Posted: February 26th, 2023

What is the opinion of the auditors about the financial statements

Work sheet for two companies Carrier Global and Burger King.

General Motors (GM)
CEO: Mary T. Barra
Inspect the 10-K

1. What is the opinion of the auditors about the financial statements? The opinion might be that the
financial statements are ‘fairly presented.’ The opinion might be that the financial statements are not fairly
presented.

-The opinion of the auditors is that the financial statements are presented fairly, in all material respects, the
financial position of the company at Dec. 31,2020 and 2019, and the results conform with US generally
accepted accounting principles. (Page 47)

2. Who audits the financial statements? The Big4 accounting firms are (1) Deloitte, (2) Ernst & Young, (3)
KPMG, and (4) Price Waterhouse Coopers. They audit most publicly available companies. State who audits
your companies

– Ernst & Young audited GM. Serving as the auditors since 2017.

3. Most, but not all companies, evaluate their internal control over financial reporting. In the opinion of

the management, does the company have good internal control? This is frequently described at Item 9A

Controls and Procedures.

-Management deemed that their internal control over financial reporting was effective as of Dec 31, 2020.
These internal controls were also audited by Ernst & Young and they concluded that GM maintained effective
quality control. (Page 99)

4. What standard does the company use to evaluate whether the internal control is satisfactory. This is
frequently COSO Internal Control –Integrated Framework (2013), but it might be another standard.

– The assessment of the internal control utilized the criteria discussed in the “Internal Control – Integrated

Framework (2013) issued by the COSO. (Page 99)

Inspect the report on management compensation.

Most of the time this is included in the proxy. It is in a form that starts DEF. It might be DEF 14A, titled
“Other Definitive Proxy Statements,” or something similar.

1. Most companies have a Compensation Committee. How many of the members of the Compensation
Committee are independent?

-The compensation committee consisted of 4 members: Carol Stephenson (Chair), Wesley G. Bush, Joseph

Jimenez and Patricia F. Russo. (Page 68). The committee is entirely composed of independent directors

determined by the board under NYSE guidelines. (Page 67)

2. Has the company ask for shareholder opinion on management compensation? This is a ‘say-on-pay’
vote.

-Yes, the company has an annual meeting for say-on-pay voting. The company views shareholder engagement
as a continuous process and seeks feedback from the shareholders. 96.5% of shareholders voted in favor of
the executive compensation programs. (Page 44)
3. Describe a little of how the Compensation Committee makes the decision about pay. a. Do they use an
outside consultant to help with the decision or is it based only on their own deliberations? If they use a
consultant, who is it? b. Is there a set of peer companies that they use as a comparison?

-The compensation uses recommendations from an outside independent compensation consultant. FW Cook
was the independent consultant. (Page 67). The committee used members of the Dow Jones Automobile &
Parts Titans 30 Index as an OEM peer group. (Page 46) They also used another peer group of 15 companies to
inform 2020 target compensation consisting of 3M, Boeing, Caterpillar, Deere & Company, Ford Motors, GE,
Honeywell, HP, IBM, Intel, Johnson & Johnson, PepsiCo, Pfizer, Proctor & Gamble, and United Technologies.
(Page 47)

4. Describe how much the CEO makes. Include a breakdown of the components of the pay. Commonly, it is
salary, bonus, and equity.

-Target –
Salary: $2,100,000;
Short Term Incentive Plan: $4,200,000;
Performance Share Unit: $11,250,000;
Stock Options: $3,750,000. (Page 50)

Actual Compensation –
Salary: $1,995,000;
Short Term Incentive Plan: $3,780,000;
Performance Share Unit: $12,988,702;
Stock Options: $3,750,000;
Restricted Stock Unit: $105,020

5. What measures are used to evaluate management, particularly for the bonus? I hope it’s not a long list

of measures. If the list is long, select some representative measures. Describe the chosen measures.*

a. Is the data item drawn from the financial statements? Which financial statement, Balance Sheet, Income

Statement, or Statement of Cash Flows?

b. If the item is not drawn from the financial statements, what information does it seem to capture?

-STIP performance measures
50% -Earnings Before Interest and Taxes-adjusted (EBIT) ($12.9 B is the target) Focus on Operating Profit and
driving strong profitability;
25% – Adjusted Automotive Free Cash Flow AFCF ($7.1 B is the target) Focus on driving strong cash flow for
investments;
25% Strategic Goals (25 pts) Focus on performance that aligns to company vision and drives business results.
(Page 51)

EBIT is from the income statement. Net Income is the accountant’s measure of profitability. Both
Interest and Taxes are expenses to arrive at Net Income on the income statement. The measure, EBIT,
uses profitability without the subtraction of Interest and Taxes. This suggests that management is
incentivized to pay careful attention to aspects of profits other than interest and taxes.

AFCF is from the statement of cash flow, and some detail in the computation is provided in the proxy’s
Appendix A. I speculate that AFCF is used because the company’s traditional core focus is on
automobiles.

LTIP performance measures

50% – Relative Return On Invested Capital-adjusted (ROIC) (20% or higher returns in vehicles and technology);
50% Relative Total Shareholder Return (TSR) (Shareholder returns outperform OEM peer group) (Page 52)

ROIC is EBIT/Average Net Assets. Net Assets is Shareholders’ Equity. This is profitability scaled by the
level of shareholders’ equity, resulting in a percentage figure. A percentage figure can be compared
across companies of different sizes. For example, profits of $100 may seem not as good as $200.
However, if the profits of $100 are generated using assets of $500, that 20 percent profit figure may be
superior to the $200 that required $2,000 of assets to generate a 10 percent return. Both EBIT and
Average Net Assets are derived from accounting reports. EBIT uses the income statement as the starting
point. Average Net Assets uses the balance sheet as the starting point.

Relative TSR is not clearly defined in the proxy, so I looked it up. A shareholder return is the dividends plus the
market price increase of a share. Scale the dividends plus the market price increase by the starting market
price and the TSR is a percentage. To make the TRS a ‘Relative TRS,’ examine where the company’s TRS ranks
among peers. A Relative TSR that ranks near the top of peers is superior to a Relative TSR that ranks at the
bottom of the peers. Accounting does not play a role in computing Relative TSR. Market price are determined
by the market, and not directly by accounting reports.

6. What does the committee have to say about whether the incentives in the compensation plan can be
dysfunctional?

-The committee completed an annual risk review and determined that the compensation program included

the following features to mitigate the risk (which the committee deemed as a low-risk program (page 66)):

Mix of pay elements, short-term and long-term programs, adjustments to compensation, compensation

committee oversight, multiple performance measures and stock ownership requirements. (Page 65)

7. If the measures turnout to be wrong, or misreported, does the company have a policy of trying to
recover the pay. For example, suppose the bonus depends on net income, and perhaps a year later, the
company discovers that the net income was incorrectly reported. Does the company have a policy of trying
to recover the pay?

-The company does have a clawback policy. The policy includes all executive officers and certain
circumstances includes approximately 275 senior leaders. The committee is empowered to recoup
compensation paid to executive officers. In the event of misconduct that causes damage to the reputation,
material inaccuracy, or accounting restatement the committee may seek to clawback incentive compensation.
The committee may also cancel any outstanding equity-based awards to the employee. (Page 66) the policy is
publicly available here: investor.gm.com/resources

8. The tax code, Section 162(m), mostly limits deductions for management compensation to $1 million. Is
the company seemingly influenced by the tax code limit on deductibility, or is the company mainly
concerned with compensation and not the tax deductibility?

-The committee choses to align itself to executive pay with performance, regardless of the performance-based

exception being removed under IRS Section 162(m) (Page 67). The company pays executives according the

compensation committee’s sense of incentivizing, and does not consider whether the pay will be deductible

for tax purposes.

Management compensation-both companies

Overview: Select two companies. They should have DEF14A or a similar filing on the SEC’s

website: sec.gov

For both companies that you selected, evaluate the extent to which accounting influence

management compensation of your companies.

For example, DESTINATION XL GROUP, INC, states that “The performance targets [for

the CEO] included Corporate targets (Sales and Adjusted EBITDA)…”

So, Sales is clearly is an accounting figure directly from the Income Statement. The other

figure is EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) and it is

“Adjusted” for events that the compensation committee believes do not relate to management

performance. These amounts, Earnings, Interest, Taxes, Depreciation, and Amortization are

clearly accounting figures from the Income Statement. The committee excludes Interest,

Taxes, Depreciation, and Amortization from the Earnings when they decide how well the CEO

has performed. As an aside, it seems to me that the CEO can influence these amounts. The

CEO might well be able to raise capital through debt increasing interest and encourage

aggressive tax positions, but these decisions to increase interest or be aggressive with taxes

are not part of the CEO’s performance metric.

Background: The point of this project is to develop some knowledge about financial reporting and its

role in how compensation committees pay top management. This includes knowing what factors the

committee uses in deciding whether the management did a good job or not and what forms the pay

comes in (cash salary, cash bonus, options, restricted stock, other). Please inspect the report of the

compensation committee in the proxy statement for your company. The proxy may be available on

the website of the company. Alternatively, if you are looking at the SEC’s website, the form is titled,

“DEF14A, Other Definitive Proxy Material.”

The “Report of the compensation committee” will usually describe what they look at when deciding

how to reward management. This section might also be titled, “How executive pay levels are

determined.” Please read the report of the compensation committee carefully. There are two parts to

the project. The first is to describe all the data items that the committee uses to determine how to

compensate the executives. The second is to find out how much the CEO makes and what forms the

compensation takes.

When you find out what the compensation committee looks at to decide whether management did a

good job or not, describe whether (1) each data item is drawn from the financial statements, (2) is not

drawn from the financial statements, or (3) is an adjusted figure or hybrid based on financial

statement information but not the same as the reported information.

If the data item is drawn from financial statements, state which statement(s) is (are) involved. For

example, Net Income and Earnings Per Share are drawn from the Income Statement. If the

compensation committee using EPS to evaluate management, then state that, and note that the figure

is drawn from the Income Statement. If the data item does not come from a financial statement

provide a guess about where the information comes from. Include a breakdown of the components of

pay. For example, an executive that makes $1 million in salary, and a bonus of $4 million, and is

granted stock options valued at $5 million, makes a total of $10 million. The factors used to

determine bonuses, for example, would vary widely. Here are three examples of factors used:

Return on assets. This is usually some form of Income divided by Assets. This is drawn from

the accounting reports. The Income is taken from the Income Statement, and Assets is found on

The two companies are Carrier Global and Burger King

the Statement of Financial Position (the balance sheet). If the compensation committee adjusts

income, be certain to describe the adjustments. Typical adjustment would include the effect of

mergers, restructuring costs, restatements, or unusual items. Describe the probable effect of the

adjustments on income and the bonus.

For example, Pfizer uses a figure they call Adjusted Income. I would describe that amount as a

hybrid figure, with the accounting part being drawn from the income statement. They start with Net

Income, but they add to and subtract items from Net Income to arrive at the figure the

compensation committee uses

Increases in stock price. Financial statements do not record the increase in market price of

a company’s stock. This is not part of the basic financial statements, so it is not an

accounting item. Instead it is drawn from observing the market price on a traded exchange.

Required: The rubric describes the requirements that are due for each company. This is a

written project. I imagine that it can be completed in about three pages per company.

Last question is do the CEO/President of each company receive bonuses based on financial performances.

The exact rubric is

Rubric

Management Compensation Report for each company

Criteria Pts

State the name of the CEO

1 pts

State which accounting firm audits the financial statements.

There are four large accounting firms: PriceWaterhouseCoopers, Deliotte, KPMG, and Ernst and

Young. They audit most publicly traded companies, but not all.

1 pts

State the accounting firm’s opinion about the financial statements.

A clean opinion would be when the accounting firm states that the financial statements “fairly

present” the results in accordance to Generally Accepted Accounting Standards. Some companies

might use International Financial Reporting Standards

1 pts

State which standards the company uses to evaluate internal control over financial reporting

processes.

The most common would be the Internal Control–Integrated Framework issued by the Committee of

Sponsoring Organizations of the Treadway Commission (2013 framework).

2 pts

State whether the management believes that the internal control has been effective. Sometimes

management will state that internal control had some deficiencies.

2 pts

State how the components of the CEO pay is divided.

(for example, salary, bonus, and long-term)
2 pts

State the reasons (the objective) the compensation committee gives for dividing the compensation in

the way they divide it.

Here’s an example: [The compensation plan] balances short- and long-term objectives to focus our

executives on actions that create value today, while building for sustainable future success.

Approximately 90% of our pay is performance-based, directly tying a significant portion of executive

compensation to Company performance and shareholder returns. Our compensation program is

market-based (to ensure our ability to attract and retain talented executives) and produces

compensation outcomes that are performance-based (to incent the achievement of profitable growth

that increases shareholder value).

5 pts

State whether the compensation committee is composed of independent directors 2 pts

Did the compensation committee use an outside consultant to help set the compensation?

Typical consultants might be Meridian Compensation Partners, Pearl Meyer & Partners, Aon plc

(Radford), Longnecker & Associates, and Compensia, Inc

2 pts

Management Compensation Report for each company

Criteria Pts

For any salary component, state how the compensation committee determines the salary.

Examples: “approximately the median for comparable companies,” “competitive with other

comparable executive officer salaries”, “to attract high quality executive talent,” “market

competitiveness, and the specific roles and responsibilities, experience, expertise and individual

performance throughout their tenure.”

3 pts

For any performance component, state how the compensation committee determines the performance

component.

A company might have a short term incentive plan (a bonus) and a long term incentive plan.

3 pts

For any non-performance component, state how the compensation committee determines the

component.

The compensation committee may make equity awards to management that are not specifically tied to

performance. When the report states “make equity awards” they mean shares of stock. The awards

might be made with the intention of having management’s personal wealth go up and down the same

way the investors’ wealth goes up and down, helping them to identify with the shareholders.

2 pts

State whether accounting is used in any of the components to determine compensation.

Examples might include

Income Before Interest Taxes Depreciation and Amortization, IBITDA

Return on Assets

Adjusted Earnings Per Share

In these examples, the raw figures from the financial statements are used in an adjusted way. For

example, in IBITDA, the net income is a starting point, but a variety of expenses are deleted before

evaluating the CEO. Adjusted Earnings Per Share might start with EPS, but if a subsidiary was

acquired or sold off (or shares of stock issued or repurchased), the EPS might be reconstructed to be

in line with the target EPS that the company had set out as a goal for the CEO.

Examples that are not based on accounting include measures like Total Return. Total Return might be

defined as the increase in the market price of the Company’s Common Shares plus dividends declared

thereon and assuming such dividends are reinvested into the Company’s Common Shares. A measure

like that is based on what happens in the market and not on the financial accounting reports.

5 pts

State which financial statement(s) the performance measure comes from, if it comes from a financial

statement 3 pts

State whether the company limits CEO compensation to the amount that is deductible under the tax

law. If not, how does the company justify paying more than is deductible.

The company might state: The Compensation Committee believes that our interests and those of our

stockholders are best served by providing competitive levels of compensation, even if not

fully deductible, so some of the compensation that we have provided to our Named Executive Officers

in the past, and that we provide to our executive officers in the future, may not be deductible under

Code Section 162(m)

3 pts

Management Compensation Report for each company

Criteria Pts

State whether the company has a provision for recovering bonus pay in the event of an error or

irregularity in the award computation. They probably call it a clawback provision.

Merck states this: Return of Incentive Compensation (“Clawback Policy”) Under our incentive

compensation recoupment policy, the Board will seek reimbursement for the annual cash incentive

and/or LTI awards paid to the executive, where the Board determines (a) the executive engaged in

misconduct that resulted in a material violation relating to (i) the research, development,

manufacturing, sales or marketing of the Company’s products or (ii) the overall goodwill or reputation

of the Company (the latter of which was added and approved by the C&MD Committee in November

2021), or (b) a significant restatement of financial results has occurred. In the event of a financial

restatement, the portion of the annual cash incentive and/or PSUs paid to the executive, in excess of

the amount that would have been paid if the financial results were reported accurately, will be

recouped.

0 pts

No

Mark

s

3 pts

Total Points: 40