Corporate Annual Reports

Public corporations issue annual reports summarizing their operating activities for the past year and plans for the future. Such annual reports include the financial statements and the accompanying notes. In addition, annual reports normally include the following sections:

• Management discussion and analysis
• Report on internal control
• Report on fairness of the financial statements

1. Management Discussion and Analysis

Management’s Discussion and Analysis (MD&A) is required in annual reports filed with the Securities and Exchange Commission. It includes management’s analysis of current operations and its plans for the future. Typical items included in the MD&A are as follows:

• Management’s analysis and explanations of any significant changes between the current and prior years’ financial statements.
• Important accounting principles or policies that could affect interpretation of the finan­cial statements, including the effect of changes in accounting principles or the adoption of new accounting principles.
• Management’s assessment of the company’s liquidity and the availability of capital to the company.
• Significant risk exposures that might affect the company.
• Any “off-balance-sheet” arrangements such as leases not included directly in the financial statements. Such arrangements are discussed in advanced accounting courses and textbooks.

2. Report on Internal Control

The Sarbanes-Oxley Act of 2002 requires a report on internal control by manage­ment. The report states management’s responsibility for establishing and maintaining internal control. In addition, management’s assessment of the effectiveness of internal controls over financial reporting is included in the report.

Sarbanes-Oxley also requires a public accounting firm to verify management’s conclusions on internal control. Thus, two reports on internal control, one by man­agement and one by a public accounting firm, are included in the annual report. In some situations, these may be combined into a single report on internal control.

3. Report on Fairness of the Financial Statements

All publicly held corporations are required to have an independent audit (examina­tion) of their financial statements. The Certified Public Accounting (CPA) firm that conducts the audit renders an opinion, called the Report of Independent Registered Public Accounting Firm, on the fairness of the statements.

An opinion stating that the financial statements present fairly the financial position, results of operations, and cash flows of the company is said to be an unqualified opinion, sometimes called a clean opinion. Any report other than an unqualified opinion raises a “red flag” for financial statement users and requires further investigation as to its cause.

The annual report of Nike, Inc. is shown in Appendix B. The Nike report includes the financial statements as well as the MD&A Report on Internal Control, and the Report on Fairness of the Financial Statements.

Source: Warren Carl S., Reeve James M., Duchac Jonathan (2013), Corporate Financial Accounting, South-Western College Pub; 12th edition.