chapter 17 financial reporting disclosure requirements and ethical responsibilities
TRANSCRIPT
CHAPTER 17FINANCIAL REPORTING
DISCLOSURE REQUIREMENTS
ANDETHICAL
RESPONSIBILITIES
Financial Statement Disclosure
Chapter focuses on the special importance of disclosure in financial reporting.
Disclosure requirements issued by:
1. FASB2. SEC
SFAC No. 5
outlines the various methods of disclosure
that corporations should utilize in published
financial statements
Financial Stmts
Stmt of Earnings &Comprensive Income
Stmt of Financial Position
Stmt of Cash Flows
Stmt of Investments by & Distributions to
Owners
Scope of Recognition & Measurements
Concepts Stmts
Notes to Financial Stmts
Examples:
Accounting Policies
General Information about the company
Basic Financial Statements
SupplementaryInformation
Examples:
SegmentInformation
Auditor’sReport
Area directly affected by existing FASB standards
Other Means ofFinancialReporting
Examples:
MD&A
Notes
Financial Reporting
All information useful for investment, credit, and similar decisions
Other Information
Examples:
Analysts’ Reports
Discussion of competition
Relationship of SFAC No. 5 to Other Method of Financial Reporting (Adapted)
Summarizes the building blocks to disclosure as:
1. The scope of recognition and measurement
2. Basic financial statements
3. Areas directly affected by existing FASB standards
4. Financial reporting
5. All information useful for investment, credit and similar decisions
SFAC No. 5
The Scope of Recognition and Measurement
Discussed earlier throughout the text.
Financial Statements
The financial statements described in SFAC No. 5 were discussed previously in chapters 4 and 5.
In addition to the four basic statements, a full set of financial statements also includes
supplementary schedules
parenthetical
disclosuresfootnotes
Footnotes
The most common examples of footnotes are:
1. Accounting policies 2. Schedules and exhibits
Example: schedules or exhibits concerning long-term debt and income tax
3. Explanations of financial statement items Example: Pensions and post-retirement benefits
4. General information about the company
Accounting Policies
Typically, companies disclose this information in a Summary of Significant Accounting Policies preceding the footnotes.
APB Opinion No. 22 requires all companies
to disclose the accounting policies
the firm follows and the methods it uses
in applying these policies.
Accounting Policies
The APB‘s principal objective in issuing Opinion No. 22: to provide information
that helps investors compare firms across and between industries.
APB Opinion No. 22 requires that the accounting
methods and procedures involving the following be disclosed:1. A selection from existing
acceptable alternatives.2. Principles and methods peculiar
to the industry in which the reporting entity operates.
3. Unusual or innovative applications of generally accepted accounting principles.
Subsequent Events During the period between the end of a
company’s fiscal year and the issuance of its financial statements, events might occur that aren’t reflected in its accounting records.
May be either Events that provide further evidence of
conditions that existed on the balance sheet date GAAP requires these to be reported in financials
Events that provide evidence of conditions that did not exist at the balance sheet date GAAP requires no adjustment to financials
Areas Directly Affected by Existing FASB Standards: Supplementary Information
Supplementary information may be mandated by the FASB or the SEC.
Examples of supplementary information include:
1. Segment information (Chapter 16)
2. The effects of price-level changes
3. The auditor’s report
4. Interim financial reports
Price Level Information
High level of inflation experienced in the United States during the 1970s caused concerns that financial statements were being distorted.
Result SEC ASR No. 190 FASB SFAS No. 33 Both pronouncements required the disclosure of
supplemental information on the effects of changing prices in the 10-K and annual report to stockholders.
Disclosures generally made in separate schedules. Later, after inflation subsided in the 1980s, these
requirements were suspended
Auditor’s Certificate Informs users of the reliability of the
financial statements The following guidelines for preparing the
auditor’s report were developed by the AICPA: Should state whether the financial statements are presented in
accordance with generally accepted accounting principles. Must identify those circumstances in which such principles have
not been consistently observed in the current period in relation to the preceding period.
Informative disclosures in the financial statements are to be regarded as reasonably adequate unless otherwise stated in the report.
The report shall either contain an expression of opinion regarding the financial statements taken as a whole, or an assertion to the effect than an opinion cannot be expressed.
Auditor’s Certificate
Types of opinions: Unqualified Qualified Disclaimer Adverse
Interim Financial Statements Two views
APB conclusion - adopted integral view
Integral view Interim periods are an integral
part of the annual period Thus revenues and expenses
might be allocated to various interim periods even though they occurred only in one period.
Discrete view Each interim period is a
separate accounting period Income should be determined
in the same manner as for the annual period
Thus revenues and expenses should be reported as they occur.
Financial Reporting: Other Means of Financial Reporting
Other relevant information can assist in understanding the financial
report presented in narrative form
Examples: 1. Management’s discussion and
analysis
2. Letter to stockholders
Management’s Discussion and Analysis
Required by the SEC Explains the reasons for a company’s
performance during the preceding annual period, including: Liquidity, capital resources and results of
operations Favorable and unfavorable trends Significant events and uncertainties
Management’s Discussion and Analysis
Designed to allow financial statement users to assess the likelihood that past performance is indicative of future performance
Contains estimates that are protected by “safe harbor” clause
Management’s Discussion and Analysis
SEC also requires disclosure of qualitative and quantitative information about market risk by all companies registered with the SEC
Market risk: the risk of loss arising from adverse changes in market rates and prices from such items as:
1. Interest rates2. Currency exchange rates3. Commodity prices4. Equity prices
Management’s Discussion and Analysis
The quantitative information about market risk sensitive instruments is to be disclosed by using one or more of the following alternatives:
1. Tabular presentation of fair value information and contract terms relevant to determining future cash flows, categorized by expected maturity dates
2. Sensitivity analysis expressing the potential loss in future earnings, fair values, or cash flows from selected hypothetical changes in market rates and prices
3. Value at risk disclosures expressing the potential loss in future earnings, fair values, or cash flows from market movements over a selected period of time and with a selected likelihood of occurrence
Management’s Discussion and Analysis
Objective of the quantitative disclosure requirements
provide investors with forward looking information about a registrant's potential exposures to market risk
Registrants are required to categorize market risk sensitive instruments into
instruments entered into for trading purposes, and
instruments entered into for purposes other than trading
Management’s Discussion and Analysis
Specifically, companies must disclose:1. Their primary market risk exposures
at the end of the current reporting period
2. How they manage those exposures such as a description of the objectives general strategies and instruments, if any, used to manage those exposures
3. Changes in a) either the primary market risk exposures b) or how those exposures are managed…when compared to the most recent reporting period and what is known or expected in future periods
Letter To Stockholders
Four main purposes. It indicates that management:
1. Is responsible for preparation and integrity of statements
2. Has prepared statements in accordance with GAAP
3. Has used their best estimates and judgment
4. States that the company maintains a system of internal controls
All Information Useful for Investment, Credit and Similar Decisions: Other Information Includes information about companies Also available outside the company’s
annual report and 10-K. Examples of these types of information
include 1. Analysts’ reports
2. News articles about the company.
Analysts’ Reports
Individual investors make essentially three investment decisions
Usually accomplished by fundamental analysis as discussed in Chapter 3
Buy
Hold
Sell
Potential investor decides to purchase a particular security on the basis of all available disclosed information
Investor decides to retain a particular security basis of all available disclosed information
Investor decides to dispose of a particular security basis of all available disclosed information
Analysts’ Reports
Investment analysis may also be made by professional security analysts
frequently specialize in certain industries use their training and experience to process and disseminate
information more accurately and economically than individual investors 3 categories of financial analysts:
1. Sell side - Work for full-service broker dealer and make recommendations on securities they cover
2. Buy side -Work for institutional money managers such as mutual funds that purchase securities for their own accounts. Counsel their companies to buy, hold and sell
3. Independent - Not associated with firms that underwrite the securities they cover. Often sell their recommendations on a subscription basis
Analysts’ Reports
Many analysts work in a world of built-in conflicts of interest and competing pressures
Sell-side firms want their individual investor clients to be successful over time because satisfied long-term investors are the key to the firm’s reputation and success
Analysts’ Reports
Several factors can create pressure on an analyst’s independence and objectivity An analysts’ firm may be underwriting a company’s
securities offering and client firms prefer favorable research reports
Positive reports can generate additional clients and revenues
Arrangements frequently tie compensation to continuation of clients
Analysts may own securities individually or they may be owned by the analyst’s firm
SEC Disclosure Requirements
The Securities Act of 1933 (Going Public) Registration statement Prospectus
The Securities Exchange Act of 1934 (Being Public) Form 10, 10K and 10Q
The Foreign Corrupt Practices Act 0f 1977
The Sarbanes-Oxley Act of 2002
Foreign Corrupt Practices Act of 1977
Provisions:1 Makes it a criminal offense to offer
bribes to foreign officials2 Requires detailed financial
records and a system of internal control
The Sarbanes-Oxley Act of 2002 Early 2000s: dozens of
major corporations either went bankrupt or faced extreme financial difficulties
Included Enron WorldCom Xerox Global Crossing Arthur Andersen Merrill Lynch Tyco International Halliburton Oil Services.
Result: Americans lost billions of
their investment dollars jobs vanished thousands of people lost
their entire retirement savings
Subsequently, corporate reform became a watchword
The Sarbanes-Oxley Act of 2002 Congress passed in 2002 Major provisions are:
1. The creation of a Public Company Accounting Oversight Board (PCAOB)
2. The Establishment of Auditing, Quality Control, and Independence Standards
3. The Inspection of CPA Firms 4. The Establishment of Accounting Standards 5. The Delineation of Prohibited Services 6. Prohibition of Acts that Influence the Conduct of
an Audit 7. Requiring Specified Disclosures 8. Requiring CEO and CFO Certification
The Sarbanes-Oxley Act of 2002: Sec. 404 Controversial
404(a) Management’s responsibilities Internal control report by management
Establishing and maintaining Assessment
404(b) Independent auditor’s responsibility
Report on management’s internal control assessment
Assessment of company’s internal controls on financial reporting
2 separate opinions required
Ethical Responsibilities
What is ethics? Difference between morals
and ethics Professions are different Western ethics is based on the concept of
utilitarianism Professional ethics proscribes a duty that
goes beyond the ordinary citizen
Ethical Conduct of Accountants
Ethical issues for accountants1 Independence2 Scope of service3 Confidentiality4 Practice development5 Differences on accounting issues
Framework for Analysis of Ethical Issues
Obtain the relevant facts Identify the ethical issues Determine the individuals
or groups affected Identify possible alternative
solutions Determine how various individuals or groups
are affected by alternative decisions Decide on appropriate action
The Ethical-Legal Question
Just because something is legal it is not necessarily ethical
AICPA Code of Professional Conduct
1 The AICPA represents itself as an ethical professional body practicing an art rather than a science
2 Accounting should be viewed as practicing a service function rather than as a profit-making function
3 As an art, accounting requires judgment which encompasses ethical conduct
4 To assist in satisfying its responsibilities to society, the accounting profession has developed a code of professional conduct
AICPA Code of Professional Conduct
Society viewed accounting favorably until the late 1960s Watergate Accountants argued they shouldn’t be held responsible
because
these activities were difficult if not impossible to discover during a normal audit
and not material in many cases anyway Also concern over audit failures for such
companies as Penn Central, National Student Marketing and Equity Funding
AICPA Code of Professional Conduct
The role of Congress and Congressmen Moss and Dingle1 Were the rules deficient?2 Were the qualifications to be a CPA sufficient?3 Was self-policing working?
In response the Cohen Commission The Expectations Gap
AICPA Code of Professional Conduct
The Anderson Report indicated that efficient performance should meet six criteria:1 Safeguard public interest2 Recognize CPA’s paramount role in the
financial reporting process3 Help assure quality performance and eliminate
substandard performance4 Help assure objectivity and integrity in public
service5 Enhance CPA’s prestige and creditability6 Provide guidance as to proper conduct
AICPA Code of Professional Conduct
As a result new ethical standards were developed in response to the expectations gap
The effect was:
1 Broader auditor responsibility to consider reliability of internal control system in planning an audit
2 Delineate audit responsibility for reporting errors, irregularities and illegal acts by clients
3 Evaluate ability of a firm to continue as a going concern
AICPA Code of Professional Conduct
The new Code of Professional Conduct contains four sections:1 Principles
Responsibility The public interest Integrity Objectivity and independence Due care Scope and nature of services
2 Rules of conduct3 Interpretations4 Ethical rulings
AICPA Code of Professional Conduct
Overall the goal of the Anderson Report and the revised Code of Professional Conduct was to be more responsive to the public’s concern by providing1 Ethical guidance2 Broad positive statements3 Specific behavioral rules4 Proactive monitoring5 Broader rules application6 Guidance on dealing with the changing environment
The profession’s image by the public has suffered but has recently recovered.
International Accounting Standards
IAS No. 1
“Presentation of
Financial Statements”
Addressed disclosure
requirements and ethical
responsibilities
IAS No. 34 “Interim Financial Reporting”
Described the preferred format for interim financial statements
IAS No. 1: Presentation of Financial Statements Requires
companies to present a statement disclosing each item of income expense gain or loss
…required by other standards to be presented directly in equity
and the total of these items
Notes to the financial statements must present information
about the basis of preparation of the financial statements
and the specific accounting policies selected
must disclose all other information required by IASC standards not presented elsewhere in the financial statements
must provide all other information necessary for a fair presentation
IAS No 34:Interim Financial Reporting Does not specify which enterprises should
present interim financial reports left to be decided by laws or regulations
Adopts the discrete view U. S. GAAP which requires the integral view
The minimum content of an interim financial report is a condensed balance sheet condensed income statement condensed cash flow statement condensed statement of changes in equity explanatory notes.
Also requires disclosure of unusual events
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Prepared by Kathryn Yarbrough, MBA