that expresses a conclusion about the reliability of a written
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assertion made by another party (SSAE No.1, AICPA, 1993). The level of service in
attestation engagements is currently limited to audit examination, review, and the
application of agreed-upon procedures. Thus, the traditional financial audit is but one
form of attest service which is, in turn, but one form of assurance service. All involve
independent verification.
Three of the six main new service opportunities identified by the committee concern
external corporate reporting. These are risk assessment, business performance
measurement, and information systems reliability. The Elliott Committees view was
that, while external users will eventually demand these new services, demand will
initially stem from the companys management.
The Financial Accounting Standards Board (FASB), the US standard-setting body, has
launched a sample business information reporting package on its website (FASB,
1998). This illustrates how a company might use the Internet to respond to the
information needs of investors and creditors as understood by the AICPA Special
Committee on Financial Reporting (The Jenkins Report). Entitled FauxCom, this fully
integrated web-based package has been specifically designed to exploit the search,
selection and analysis capabilities of modern technology. The package allows drilling
down to the desired level of detail and provides navigation buttons which allow the
user to jump between the financial statements, the related notes, five-year
summaries, and the Management Discussion and Analysis (MDA). Graphs are available
at the press of a button and information can be downloaded directly to Excel files.
The international accountancy firm Price Waterhouse (PW) proposes enhanced,
voluntary disclosure of future-oriented information covering both financial and nonfinancial performance measures. PW calls its proposed reporting model
ValueReporting, and offers an illustrative report (Blueprint Inc.) showing the possible
structure and content of corporate reporting in the future (Wright and Keegan, 1997).
The Chief Executive Officers letter includes an overview of the principal financial and
non-financial value drivers. Following this, there is a detailed quantification of
financial value drivers, customer value drivers, people value drivers, growth and
innovation
drivers,
and
process
value
drivers.
Subsequently,
as
PricewaterhouseCoopers (PwC), they published a series of surveys of preparers and
users in Western countries during 1997 and 1998 (Eccles and Kahn, 1998) that confirm
the existence of a wide information reporting gap.
In the UK, the Royal Society for Arts produced a report in 1995, entitled Tomorrows
Company (RSA, 1995), that has received considerable media attention. This inquiry
proposed a more inclusive, non-adversarial approach to both business practices and
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financial reporting, intended to support sustainable success. To achieve this, it is

argued that there would need to be relatively greater use of non-financial
performance measures.
In 1998, the RSA, under the auspices of the Centre for Tomorrows Company, issued
Sooner, Sharper, Simpler: A Lean Vision of an Inclusive Annual Report (RSA, 1998). This
proposes a largely narrative, core document, available on the Internet, for
stakeholders, supplemented by detailed reports covering financial, value chain,
people, and sustainability issues.
The Institute of Chartered Accountants in England and Wales (ICAEW) has published a
number of documents which address specific issues relating to the future of corporate
reporting. Most notably, the ICAEW has suggested a framework for the comprehensive
reporting of risk (ICAEW, 1997) and has considered the implications of digital
technology (ICAEW, 1998).
The users dissatisfaction with historical-cost financial information and their
consequent interest in alternatives have driven these changes. There are three
reasons why the profession should pay more attention to complaints about the
usefulness of traditional reports. These are:
i) the growing importance of assets and risks not measured by historical cost
accounts as determinants of a business future success;
ii) the growing reliance by some users on direct meetings with companies as an
information source, raising issues to do with equality of access; and
iii) changes in information technology (Swinson, 1998).
In 1999, The Institute of Chartered Accountants of Scotland (ICAS) published a
discussion document entitled Business Reporting: the Inevitable Change? (ICAS, 1999).
This presents a blueprint for business reporting based on detailed empirical research
into interested parties views about current financial reporting. Four key themes were
investigated, arising from exploratory interviews:
o
o
o
o

the cyclical nature of corporate communications and users decision-making;

the perception of differential user access to company information;
differing concerns regarding information overload; and
the need to create and maintain confidence in the company via the provision
of assurance relating to business information.

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From the above summary, it can be seen that the current re-examination of corporate
reporting embraces five distinct aspects:
i) the parties to whom the company has an obligation (including a reporting
obligation),
ii) the means of disseminating information,
iii) the content of the reporting package,
iv) the need for assurance services in relation to new information types, and
v) the need for regulatory reform.
Each of these aspects is considered, in turn, as follows.
The parties to whom the company has an obligation to report:
In the early 1970s, great attention was given to the objectives of financial
statements. It became generally accepted that the primary objective of financial
accounting should be to aid users in their decisions. In the UK, The Corporate Report
(ASSC, 1975) identified seven legitimate user groups, such as employees, customers
and suppliers. Despite this, investors are currently viewed as the defining class of
user (ASB, 1999, para.1.10).
The debate regarding the participant groups in whose interests a company should be
run is still ongoing. Currently there are two approaches being advocated, the
enlightened shareholder value approach, in which management run the company
with the exclusive objective of maximizing shareholder value, and the pluralist
approach, in which a wider range of interests is valid and has to be balanced. It is
the former approach that is currently enshrined in law and, hence, companies
reporting obligations do not extend to stakeholder groups other than shareholders. In
proposing an inclusive, non-adversarial approach both to business practices and
corporate reporting, the RSA is voicing support for the pluralist approach.
Means of disseminating information:
Wallman (1997), FASB (1998a), ICAEW (1998a,b), ICAS (1999), and the company law
review (DTI, 1999, ch.5.7) all address explicitly the impact of information and
communications technology on corporate reporting. The Internet is generally viewed
as the principal means of information dissemination in the future. This technology
allows anyone with a telephone line and a networked digital terminal to access any
database connected to the network and to download information for their own use.
The use of this technology has been growing exponentially over recent years, a trend
that is expected to continue. Commercial websites are increasingly being used as a
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reporting medium, with financial and other corporate information being included in
addition to promotional and sales material.
A recent study (Hussey and Sowinska, 1999) has shown that, in March 1998, 91 of the
FTSE 100 companies had a website, 63 of which included financial disclosures. Fiftyfour included detailed accounts, 45 included an interim statement, 17 included their
preliminary statement, 12 included a summary statement, and 26 included financial
highlights. Yet the Auditing Practices Board (APB) has confirmed that auditors do not
currently have any responsibility for financial information on the Web. The Board
acknowledges, however, that it would be possible for auditors to offer an opinion on
whether a company has controls in place to ensure reliable online information.
The Internet is also capable of supporting two-way communication, a feature that is
exploited in the ICAS (1999) proposals relating to on-line questioning of management.
This facilitates interaction between management and interested parties, thereby
enhancing corporate governance structures. ICAS (1999, p.74) suggests that the two
principal functions of the Annual General Meeting (the opportunity for questioning of
management by shareholders and voting) could be conducted more effectively via the
Internet.
Content of the business reporting package:
The above summary of key influential reports gives an indication of the broad range
of information types that have been suggested as part of the reporting package. It is
apparent that there is a degree of overlap between the suggestions, but a detailed
comparison is rendered extremely problematic due to terminological differences and
variations in both the scope covered and the level of detail provided. This sub-section
attempts to synthesise this material by providing a tentative framework for classifying
and describing information types.
AICPA (1994), RSA (1995), Wallman (1996), Price Waterhouse (1997), ICAEW (1999),
ICAS (1999), FPM (1999), and DTI (1999) all address explicitly, either in general or
specific terms, the content of the business reporting package. Their suggestions are
based either on a combination of casual observation and logical argument or, in a few
cases, on detailed empirical investigation. This reflects the two approaches that are
used in practice to determine the content and presentation of corporate reporting,
i.e., the normative approach (what users should know) and the empirical approach
(what users want to know).
In general terms, there is a call for more information. This is because advances in
information technology (in particular, sophisticated software agents) mean that large
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quantities of data can be searched and analyzed based on the users individual
specifications. More specifically, however, there is a call for information that is
forward-looking and/or non-financial in nature. This information may be quantitative
or qualitative and is intended to augment, and not replace, the existing set of largely
historical, financial information contained in the financial statements.
There are two main reasons for this shift in the nature of the reportable information
set. First, it is recognized that many non-financial performance indicators lead
financial performance indicators, hence providing more up-to-date information about
future prospects. This is important in a world where rapid change means that
companies must be adaptable in order to survive. Second, it can be argued that the
exclusive reliance on financial performance indicators, which appears to privilege the
interests of shareholders, is inconsistent with the pluralist approach to business. Nonfinancial performance indicators, for example employee turnover and average
delivery time, address the specific interests of these stakeholder groups directly.
Several of the reports share the concept of a business having key drivers of success
that must be identified and communicated. Unfortunately, the terms used vary. The
AICPA refers to critical success factors, Price Waterhouse (1997) refers to value
drivers, while ICAS (1999) refers to drivers of company performance. In the general
call for more forward-looking and non-financial information, it is possible to identify
four broad issues about which such information is considered desirable.
First, there is forward-looking information about strategy. Second, there is
information relating to risk. Third, the reports all tend to discuss (although at
different levels of detail) value drivers and related non-financial performance
measures (or performance indicators). The fourth and final area where additional
information is required is background information, principally about the business of
the company and the people who manage it.
The AICPA (1994) discusses risk only generally under the heading forward-looking
information. ICAS (1999) identifies a number of specific sources of risk, ranked in a
user survey in terms of their importance as drivers of company performance. Among
29 drivers, six risk-related drivers ranked highly as follows: vulnerability to
competition ranked second, customer and supplier dependencies ranked tenth, while
flexibility to technological change, vulnerability to exchange rate changes,
vulnerability to interest rate changes, and vulnerability to changes in government
policy all ranked between ten and twenty.

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The most detailed proposals in relation to risk are contained in ICAEW (1997). This
discussion paper proposes a separate statement of business risk that not only brings
together the current piecemeal disclosures required by various accounting standards
and guidelines (e.g., SSAP 18, FRS 13, and the Operating and Financial Review), but
radically augments them. This statement would identify and prioritize key risks,
describe the actions taken to manage each risk, and identify how each risk is
measured. The identification of key risks would be based on their likelihood and
significance, perhaps using a risk mapping technique. Importantly, all types of
business risk, rather than only financial risks, would be included. Thus, the statement
of business risk would encompass external, environmental risks as well as internal
risks, the latter of which could arise from operational, financial or other sources. A
variety of possible measurement methods is considered. In a follow-up report, the
ICAEW (1999b) rebut concerns regarding directors legal liability and commercial
sensitivity, noting that extensive risk disclosures are made in prospectuses. The need
for a separate statement of business risk is, however, played down.
Non-financial performance measures are frequently grouped into themes, with the
themes sometimes linked to the identified value drivers. For example, Price
Waterhouse (1997) identifies four non-financial value drivers, relating to customers,
people, growth and innovation, and process. RSA (1998) identifies three non-financial
themes as the basis for reports to supplement the core document: value chain,
people, and sustainability. FPM (1999) identifies four non-financial themes around
which to group performance measures: activity, development, environment, and
relations.
In each of these three examples, financial was an additional theme. Allowing for
terminological differences, a consensus does seem to emerge from this. Four distinct
themes
appear
to
exist
in
addition
to
the
financial
theme:
customer/relations/people;
growth
and
innovation/development;
sustainability/environment; and process/value chain/activity.
Finally, background about the company and information about management and
shareholders are two of the five broad categories of information proposed by the
AICPA (1994). ICAS (1999) identify, through empirical investigation, quality of
management as the top driver of company performance and, consequently,
recommend that detailed biographical information relating to the top management
team be disclosed (pp.76-77).
It is possible to describe information items based on their character and attributes. In
particular, within the literature it has become common to use the following three
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dichotomous descriptors: forward-looking versus historical; financial versus nonfinancial; and quantitative versus non-quantitative.
Assurance services:
Not surprisingly, fundamental changes in the business reporting package necessitate
changes to the way in which that information is audited. AICPA (1996) has a seminal
work relating to this changed set of practices. This report introduces the term
assurance services and provides a detailed examination of the issues. It is argued
that the traditional attest function provides reliability assurance, with direct
assurance on relevance representing a new field for the accountancy profession. Two
forms of reliability assurance are distinguished: data assurance which relates to
specific data items and system assurance which relates to the design and operation
of an information system. If the anticipated move away from point-in-time to realtime corporate reporting occurs, then system assurance will become of increasing
importance to users. Relevance assurances support the various stages of the users
decision-making process, from problem definition, through information search,
selection and analysis stages. Relevance services are more customized, targeted
services compared to the highly structured audit services.
Given the importance to users of information about risk and non-financial
performance measures in business reporting models, assurance service opportunities
relating to risk assessment and performance measures are clearly of direct relevance.
They are types of data assurance. Given the move towards allowing external users
access to large sections of the corporate database, potentially on a real-time basis,
assurances relating to information systems reliability are also of direct relevance.
ICAS (1999) identifies, based on its empirical research, confidence in business
information as one of four important themes relating to the corporate
communications process. It proposes a shift towards the assurance of processes in
addition to outputs and that multiple levels and forms of assurance be developed
(p.79). It suggests that assurance seals could be tagged either to individual
information items or to entire web pages, with electronic warnings at the gateways
between assurance levels (p.82).
It is, however, clear from the available literature that, although the general direction
and nature of future developments in assurance services in relation to business
reporting have been mapped out, detailed methods and procedures have yet to be
determined.
The need for regulatory reform:
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The regulations concerning corporate reporting emanate principally from Statement

of Accounting Standards (SAS) and other statues, with the Stock Exchange listing
requirements being a further consideration for listed companies. Currently, the
information contained in a companys annual report and accounts is a mixture of
mandated information (contained principally in the audited financial statements and
the directors report) and voluntary information. Indeed, over the years, the amount
of voluntary information (disclosed mainly in the unaudited sections of the annual
report) has been rising at a faster rate than the amount of mandated information
(Lee, 1994). The auditors responsibility with respect to other information in
documents containing audited financial statements is limited to a review for material
inconsistencies (APB, 1995).
The nature and scope of regulatory reform required to accommodate the proposed
changes in business reporting depend largely upon whether the changes are made
mandatory or not. If, for example, it becomes mandatory to provide information
relating to strategy, risk, non-financial performance indicators, and background, then
new financial reporting and assurance standards will clearly need to be developed.
However, to date, commentators who have discussed regulatory requirements have
proposed evolutionary, voluntary, user-driven change in the short-to-medium term
(e.g., ICAS, 1999, pp.82-84). It is likely that regulatory reforms will seek to
accommodate gradual change in business reporting, rather than mandate radical
change.
APPLICATION OF ANALYTICAL REVIEW PROCEDURES
The current demand for going-concern audit mandates that auditors conduct some
analysis of the corporate reports. The adversarial nature of financial reporting
provides opportunistic financial reporting practices. As opined by the Chairman of the
FASB, Beresford (1997), there is virtually no standardthat has been written that is
free from judgment in its application.
For instance GAAP permits alternatives (such as, LIFO versus FIFO for inventory
valuation), requires estimates for (for example, the useful life of depreciable assets),
and incorporates management judgments (are assets impaired?). Managers have a
degree of flexibility in choosing specific accounting techniques and reporting
procedures and the resulting financial statements are sometimes open to
interpretation.
The flexibility of GAAP financial reporting standards provides opportunities to use
accounting tricks that make the company seem less risky than it really is. For
instance, some real liabilities like equipment leases can be transformed into off15 | P a g e

balance sheet (and thus less visible) items. The company would appear from the
balance sheet data alone, to have less debt and more borrowing capacity than is
really the case. Bankers who fail to spot off-balance sheet liabilities of this sort can
underestimate the credit risk lurking in their loan portfolios.
Companies can also smooth reported earnings by strategically timing the recognitions
of revenues and expenses to dampen the normal ups and downs of business activity.
This strategy projects an image of a stable company that can easily service its debt,
even in severe business downturn.
According to SAS 10, Banks recognize their revenues when they are earned or
realized. The timing of classification of loans and advances as non-performing, so as
to put the related interest income in suspense, is a controversial issue. Whilst some
banks take such interest income on non-performing loans into interest suspense
account, others take it into interest income thereby overstating profits.
Managers have reasons to exploit this flexibility. Their interests may conflict with the
interests of shareholders, lenders, and others who rely on financial statement
information. There is therefore, the need to undertake further analysis of the
corporate reports. The Auditors rely on Analytical Review Procedures to assess the
corporate reports.
Analytical Review is the examination of ratios, trends, and changes in balances from
one period to the next, to obtain a broad understanding of the financial statements.
Analysts can broadly be defined as anyone who uses financial statements to make
decisions as part of their job. This includes investors, creditors, financial advisors,
and auditors. To perform good audits, we need more skills than forensic and general
accounting skills, tax planning, risk management, and securities analysis are all vital
competencies for auditors to possess.
Independent auditors carefully examine financial statements prepared by the
company prior to conducting an audit of those statements. An understanding of
managements reporting incentives coupled with detailed knowledge of reporting
rules enables auditors to recognize vulnerable areas where financial abuses are likely
to occur. Astute auditors choose audit procedures designed to ensure that major
improprieties can be detected.
Current Auditing Standards require independent auditors to use Analytical Review
Procedures (ARP) on each engagement. This can help auditors avoid the
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embarrassment and economic loss from accounting surprises, such as the one that
occurred in WorldCom.
Analytical Review Procedures are the tools auditors use to illuminate relationships
among the data. These procedures range from simple ratio and trend analysis to
complex statistical techniques. The auditors goal is to assess the general
reasonableness of the reported financial information in relation to the companys
activities, industry conditions, and business climate. Auditors look behind the numbers
when the reported figures seem unusual.
Three types of financial information are needed (AICPA, 1994):
1. Quarterly and annual financial statements along with nonfinancial operating
and performance data like order backlogs, customer retention rates, etc
2. Managements analysis of financial and nonfinancial data (including reasons for
changes) along with key trends and a discussion of the past effect on those
trends.
3. Information that makes it possible both to identify the future opportunities and
risks confronting each of the companys businesses and to evaluate
managements plans for the future.
The auditor should consider analytical review information that has already been
prepared by management. Examples include exhibits, charts, graphs and similar
analyses included in the companys internal management reports, board reports,
divisions or line of business statistics, and similar documents. The key is not to
calculate all the ratios possible, but to identify those few key relationships that best
satisfy the auditors objective of substantiating or corroborating the account balance.
When deciding whether to incorporate analytical review procedures into the audit
programme as substantive tests of balances, the auditor should consider the extent to
which the underlying data should be tested.
Analytical procedures means the analysis of significant relationships, ratios and
trends, including the resulting investigation of fluctuations or relationships that are
inconsistent with other relevant information or which deviate from predicted
amounts. Analytical procedures include the consideration of comparisons of the
entitys financial or non-financial information with, for example comparable
information for prior periods.;
Analytical procedures also include consideration of relationships among elements of
information that would be expected to conform to a predictable pattern based on the
entitys experience. Various methods may be used in performing the above
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procedures. These range from simple comparisons to complex analyses using advanced
statistical techniques. Analytical procedures may be applied to consolidated financial
reports, financial information of components (such as subsidiaries, divisions or
segments), individual elements of financial information and individual elements of
non-financial information. The auditors choice of procedures, methods and the level
of application is a matter of professional judgement.
Analytical procedures are used for the following purposes:
a) to assist the auditor in planning the nature, timing and extent of other audit
procedures;
b) as a substantive procedure when the use of analytical procedures can be more
effective or efficient than tests of detailed transactions or items in reducing
detection risk; and
c) as an overall review in the final stage of the audit.
Analytical procedures have become increasingly important to audit firms and are now
considered to be an integral part of the audit process. The importance of analytical
procedures is demonstrated by the fact that the Auditing Standards Board, the board
that establishes the standards for conducting financial statement audits, has required
that analytical procedures be performed during all audits of financial statements. The
Auditing Standards Board did so through the issuance of Statement on Auditing
Standards (SAS) No. 56 in 1988, which requires that analytical procedures be used by
auditors as they plan the audit and also in the final review of the financial
statements. In addition, SAS No. 56 encourages auditors to use analytical procedures
as one of the procedures they use to gather evidence related to account balances
(referred to in auditing as a substantive test).
SAS No. 56 describes analytical procedures as the "evaluation of financial information
made by a study of plausible relationships among both financial and nonfinancial
data" (AICPA, 1998, 56 p. 1). Accounting researchers have helped to clarify the
process that auditors use to perform analytical procedures by developing models that
describe the various stages of the process. One such model developed by Hirst and
Koonce (1996) describes the performance of analytical procedures as consisting of five
components:
a)
b)
c)
d)
e)

expectation development,
explanation generation,
information search and explanation evaluation,
decision making, and
documentation.

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Due to the importance of each of these five components to understanding the

analytical procedures process, each of them is described in more detail.
The first step in the analytical procedures process is the development of an expected
account balance. SAS No. 56 and O'Reilly et al. (1998) provide some guidance as to the
sources of information an auditor can use to develop these expectations. Examples of
such sources include the following:
i) Financial information from comparable prior periods adjusted for any changes
expected to affect the current-period balances. For example, an expectation
of sales revenues for the current year might be based on the prior year's sales,
adjusted for factors such as price increases or the known addition or loss of
major customers.
ii) Expected results based on budgets or forecasts prepared by the client or
projections of expected results prepared by the auditor from interim periods or
prior comparable periods.
iii) Available information from the company's industry. For example, changes in
sales revenue or gross margin percentages might be based on available data
from industry-wide statistics.
iv) Nonfinancial information. For example, sales revenue for a client from the
hotel industry might be based on available data as to room occupancy rates.
After an auditor has developed an expectation for a particular account balance (e.g.,
sales revenue), the next step in the analytical procedures process is to compare the
expected balance to the actual balance. If there is no significant difference (referred
to by auditors as a material difference) between the expected and actual balance,
this conclusion provides audit evidence in support of the account balance being
examined. However, if there is a material difference between the expected and
actual balance, the auditor will investigate this difference further.
At this point the auditor will develop an explanation for the difference. Hirst and
Koonce (1996) interviewed auditors from each of the six largest accounting firms and
found that the source of the explanation usually depends on what types of analytical
procedures are being performed. If analytical procedures are being performed during
the planning phase of the audit, the auditor usually asks the client the reason for the
unexpected difference. However, if the analytical procedures are being performed as
a substantive test (method of obtaining corroborating evidence) or during the final
review phase of the audit, in addition to asking the client, auditors will often
generate their own explanation or ask other members of the audit team for an
explanation.
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When developing an explanation for an unexpected change in account balances, an

auditor considers both error and nonerror explanations. Nonerror explanations are
sometimes referred to as environmental explanations, since they refer to changes in
the business environment in which the client operates. For example, an
environmental explanation for an unexpected decline in gross profit (sales revenue
less cost of sales) may be that the client faces increasing foreign competition and has
been forced to reduce selling prices. An error explanation, on the other hand, might
be that the client has failed to record a profitable sale to a major customer. If this
mistake is unintentional, then auditors refer to the mistake as an "error." However, if
this mistake was intentional (i.e., the client failed to record the sale on purpose),
auditors refer to the mistake as a "fraud." Auditors are much more concerned about
errors and fraud than changes resulting from environmental factors. In fact, auditors
are most concerned about fraud, since this raises doubts about the integrity of the
client as well as about the process of recording transactions affecting other account
balances.
Once an auditor has a potential explanation, whether self-generated or obtained from
the client, the next step in the analytical procedures process is to search for
information that can be used to evaluate the adequacy of the explanation. Similar to
the explanation generation phase of the process, the extent of information search and
explanation evaluation depends on the type of analytical procedures being
performed. Hirst and Koonce (1996) found that during the planning phase of analytical
procedures, auditors do little if any follow-up work to evaluate an explanation.
Instead, consistent with SAS No. 56, auditors typically use analytical procedures at
the planning stage to improve their understanding of the client's business and to
develop the audit plan for the engagement. For example, if analytical procedures
performed on inventory during audit planning indicated the inventory balance was
higher than expected, the auditor would most likely adjust the audit plan by
increasing the number of audit tests performed on inventory or assigning more
experienced personnel to the audit of inventory. Thus, if an error or fraud has
occurred with inventory, the revised audit plan for obtaining corroborating evidence
will lead to detection of the error or fraud.
If analytical procedures are being performed as a substantive test, the auditor will
need to gather information to evaluate the explanation being considered, since the
primary purpose of substantive analytical procedures is to provide evidence as to the
validity of an account balance. The type and amount of corroboration for the
explanation will vary based on factors such as the size of the unexpected difference,
the significance of the difference to the overall financial statements, and the risks
20 | P a g e

(e.g., internal control and inherent) associated with the account balance(s) affected.
As any of these factors increase, the reliability of the information obtained in support
of the explanation should also increase. SAS No. 56 provides guidance for auditors in
the evaluation of the reliability of data. Some of the factors to be considered by the
auditors include the following:
Data obtained from independent sources outside the entity are more reliable
than data obtained from sources within the entity.
ii) If data are obtained from within the entity, data obtained from sources
independent from the amount being audited are more reliable.
iii) Data developed under a system with adequate controls are more reliable than
data from a system with poor controls.
i)

After an auditor gathers information for purposes of evaluating an analytical

procedures explanation, it is a matter of professional judgment in determining
whether the evidence adequately supports the explanation. This is one of the most
important steps of the analytical procedures process and is referred to as the decision
phase of the process. Factors the auditor should consider in evaluating the
acceptability of an explanation include the materiality of the unexpected difference,
reliability of the evidence obtained to support the explanation, and whether the
explanation is sufficient to explain a material (significant) portion of the unexpected
difference. If, after evaluating the evidence, the auditor finds that the explanation
being considered does not adequately explain the unexpected difference, the auditor
should return to the "explanation generation" phase of the process. If the auditor
believes that the audit evidence obtained adequately supports the explanation, the
auditor may proceed to the final step of the process, which is "documentation." While
the extent of written documentation will vary depending on the materiality of the
unexpected difference, the audit work papers will generally include a written
description of material unexpected differences, an explanation for the difference,
evidence that corroborates the explanation, and the judgment of the auditor as to
the adequacy of the explanation.
Ratios commonly used for comparative analysis
Corporate report analysis could be undertaken to evaluate audit risks. It can provide
information on:
a) Earnings quality considerations/earnings sustainability
b) Cash flow
c) Balance sheet quality considerations/Balance Sheet measurements

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Horizontal and Vertical analysis can also be conducted to elicit information on trend.
The ratios commonly used for comparative analysis are presented below:
Ratio

Elements compared

Gearing or debt to equity ratio

Long term liabilities to equity

Current ration or working capital ratio Current assets to current liabilities

Liquid ratio, quick asset ratio, or acid Cash and
test
liabilities

accounts

receivable

to

current

Equity ratio

Total shareholders equity to total assets

Debt ratio

Total liabilities to total assets

Return on total assts

Operating profit to total assets

Return on shareholders equity

Operating profit to ordinary shareholders equity

Turnover of fixed assets

COGS to fixed assets (or sales)

Turnover of total assets

COGS to total assets (or sales)

Net profit ratio

Operating profit to net sales

Stock turnover

COGS to average stock (or sales)

Debtors turnover - average to collect

Debtors to net sales * no. of days in the period

Sales to total assets

Net sales to average total assets

Average days to sell stock

COGS to average stock (or sales)

Gross Profit ratio

Gross profit to net sales

COGS to sales

Operating expense ratio

Finance exp to net sales

Admin exp to net sales
Selling exp to net sales

Net profit ratio

Operating profit to net sales

CASE STUDY
ANALYSIS OF BANK USING PUBLISHED FINANCIAL STATEMENTS
1. Capital adequacy variables

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A bank should have adequate amount of capital to support the stability and
sustainability of its operations. There are three variables which describe what is
called a capital adequacy:
i)
Equity over Assets (E/A),
ii)
Equity over Earning Assets (E/EA), and
iii)
Equity over Loans (E/L).
It is preferable for a bank to have high amount of Equity, as a bank expands its
earning assets, it has to maintain Capital Adequacy Ratio ruled out by the Central
Bank.
Logically it seems more correct for us to consider E/EA instead of E/A because in fact
only earning assets, which directly generate earning, contains risks to be covered.
2. Growth and Aggressiveness variables
i)
Loans Growth Rate (LGR).
ii)
Loans Market Share Increment (LMSI).
iii)
Deposits Growth Rate (DGR).
iv)
Deposits Market Share Increment (DMSI).
The higher these four variables are the more aggressive the policy of a bank is.
However, it is not clear whether to be aggressive all the time is necessarily a good
strategy. We would rather share a point of view that this should remain a matter of
specific policy within specific circumstances of a bank.
3. Cost of fund as a credibility measurement of a bank
It is commonly accepted that one can use cost of fund to measure credibility of a
bank. If a bank pays relatively lower interest to funds received than other banks, it
means that the bank is perceived as a more secure and trustworthy than other banks.
4. Sources of income and funds diversification variables
Dependence on single type of income source and on single type of fund source may be
considered as not a good practice as this practice is relatively more viable to change
in market conditions. It should be considered good for a bank to be able to generate
fee-based income from activities like arranging syndicated loans, credit card
administration, trade finance administration, payment agent, or collection agent, as
they are relatively risk-less activities. Also, it should be considered good if a bank
does not depend solely on deposits and can diversify its source of funds, for instance,
by issuing marketable securities or receiving low-interest off-shore loans.
The two ratios are:
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i) Non-Interest Income over Operating Income (NonII/OI) ratio as a measure of

diversification in sources of income and
ii) Deposits over Third Party Funds (D/TPF) ratio as a measure of dependence on
deposits as a source of funds.
5. Liquidity variable
A bank should keep sufficient amount of its assets in liquid assets in case of hugely
and abruptly withdrawal of deposits. Liquid assets can be in the forms of cash in
vault, current account at other banks, current account at BI, or marketable
securities.
The LA/D variable measures the proportion of deposits which can be repaid promptly
if there is a run on that bank. Indeed, the higher this ratio the better bank is.
Empirical data demonstrates that the normal banks have the highest LA/D.
Others:
Loans over Deposits (L/D): The Loan/Deposit (L/D) ratio measures a balance between
deposits taking and lending activities of a bank. It is commonly preferable for a bank
to have this ratio not too far from 100%.
Provision for loan losses over equity: Provision for loan losses over equity PLL/E for
measuring quality of loans.
CONCLUSION AND RECOMMENDATIONS
The modern corporate report is the product of financial accountings gradual
evolution into financial reporting. The former was concerned almost exclusively with
the financial statements and related notes, while the latter refers to an expanded
package containing a great deal of narrative, graphical, and photographic material. It
appears that we are now on the brink of a further metamorphosis, as financial
reporting evolves into business reporting. Business reporting is the term used by
both the AICPA (1994) and ICAS (1999) to signal the end of a focus on purely financial
information. Allied to this, the traditional audit function (a market experiencing
stagnant fee income) is now conceived as part of a broader range of assurance
services. Some changes have already occurred, while others are anticipated. These
changes have been driven by external changes and are not research-led. Yet research
now has a crucial role to play in the development of these new practices and
procedures.
The second issue addressed in this paper has been to provide a basic understanding of
analytical procedures as basis of corporate report analysis. Space limitations, how
ever, preclude discussing in more detail some of the complexities associated with
24 | P a g e

analytical procedures. Some of the major issues that companies will need to deal with
over the next few years include:
Electronic/Internet reporting: From early 2007, this is likely to cause issues during
the transition phase; companies will also need to develop new processes to handle the
online materials, whilst maintaining the old-style paper reports for those who want
them. As firms need to provide more information to more people in more forms than
ever before, it is likely that there will be a shift to new models for gathering and
managing parcels of information, and disseminating them in different ways to
different audiences. The corporate report, as the key strategic and operational
summary of the business, is likely to remain central to those developments.
Global developments: The current trend is towards more international harmonization
of Accounting Standards. The International Accounting Standards Board (IASB) has set
out a roadmap for the convergence of the International Financial Reporting Standards
(IFRS) and Nigeria is at advanced stage of pronouncing its roadmap towards full
adoption of IFRS, and has committed not to expose existing standards as part of the
transition.
For multinational companies no longer having to prepare accounts to meet multiple
different standards, the cost savings could be considerable. So could the benefits for
analysts wishing to compare performance. But as well as the obvious surface
differences between accounting standards, there are also differences in the
underlying philosophical approaches followed in different regions of the world,
especially the conflict between a rules-driven and a principles-driven approach.
Auditors and other stakeholders must brace up to these challenges.
Changes from the major accounting firms: The recent call by the major accounting
firms for a radical change to the current financial reporting model would have an
even more significant impact on corporate reporting than the changes we have just
seen. The firms have called for quarterly financial reporting statements (with a
historic perspective on performance) to be replaced by real-time, internet-based
reporting that would encompass a wide range of financial and non-financial
performance measures. This, they suggest, would provide a more valuable indication
of company value and its future prospects than current reporting. It seems unlikely
that these changes would happen quickly. But the shift from providing historic to realtime information, and the associated shifts in systems, processes and relationships
with external auditors, would be so fundamental that this is an issue no Accountant or
Finance Director can afford to ignore.
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Improving business performance: It makes no sense to have two separate processes

for gathering and reporting information: one for external audiences and one for the
managers of the business. As the focus of management information shifts away from
measures of past/current performance towards indicators of future performance, it is
common sense that external reporting systems will become more closely linked to
those used for internal reporting. At one level this will include the identification,
tracking and integration of financial and non-financial key performance indicators
(KPIs). At another, it could extend to measuring how well corporate values are put
into practice (since values drive behaviour, and behaviour drives results). Ultimately
though, these changes will be about improving the boards understanding of its
business model, improving its ability to manage that business model, and enabling it
to develop more robust business models for the future.
Thanks for this exciting opportunity to address my distinguished professional
colleagues.

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