Financial Accounting: An Integrated Statements Approach, 2nd Edition

Chapter 14 Financial Statement Analysis 653

CORPORATE ANNUAL REPORTS

Public corporations are required to issue annual reports to their stockholders and other

interested parties. Such reports summarize the corporation’s operating activities for

the past year and plans for the future. There are many variations in the order and form

for presenting the major sections of annual reports. However, one section of the an-

nual report is devoted to the financial statements, including the accompanying notes.

In addition, annual reports usually include the following sections:

1. Management Discussion and Analysis


2. Report on adequacy of internal control


3. Report on fairness of financial statements
   In the following paragraphs, we describe these sections. Each section, as well as
   the financial statements, is illustrated in the annual report for Pixaron their Web site.

Management Discussion and Analysis

A required disclosure in the annual report filed with the Securities and Exchange

Commission is the Management Discussion and Analysis (MDA). The MDA provides

critical information in interpreting the financial statements and assessing the future of

the company.

The MDA includes an analysis of the results of operations and discusses manage-

ment’s opinion about future performance. It compares the prior year’s income state-

ment with the current year’s to explain changes in sales, significant expenses, gross

profit, and income from operations. For example, an increase in sales may be explained

by referring to higher shipment volume or stronger prices.

The MDA also includes an analysis of the company’s financial condition. It com-

pares significant balance sheet items between successive years to explain changes in

business’s operations usually affect the measures used. For example, analysis for an

airline might include revenue per passenger mile and cost per available seat as mea-

sures. Likewise, analysis for a hotel might focus on occupancy rates.

Percentage analyses, ratios, turnovers, and other measures of financial position

and operating results are useful analytical measures. They are helpful in assessing a

business’s past performance and predicting its future. They are not, however, a sub-

stitute for sound judgment. In selecting and interpreting analytical measures, condi-

tions peculiar to a business or its industry should be considered. In addition, the

analytical measures are not ends in themselves. They are only guides in evaluating fi-

nancial and operating data. Many other factors, such as trends in the industry and gen-

eral economic conditions, should also be considered.

In determining trends, the interrelationship of the measures used in assessing a

business should be carefully studied. Comparable indexes of earlier periods should

also be studied. Data from competing businesses or the industry may be useful in as-

sessing the efficiency of operations for the firm under analysis. For example, in Exhibit

8, it is clear that both DreamWorks and Pixar are performing better than the motion

picture industry as a whole for this time period. The motion picture industry has been

suffering losses as seen from the first three ratios. In addition, the industry as a whole

uses more debt than does either Pixar or DreamWorks. In making such comparisons,

however, the effects of differences in the accounting methods used by the businesses

and multiple year comparisons should be considered.

Describe the contents of
corporate annual reports.

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