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Financial Statement Analysis

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Financial Statement Analysis-FIN621
VU
Lesson-22
NOTES TO FINANCIAL STATEMENTS
(Continued)
Depreciation expenses for year would be: =cost-(estimated) Residual value = 17,000-2000 = 3000
*(Estimated years of useful life-5)
ii)
Accelerated-Depreciation method: In this method higher depreciation rate is charged
in early years and lower rate in later years. Since new plants are most efficient in early
years, matching principle demands that higher depreciation may be charged in earlier
years.
Depreciation = Book Value x Accelerated Dep. Rate
Example: Taking the above case of plant asset acquired for Rs.17, 000
Year
Depreciation
Accumulated
Book Value
Depreciation
1
17,000 X 40%
6800
6800
10200
2.
10,200 X 40%
4080
10880
6120
3.
6,120 X 40%
2448
13328
3672
4.
3,672 X 40%
1469
14797
2203
5.
2,203 X 40%
881
15000
2000
(reduced to 203)
Note that sine total depreciation in five years is Rs.15, 000 (Rs.17, 000 ­ 2,000), the depreciation for the
last year is reduced from 881 to 203 to bring the total depreciation amount in 5 years to Rs.17, 000.
Principles of disclosure and Consistency of Accounting Methods. This is the  basic
concept underlying reliable financial statements, i.e. consistently following the Inventory valuation/
pricing and Depreciation calculation Methods. Disclosure of the Accounting methods used, in Balance
Sheet or in the Notes is also an essential requirement of Disclosure Principle. If however, Accounting
Method (s) are changed disclosure must be made of reasons for such change, and of the effect of change
upon the company's net income.
Annual Report Generated By Business
Annual Report is part of Financial Reporting Process which contains Financial
Statements, Notes to financial statements, Auditors' Report, Five-year summary of key financial and
non-financial data, and Management's discussion and analysis of operations (MD&A).
Auditor's Report
Audit of financial statements is independent of the business issuing these. Financial
Statements preparation is Management's responsibility, whereas expressing opinion as to their fairness
is the Auditor's responsibility, Audit Report is issued along with financial statements to persons outside
the business. It provides assurance to outside users about the completeness and reliability (not
necessarily accuracy) of Financial Statements.
Auditor is hired by the company being audited. Usually a Management letter is also
issued by Auditors to Company's management, recommending steps for improving company's internal
control structures.
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Financial Statement Analysis-FIN621
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Fairness' in the context of Auditor's Report means that financial statements
are not
misleading. Audit is conducted according to Generally Accepted Auditing Standards. During Audit, the
Auditors obtain reasonable assurance that financial statements are free of "material" misstatements.
Audit is conducted by examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. It assesses the accounting principles used and significant estimates made by
management. It must also be noted that Audit`s purpose is to determine fairness of financial statements
and not to detect frauds, as such. In the context of materiality, it is to be noted that an item is material if
knowledge of this  might reasonably be expected to influence user's decisions. Also to be noted is the
fact an auditor can also make errors like a physician does in diagnosis.
End product of every audit is the auditor's report. An audit involves collection of audit evidence about
the truth and fairness of financial statements or other proposition under review. By careful examination
of the evidence so called the auditor draws appropriate conclusions and forms his opinion. The auditor's
report summarizes results of the work conducted by the auditor and formally communicates the
auditor's opinion.
It is important to note that the auditor's report simply expresses the auditor's opinion on truth and
fairness of financial statements as absolutely correct. An auditor's report is a formal statement that
includes the reporting auditor's opinion formed after careful examination of books of accounts and
related documents. Where as, a certificate is written conformation of absolute accuracy of the facts
stated therein and does not involve any estimate or opinion.
Types of auditor's opinion
An auditor's opinion may be unqualified, qualified or adverse. In certain circumstances the auditor may
disclaim an opinion i.e states his inability to express an opinion.
Unqualified opinion
Opinion of an auditor is termed as unqualified when the auditor concludes that that the financial
statements give a true and fair view in accordance with the identified financial reporting framework.
There is no statuary definition of the words "true and fair". However, true and fair has been taken to
mean the following: (I) free from prejudice or bias, (II) presentation of an objective picture, (III) in
accordance with generally accepted accounting principles, (IV) consistent and having clarity,(V) not
misleading and understandable by the reader of financial statements,. (V) presented fairly, in all
material respects.
Identified financial reporting framework means the set of statutes, rulers, and standards etc. That apply
to the preparation and presentation and presentation of such financial statements.
According to the companies ordinance 1984, in an unqualified audit report the auditor is required to
make some statutory affirmations without reservations, as prescribed in section 255(3).
In an unqualified opinion the auditor also impliedly undertakes that any changes in accounting
principles or in the method of their application, and the effects thereof, have been properly determined
and disclosed in the financial statements.
Modified opinion
An auditor may not be able to express an unqualified opinion. When either of the following
circumstances exists and, in the auditor's judgment, the effect of which is or may be material to the
financial statements:-
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Financial Statement Analysis-FIN621
VU
(a) There is a limitation on the scope of the auditor's work; or
(b) There is a disagreement with management regarding the acceptability of the accounting policies
selected, the method of their application or the adequacy of financial statement disclosures.
The circumstances described in (a) could lead to a qualified opinion or a disclaimer of opinion. The
circumstances described in (b) could lead to a qualified opinion or an adverse opinion.
(i) Qualified Opinion
Opinion of an auditor is termed as qualified opinion when the auditor concludes that an unqualified
opinion cannot be expressed but that the effect of any disagreement with management, or limitation on
scope is not so material and pervasive as to require and adverse opinion or a disclaimer of opinion. A
qualified opinion is expressed as being `except for' the effects of the matter to which the qualification
relates.
(ii) Disclaimer of opinion
A disclaimer of opinion should be expressed when possible effect of a limitation on scope of audit is so
material and pervasive that the auditor has not been able to obtain sufficient appropriate audit evidence
an accordingly is unable to express an opinion on the financial statements
(iii) Adverse opinion.
An adverse opinion should be expressed when the effect of a disagreement is so material and pervasive
to the financial statements that the auditor concludes that a qualification of the report is not adequate to
disclose the misleading or incomplete nature of the financial statements.
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