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Have You Looked At The Disclosures?
Education | 30 March 2012
By: Louis Kent Lee
Articles (199) Profile

So tell me, what do you look at immediately when you delve into a company’s financial statement (FS)? Profits? Revenue? Growth? You would have probably said yes to all of them. Was it surprising? Not really. It is very common for people to immediately zoom into said areas as it conveys the well being of the firm, whether or not its revenue has fallen, grown, or is it more profitable now. These figures also then translate into ratios, which would then be used for different valuation purposes.

But have you looked at the disclosures made by the company within the same FS as well? Oh. What are disclosures you ask? Disclosures basically consist of comments or explanations listed in a company’s financial report whereby the information are generally provided to clarify or interpret certain published financial information, which the company wishes to highlight to readers of its financial statement about. It’s to prevent any obscured perception with the withholding of certain information, which could affect the way a rational minded individual will interpret its financial statement.

Why Are Disclosures So Important
Say for example, company A’s FS has reflected steady growth this year in terms of profits and revenue. Gearing levels are maintained and in fact without really peering further, this actually looks good on the onset. Then you zoom in to the disclosures section and realise that due to unforeseen circumstances, one of the major customer of the company has just announced that it is facing serious liquidity issues due to heavy write downs in its held for trading investments.

This will effectively change the outlook of the company in the future and withholding this key piece of information would have possibly made investors think this company is not faced with any immediate threats or barriers in the first place.

Let us look at another example for illustration purposes. Say the company you are looking at is a company that specialises in building oil rigs. The financials are steady and in line with growth expectations. However, upon closer scrutiny, an accident has occurred due to unforeseen circumstances and “clean-up costs”, which runs in a rough approximation of $200 million will be expected to be incurred moving forward.

How substantial will the impact be on the company? Will there be further liabilities as a result of other litigations which could possibly follow through due to the accident? What about fines for breaches of environmental laws and whatnot?

These events, as evidenced by the classic oil spill accident in the gulf by British Petroleum has the ability to impair investors’ confidence and cast a heavy impact on the share price.

Types Of Information To Be Disclosed In The FS
Typically, under international financial reporting standards, the FS has to be prepared in a way that complies to the reporting standards. Also, different stock exchanges will have different listing requirements to be complied with, to safeguard investors’ interests.
In a general context, there are certain criteria which puts forth what is expected to be disclosed. The first one would be Significant Accounting Policies. This includes anything from change of depreciation policy or change in its revenue recognition policy, which could in turn affect profit figures.

The second one would be events which occur after a company closes its books for the year, or to some people, the cut-off date of its financial year. Examples of such would be taking up a substantial long term loan, sale of fixed assets, or other significant items. This is important as it gives investors awareness of any major activity that the company might engage in, which could suggest any potential implications moving forward.

The last one would be transactions, events or activity which does not meet market standards. Examples of this would be that of irregularities, illegal actions or when qualified audit opinions are issued by the auditors. This allows the stakeholders to be aware of the impact of the company, be it positive or negative.

Be Comprehensive
In a nutshell, no one can blame anyone on his or her own investment choices because he or she overlooked the disclosures, which highlighted information which could probably change the investment view.

The safer bet will be to look at the disclosures, relate what kind of immediate implications it could have on the company, and then formulate your investment filter together with your conclusion that you have drawn based on its financials and future outlook.

Everyone likes to play it safe. But I like to play it safer. Maybe you could too.

Louis is a qualified accountant with the ACCA, and is the Research Editor at Shares Investment magazine.

Please click here for more information about this author.


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The Shares Investment editorial team welcomes constructive feedback on our coverage and content. We would also be delighted to answer any questions on the above article. Leave us a comment below, and we'll get back to you shortly!

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