Accounting: The Language of Business - Vol. 2 (Intermediate: Part 79)

One of the common traits of outstanding performers-coaches, athletes, managers, sales representatives, executives, and others who face a daily up/down, win/lose accounting system-is that a rejection, that is, defeat, is quickly forgotten, replaced eagerly by pursuit of a new order, client, or opponent.

Bill Walsh

 Statements of Financial Position and Cash Flows and the Annual Report (Part Q)

by

Charles Lamson

Auditors' Report

An audit is an examination of the financial statements (including the footnote disclosures) and the internal controls over the systems that generate the financial statements and notes. Auditors then attest to the fairness of the financial statements. for public companies, The auditors must also test the internal controls and attest to their effectiveness. The SEC requires all public companies to conduct an annual audit of their financial statements and footnote disclosures. Many private companies also choose to have an annual audit.

The format of most auditors' reports is nearly identical because the report must be in compliance with standards set forth by the Public Company Accounting Oversight Board (PCAOB). The PCAOB sets the standards for public company audits, whereas the American Institute of Certified Public Accountants (AICPA) sets the standards for private company audits.

Typically, companies will receive an unqualified opinion, but other opinions are sometimes found in practice. Exhibit 6.19 summarizes the types of auditors' opinions.

EXHIBIT 6.19 Auditors' Opinions

The firm may issue the auditor's report on the effectiveness of the internal controls as a separate report within the annual report or include it with the opinion regarding the presentation of the financial statements within the annual report. 

Johnson & Johnson's auditors prepared a combined report, as presented on page 84 of its 10-K filing (A 10-K filing is an annual report that publicly traded companies file with the U.S. Securities and Exchange Commission (SEC) to disclose their financial performance. The 10-K provides a comprehensive overview of the company's condition, including audited financial statements. The 10-K also includes information about the company's history, organizational structure, equity and subsidiaries holdings, and key financial indicators like earnings per share.) The first paragraph of the report states that Johnson & Johnson received an unqualified opinion; it goes on to state that the auditors believe that Johnson & Johnson's internal controls are effective.

Financial statement users should always read the auditors' report. The statements should be used with caution if a company receives anything other than a clean opinion on its financial statements. 

Management Report

The management of a publicly traded entity is required to provide two letters in the annual report: a letter stating its responsibility for the financial statements and a letter providing an assessment of the effectiveness of the internal controls over the financial reporting process. The letter of management responsibility for the financial statements and the management assessment of internal controls letter can be combined.

Management's Responsibility for the Financial Statements. The management of a firm is ultimately responsible for the preparation and presentation of the financial statements. In order to emphasize this point and hold management accountable, the annual report or Form 10-K of a publicly traded entity must include certifications from the firm's management that include:

• A statement that the officers have reviewed the financial report.

• A statement that the financial statements do not contain any material omissions or untrue or misleading statements.

• A statement that the financial statements fairly present the financial condition and results of the entity.

• A statement that the officers are responsible for and have evaluated the internal controls.

• A list of all deficiencies in the internal controls.

• Information on any fraud that involves employees who are involved with internal activities.

• A discussion of any significant changes in internal controls that could have a negative impact on the internal controls (Section 302 of the Sarbanes-Oxley Act).

Johnson & Johnson includes the certifications in Exhibits 31(a) and 31(b) of its Form 10-K.

Management's Report on Internal Control over Financial Reporting. Annual reports of publicly traded entities must also include a letter that provides an assessment of the company's internal controls. In this letter, management is required to provide a statement: 

• On management's responsibility for establishing and maintaining adequate internal control over financial reporting for the company.

• On management's assessment of the effectiveness of the company's internal control over financial reporting.

• Identifying the framework used by management to evaluate the effectiveness of the company's internal control over financial reporting.

• That the registered public accounting firm that audited the company's financial statements included in the annual report has issued an attestation report on management's assessment of the company's internal control over financial reporting (Section 404 of the Sarbanes-Oxley Act).

Johnson & Johnson's letter, presented on page 85 of its 10-K filing, states that management has assessed the effectiveness of internal controls and concluded that the internal controls over financial reporting are effective. As is the case with the management responsibility letter for the financial statements, this letter is signed by the CEO and the CFO.

Board of Directors

Public entities must provide a disclosure of the members of its board of directors, a body that oversees the activities of the company. Companies are also required to provide the principal occupations of their board members. This disclosure includes the names and the principal business activities of the entities employing the members of the board.

Johnson & Johnson's 10 directors, including the CEO and chairman, approved the corporations annual report. A number of its board members are retired CEOs from other large corporations. 

*GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 263-265*

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