The rationale, aim and purpose of this study guide
The rationale for a study guide on how to read and interpret annual reports is that this is a skill that can prove valuable in many contexts, situations and job positions. Whether you are the decision maker in, or you are contributing to the decision of, selecting a business partner or a supplier or a client, you will find that being able to have an informed insight in the financial performance and position of these third parties that you are considering is rather useful. You can be a project manager, the responsible for a product line, a production manager, an independent consultant, and still be interested in making your opinion about the current solidity and future perspective of a business with which you are considering collaborating.
This study guide is aimed at anyone, with no or basic accounting expertise and knowledge, interested in reading and making sense of corporate annual reports. Also readers who have been trained in bookkeeping might find this study guide useful.
Whilst the purpose of the study guide is to guide the readers through the corporate document called 'annual report', for them to interpret its meaning, the readers will not learn how to prepare the annual report.
Upon completing this study guide, the readers should be able to read and interpret any annual report based on International Accounting Standards and, even though they might still lack the full knowledge of unusual or very technical information, they should be able to make their own informed opinion about the financial performance, situation and perspective of the reporting entity that published that annual report.
About the author
Dr Marco Mongiello is Teaching Fellow in Accounting at the Imperial College Business School, which he joined in September 2007 and where he also is the Director of the MSc Management program. He holds a BA degree with honors in Business Administration from Ca' Foscari University in Venice (Italy - 1993) and a PhD in Accounting also from Ca' Foscari (1998). In the meantime he became Chartered Accountant (1995) and subsequently Certified Auditor (1999) in Italy. He then obtained the Certificate in Teaching and Learning in Higher Education (2001) in Oxford and became Fellow of the UK Higher Education Academy (2007).
Prior to joining Imperial College, Marco has taught and researched accounting for more than ten years, mostly in the UK at Oxford Brookes University and University of Westminster. He internationally published articles, presented papers and led and contributed to editorial tasks in accounting.
His teaching interests lie in managerial and financial accounting both for specialized and non-specialized academic curricula and for the corporate market
Marco's personal webpage is: imperial.ac.uk/people/m.mongiello
This study guide is aimed at exploring the informational value of the annual report under the International Financial Reporting Standards' (IFRS) provisions.
The annual report is a publication that fulfils the regulatory requirements of reporting the financial performance and situation of a reporting entity and, at the same time, is also used for wider corporate communication purposes.
A reporting entity (which we will call "entity" from here onwards) is either a company or a group of companies, which are all controlled by the same decision maker, i.e. normally the same board of directors. This occurs when the board of directors of a company controls directly or indirectly a number of other companies, by holding directly or indirectly the absolute or relative majority of the voting rights of other companies. Figure 1 illustrates an example where Alfa Ltd is a company that controls a group of companies made of: Beta Ltd (directly controlled), Gamma Ltd (indirectly controlled), Delta Ltd (directly controlled by absolute majority) and Epsilon Ltd (indirectly controlled by relative majority), whilst Theta Ltd is not part of the group, the Alfa group' either exercises significant influence over Theta Ltd or does not, making Theta Ltd respectively either an associate company or simply an investment of the Alfa group'. This simple example is based on the assumptions that the remaining part of the capital1 of Epsilon Ltd is spread among many shareholders, none of which controls more than 15% and that this does not apply to the remaining capital of Theta Ltd. All the companies that are part of the group are 'subsidiaries' of Alfa Ltd.
Figure 1 - Alfa group
The annual report's contents vary from entity to entity, yet they must include certain compulsory elements, which are required by the legislations of the respective countries where companies are registered and, in case, listed in the stock exchanges; these legal requirements and regulations mostly refer to the provisions of the IFRS - with notable exceptions of countries that have not as yet fully embraced the IFRS.
Several reasons affect the variability of the contents of the annual reports. Firstly, the IFRS allow wide areas of choice for what concerns the formats of the financial statements, implying that the cultural background and past experience of the preparers of the accounts determines what interpretation to adopt, let alone that some provisions' interpretation are subject of controversy among accountants. Secondly, the IFRS have been subject to a relatively high-paced development over the last decade or so; normally the changes are phased in, with the companies' end (or beginning) of the financial year falling on either sides of the enforcement date of the revised standards, and often allowing the possibility to comply with the revised standard earlier than the starting enforcement date. Thirdly, the more the annual report is used for wider communication purposes, the more the companies' directors choose to include information aimed at distinguishing their report from those of other companies. Other reasons lie on the different versions of the standards endorsed in different world regions; chiefly the European Union's (EU) 'carve outs' of the IAS 39, whereby certain provisions that refer to the treatment and reporting of certain financial instruments is different in the EU than in the rest of the world2.
Finally, the format of the annual reports has been affected more and more by the possibility of using information technology tools to communicate the financial statements and all the other contents of the annual report. Some examples of how this affects the reporting can be easily found on the internet: see in particular BMW's3 and Marks & Spencer's4 official web pages' investor relations areas. In these examples you can see a 'technological' interpretation of the principle of fairness in the presentation of the statements, as the hyperlink to Excel enables the readers of the accounts to carry out their analysis more easily and efficiently than if they had to copy the relevant figures in their own spreadsheets.
These and other examples5 also show how the medium of communication can be used to convey the innovation strive of the entity originating the accounts.
I suggest that you browse a number of annual reports of reporting entities on which you feel interested; think of the companies whose brands you know or those whose products or policies you either particularly like or dislike. You can easily download these annual reports from the companies' respective web pages or obtain free paper versions by contacting their headquarters. You should aim at familiarizing yourself with these documents and try to understand as much as you can from the narrative parts and from the financial statements parts.
You should be aware that with the expressions "IFRS" and "IAS" it is normally intended to refer to the whole body of standards that are under the names of International Accounting Standards (IAS) and the newer International Financial Reporting Standards (IFRS). Many IAS are still valid insofar they have not been replaced by new IFRS. When the International Accounting Standard Board intervenes in the body of accounting standards it:
o either modifies existing IAS or IFRS
o or issues new standards (IFRS), which are added to the existing list of standards superseding existing IAS, which are then no longer used
o or issues new standards (IFRS), which address completely new areas of accounting.
This is the reason why both IAS and IFRS are coexisting and make, together, the whole body of international accounting standards.