Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
4th session:
Corporate Governance
and Financial accounting
measures of performance
Performance Evaluation
IMSc in Business Administration
October-November 2007
05/11/2015
Ricardo F Reis
[email protected]
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 Corporate Governance
Sarbanes-Oxley
 “Five years under the thumb”
 Auditing Profession

 Financial Performance Measures

05/11/2015
Performance Evaluation
Earnings per Share
Ricardo F Reis
[email protected]
Session 04 - 2/33
Sarbanes-Oxley
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 The Sarbanes-Oxley Act of 2002, also
known as the Public Company
Accounting Reform and Investor
Protection Act of 2002 and commonly
called SOX or Sarbox; is a United
States federal law signed into law on
July 30, 2002 in response to a number of
major corporate and accounting
scandals including those affecting Enron,
Tyco International, Peregrine Systems
and WorldCom.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 3/33
TITLE I - “Public Company
Accounting Oversight Board
(PCAOB)”
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 PCAOB to provide independent
oversight of public accounting firms
providing audit services ("auditors"). It
also creates a central oversight board
tasked with registering auditors, defining
the specific processes and procedures
for compliance audits, inspecting and
policing conduct and quality control, and
enforcing compliance with the specific
mandates of SOX.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 4/33
TITLE II - “Auditors
Independence”
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 Establishes standards for external
auditor independence, to limit conflicts of
interest. It also addresses new auditor
approval requirements, audit partner
rotation policy, conflict of interest issues
and auditor reporting requirements. This
title restricts auditing companies from
doing other kinds of business apart from
auditing with the same clients.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 5/33
TITLE III - “Corporate
Responsibility”
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 This title mandates that senior executives take
individual responsibility for the accuracy
and completeness of corporate financial
reports. It enumerates specific limits on the
behaviours of corporate officers and describes
specific forfeitures of benefits and civil penalties
for non-compliance. For example, Section 302
implies that the company board (Chief
Executive Officer, Chief Financial Officer)
should certify and approve the integrity of their
company financial reports quarterly. This helps
establish accountability.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 6/33
TITLE IV - “Enhanced
Financial Disclosures”
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 Title IV describes enhanced reporting
requirements for financial transactions,
including off-balance sheet transactions, proforma figures and stock transactions of
corporate officers. It requires internal controls
for assuring the accuracy of financial reports
and disclosures, and mandates both audits and
reports on those controls. It also requires timely
reporting of material changes in financial
condition and specific enhanced reviews by the
SEC or its agents of corporate reports.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 7/33
TITLE V - “Analyst Conflicts
of Interest”
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 Title V defines the codes of conduct for
securities analysts and requires
disclosure of knowable conflicts of
interest.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 8/33
TITLE VI - “Commission
Resources and Authority”
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 Title VI defines the SEC’s authority to
censure or bar securities professionals
from practice and defines conditions
under which a person can be barred
from practicing as a broker, adviser or
dealer.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 9/33
TITLE VII - “Studies and
Reports”
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 Title VII is concerned with conducting
research for enforcing actions against
violations by the SEC registrants
(companies) and auditors.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 10/33
TITLE VIII - “Corporate and
Criminal Fraud Accountability”
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 Title VIII is also referred to as the
“Corporate and Criminal Fraud Act of
2002.” It describes specific criminal
penalties for fraud by manipulation,
destruction or alteration of financial
records or other interference with
investigations, while providing certain
protections for whistle-blowers.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 11/33
TITLE IX - “White Collar Crime
Penalty Enhancement”
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 This section is also called the “White
Collar Crime Penalty Enhancement Act
of 2002.” This section increases the
criminal penalties associated with whitecollar crimes and conspiracies. It
recommends stronger sentencing
guidelines and specifically adds failure to
certify corporate financial reports as a
criminal offence.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 12/33
TITLE X - “Corporate Tax
Returns”
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 Title X consists of one section, which
states that the Chief Executive Officer
should sign the company tax return.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 13/33
TITLE XI - “Corporate Fraud
Accountability”
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 Also known as “Corporate Fraud
Accountability Act of 2002” . It identifies
corporate fraud and records tampering
as criminal offences and joins those
offences to specific penalties. It also
revises sentencing guidelines and
strengthens their penalties. This enables
the SEC to temporarily freeze large or
unusual payments.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 14/33
The Certified Public
Accountant and the Auditor’s
Opinion
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 An audit is an examination of a
company’s transactions and the resulting
financial statements
 The auditor’s opinion describes the
scope and results of the audit and a
judgment that the financial statements
prepared by management are accurate
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 15/33
Public Accounting Firms
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 The four largest public accounting firms
are




Deloitte Touche Tohmatsu
Ernst & Young
KPMG International
PricewaterhouseCoopers
 97% of the firms listed on the NYSE are
clients of these four firms
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 16/33
Public Accounting Firms
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 Each firm has annual billings in excess
of $1 billion
 All firms must follow generally accepted
accounting principles (GAAP)

05/11/2015
Performance Evaluation
The broad concepts and detailed practices
of preparing and distributing financial
statements
Ricardo F Reis
[email protected]
Session 04 - 17/33
Sarbanes-Oxley Act
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 Established the Public Company Accounting
Oversight Board to regulate public accounting
and to set standards for audit procedures
through the issuance of generally accepted
auditing standards (GAAS)
 Prohibits public accounting firms from providing
audit clients with certain non-audit services
 Requires rotation every 5 years of the lead
audit or coordinating partner and the reviewing
partner on an audit
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 18/33
Sarbanes-Oxley Act
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 Provides regulation of corporate governance



05/11/2015
Performance Evaluation
Requiring boards to appoint an audit committee
composed only of “independent” directors
Requiring CEOs and chief financial officers (CFOs)
to personally sign a statement certifying the
appropriateness and fairness of their companies’
financial statements
Increasing criminal penalties for knowingly
misreporting financial information
Ricardo F Reis
[email protected]
Session 04 - 19/33
Professional Ethics
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 Members of the AICPA must abide by a code of
professional conduct
 The Institute of Management Accountants has a
code of ethics for management accounts
 Auditors and management accountants have
professional responsibilities concerning
competence, confidentiality, integrity, and
objectivity
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 20/33
Professional Ethics
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 Ethical standards are personal and
depend on the values of the individual
 A successful manager must recognize
the ethical dimensions of a situation and
act with absolute integrity
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 21/33
Professional Ethics
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 Despite the criticism of accounting ethics,
accountants were responsible for revealing the
problems in many of the recent corporate
scandals
 Companies often rely on accountants to
safeguard the ethics of the company
 WorldCom and Enron whistle-blowers became
two of the three 2002 Persons of the Year in
Time magazine (Cynthia Cooper of Worldcom
and Sherron Watkins of Enron)
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 22/33
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 23/33
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
Financial accounting
measures of
performance
Computing Earnings per Share
(EPS)
05/11/2015
Ricardo F Reis
[email protected]
Computing Earnings per Share
(EPS)
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
•
•
•
05/11/2015
Performance Evaluation
Earnings per share indicates the
income earned by each share of
common stock.
Reported at the end of the income
statement
Should report intermediate
components as well.
Ricardo F Reis
[email protected]
Session 04 - 25/33
EPS on Simple Capital
Structure
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 Simple Capital Structure means that there is
only common stock and there is no potential
common stock (securities that can potentially
be converted into common stock and dilute
EPS).
Net Income
EPS=
Weighted Average Number of Shares
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 26/33
Preferred Stock Dividends
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 Preferred Stock Dividends are compensation
not available for common stockholders,
therefore they are subtracted from the Net
Income.
Net Income – Preferred Dividends
EPS=
05/11/2015
Performance Evaluation
Weighted Average Number of Common Stock
Ricardo F Reis
[email protected]
Session 04 - 27/33
Weighted Average Number od
Shares Outstanding
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 Weighted by the fraction of the period
they are outstanding
 Find the equivalent number of whole
shares outstanding for the year.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 28/33
Stock Dividends and Stock
Splits
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 When these happen computation of the
average number of shares outstanding
needs to be redone.
 A stock dividend or split does not
change the shareholders’ total
investment.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 29/33
Complex Capital Structure
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 Dilutive securities are securities that can
be converted into common stock
(through conversion or exercise) and will
dilute earnings per share.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 30/33
Diluted EPS
Faculdade de
Ciências
Económicas e
Empresariais
Note that:
Only dilutive securities are to be reported!
Antidilutive are not considered.
Universidade
Católica
Portuguesa
Net income- Preferred
dividends
EPS=
Weighted Average Shares
Outstanding
05/11/2015
Performance Evaluation
-
Impact of
Convertibles
Ricardo F Reis
[email protected]
-
Impact of Option,
Warrants, and
Other Dilutive
Securities
Session 04 - 31/33
Diluted EPS – Convertible
Securities
If-Converted Method
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
1. Conversion of the convertible securities
as soon as possible (beginning of
period or issuance)
2. Elimination of related interest, net of
tax.
 Logic is that if the convertible securities
were converted, then they didn’t
produce any interest and net income
has to be filtered of this.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 32/33
Diluted EPS – Options and
Warrants
Treasury Stock Method
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
1. Exercise of options or warrants as soon
as possible (beginning of period or
issuance)
2. Proceeds from the exercise are used to
purchase common stock.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 04 - 33/33