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Prepared byCoby Harmon

University of California, Santa Barbara

IntermediateAccounting

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Intermediate Accounting

14th Edition

24 Full Disclosure inFinancial Reporting

Kieso, Weygandt, and Warfield

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1. Review the full disclosure principle and describe implementationproblems.

2. Explain the use of notes in financial statement preparation.

3. Discuss the disclosure requirements for major business segments.

4. Describe the accounting problems associated with interim reporting.

5. Identify the major disclosures in the auditors report.

6. Understand managements responsibilities for financials.

7. Identify issues related to financial forecasts and projections.

8. Describe the professions response to fraudulent financial reporting.

Learning Objectives

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Accountingpolicies

Commonnotes

Full Disclosure

Principle

Notes to

Financial

Statements

Disclosure

Issues

Auditors and

Managements

Report

Current

Reporting

Issues

Increase inreportingrequirements

Differentialdisclosure

Specialtransactionsor events

Post-balance-sheet events

Diversified

companies

Interimreports

Auditors

report

Managements

reports

Reporting onforecasts andprojections

Internet financialreporting

Fraudulent

financialreporting

Criteria foraccounting andreportingchoices

Full Disclosure in Financial Reporting

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Full disclosure principlecalls for financial reporting of anyfinancial facts significant enough to influence the judgment

of an informed reader.

Financial disasters at Microstrategy, PharMor, WorldCom,andAIG highlight the difficulty of implementing the full

disclosure principle.

LO 1 Review the ful l disc los ure pr inc ip le and descr ibe implementat ion prob lems.

Full Disclosure Principle

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24-6 LO 1 Review the ful l disc los ure pr inc ip le and descr ibe implementat ion prob lems.


Illustration 24-1

Types of FinancialInformation

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24-7

Increase in Reporting Requirements

Reasons:

Complexity of business environment.

Necessity for timely information.

Accounting as a control and

monitoring device.



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Differential Disclosure



Big GAAP versus Little GAAP.

FASB takes the position that there should be one set ofGAAP.

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Notes are the means of amplifying or explaining the itemspresented in the main body of the statements.

LO 2 Expla in the use of notes in f inancia l statement preparation.

Notes to the Financial Statements

Accounting Policies

Companies should present a statement identifying the accounting

policies adopted (Summary of Significant Accounting Policies).

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24-10 LO 2 Expla in the use of notes in f inancia l statement preparation.


Which of the following should be disclosed in a Summary ofSignificant Accounting Policies?

a. Types of executory contracts.

b. Amount for cumulative effect of change in accounting

principle.

c. Claims of equity holders.

d. Depreciation method followed.

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Common Notes

Inventory

Property, Plant, and Equipment

Creditor Claims

Equityholders Claims

Contingencies and Commitments

Fair Values

Deferred Taxes, Pensions, and Leases

Changes in Accounting Principles



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Disclosure of Special Transactions or Events

Related-party transactions

Nature of relationship.

A description of the transactions for each of the

periods for which income statements are presented.

Dollar amounts of transactions for each of the

periods for which income statements are presented.

Amounts due from or to related parties.

Errors and fraud.


Disclosure Issues

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Post-Balance Sheet-Events (SubsequentEvents)


Disclosure Issues

1 - Events that provide additionalevidence about conditions that

existed at the balance sheet date.

2 - Events that provideevidence about conditions that

did not exist at the balance

sheet date.

Illustration 24-3

Time Periods forSubsequent Events

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______ 1. Settlement of federal tax case at a cost considerably in

excess of the amount expected at year-end.

______ 2. Introduction of a new product line.

______ 3. Loss of assembly plant due to fire.

______ 4. Sale of a significant portion of the companys assets.

______ 5. Retirement of the company president.

______ 6. Issuance of a significant number of ordinary shares.

E24-2 (Post-Balance-Sheet Events): For each of the followingsubsequent events, indicate whether a company should (a)adjust the

financial statements, (b)disclose in notes to the financial statements, or

(c)neither adjust nor disclose.


Disclosure Issues

a

c

b

b

c

b

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24-16 LO 2 Expla in the use of notes in f inancia l statement preparation.

Disclosure Issues

______ 7. Loss of a significant customer.

______ 8. Prolonged employee strike.

______ 9. Material loss on a year-end receivable because of a

customers bankruptcy.

______ 10. Hiring of a new president.

______ 11. Settlement of prior years litigation.

______ 12. Merger with another company of comparable size.

c

c

a

c

a

b

E24-2 (Post-Balance-Sheet Events): For each of the followingsubsequent events, indicate whether a company should (a)adjust the

financial statements, (b)disclose in notes to the financial statements, or

(c)neither adjust nor disclose.

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Reporting for Diversified Companies

LO 3

Disclosure Issues

Investors and investment analysts income statement, balance

sheet, and cash flow information on the individual segments

that compose the total income figure.

Illustration 24-5

Segmented Income

Statement

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Objective of Reporting Segmented Information

LO 3 Discuss the disc los ure requirements for major business segments.

Disclosure Issues

To provide information about the different types of business

activitiesin which an enterprise engages and the different

economic environmentsin which it operates.

Meeting this objective will help users:

a) Better understand the enterprises performance.

b) Better assess its prospects for future net cash flows.

c) Make more informed judgments about the enterprise as a

whole.

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Basic Principles


Disclosure Issues

GAAPrequires that general-purpose financial statements

include selected information on a single basis of segmentation.

A company can meet the segmented reporting objective byproviding financial statements segmented based on how the

companys operations are managed (management

approach).

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Identifying Operating Segments


Disclosure Issues

An operating segment is a component of an enterprise:

a. That engages in business activities from which it earns

revenues and incurs expenses.

b. Whose operating results are regularly reviewed by the

companys chief operating decision maker.

c. For which discrete financial information is available.

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Quantitative Materiality Test: Must satisfy oneto determine

whether the segment is significant enough to warrant actual

disclosure.

1. Its revenue is 10 percent or more of the combined revenue of all

the companys operating segments.

2. The absolute amount of its profit or loss is 10 percent or more of

the greater, in absolute amount, of (a) the combined operating

profit of all operating segments that did not incur a loss, or (b) the

combined loss of all operating segments that did report a loss.

3. Its identifiable assets are 10 percent or more of the combined

assets of all operating segments.

LO 3

Disclosure Issues


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Quantitative Materiality Test: In applying these tests, the

company must consider two additional factors.

1. Segment data must explain a significant portion of thecompanys business. Specifically, the segmented results must

equal or exceed 75 percent of the combined sales to

unaffiliated customers for the entire company.

2. The FASB decided that 10 is a reasonable upper limit for thenumber of segments that a company must disclose.

LO 3

Disclosure Issues



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Materiality Test Illustration

LO 3

Disclosure Issues

10%*2150=215 c,d,e meet test

10%x90=9 (note 5 loss is ignoredA,C,D,E meet this test

10%x 970 =97 ,c,d,e meet this test

Reporting segments are therefore A, C, D, and E, assuming that these four

segments have enough sales to meet the 75 percent of combined sales test.

Illustration 24-6

Data for Different PossibleReporting Segments

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24-24LO 3

Disclosure Issues


Materiality Test Illustration

The 75 percent test is computed as follows.

75% of combined sales test: 75% x $2,150 = $1,612.50. The sales of A,

C, D, and E total $2,000 ($100 + $700 + $300 + $900); therefore, the 75

percent test is met.

Illustration 24-6

Data for Different PossibleReporting Segments

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Segmented Information Reported


Disclosure Issues

1. General information about operating segments.

2. Segment profit and loss and related information.

3. Segment assets.

4. Reconciliations.

5. Information about products and services and geographic

areas.

6. Major customers.

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24-26 LO 3 Discuss the disc los ure requirements for major business segments.

Disclosure Issues

Revenue of a segment includes

a. only sales to unaffiliated customers.

b. sales to unaffiliated customers and intersegment

sales.

c. sales to unaffiliated customers and interest

revenue.

d. sales to unaffiliated customers and other revenueand gains.

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24-27 LO 3 Discuss the disc los ure requirements for major business segments.

Disclosure Issues

The profession requires disaggregated information in thefollowing ways:

a. products or services.

b. geographic areas.

c. major customers.

d. all of these.

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Interim Reports

LO 4 Descr ibe the account ing p roblems assoc iated with inter im report ing.

Disclosure Issues

Cover periods of less than one year.

Two viewpoints exist:

1. Discreteapproach

2. Integralapproach

Companies should use the same accounting principles forinterim reports that they use for annual reports.

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Unique Problems of Interim Reporting

LO 4 Descr ibe the account ing p roblems assoc iated with inter im report ing.

Disclosure Issues

(1) Advertising and similar costs

(2) Expenses subject to year-end adjustment

(3) Income taxes

(4) Extraordinary items

(5) Earnings per share

(6) Seasonality

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24-30 LO 4 Descr ibe the account ing p roblems assoc iated with inter im report ing.

Disclosure Issues

In considering interim financial reporting, how does theprofession conclude that such reporting should be viewed?

a. As a "special" type of reporting that need not follow

generally accepted accounting principles.b. As useful only if activity is evenly spread throughout the

year so that estimates are unnecessary.

c. As reporting for a basic accounting period.

d. As reporting for an integral part of an annual period.

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Illustration 24-13

Auditors Report

Auditors and Managements Reports

Auditors Report

Unqualified Opinion

auditor expresses the

opinion that the financial

statements are presented

fairly in accordance with

GAAP. Other opinions:

Qualified

Adverse

Disclaim

LO 5

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24-32 LO 5 Identify the major disclosures in the auditors report.


Certain circumstances, although they do not affect the

auditors unqualified opinion, may require the auditor to add

an explanatory paragraphto the audit report.

Going Concert

Lack of Consistency- apple to apple

Emphasis of a Matter-

Auditors Report

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Qualified opinioncontains an exception to the standard

opinion. Usual circumstances may include:

1. Scope limitation.

2. Statements do not fairly present financial position or

results of operations because of:

a. Lack of conformity with GAAP.

b. Inadequate disclosure.


LO 5 Identify the major disclosures in the auditors report.

Auditors Report

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24-35 LO 5 Identify the major disclosures in the auditors report.


The MD&A section of a company's annual report is to cover the

following three items:

a. income statement, balance sheet, and statement of

owners' equity.

b. income statement, balance sheet, and statement of cash

flows.

c. liquidity, capital resources, and results of operations.d. changes in the stock price, mergers, and acquisitions.

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24-36 LO 6 Understand managements responsibilities for financials.


Managements Responsibilities for FinancialStatements

The Sarbanes-Oxley Act requires the SEC to develop

guidelines for all publicly traded companies to report on

managements responsibilities for, and assessment of, the

internal control system

----Management have the responsibility what GAAP they

want to choose.

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24-37 LO 7 Ident i fy issues related to f inancia l forecasts and project ions.

Current Reporting Issues

Reporting on Financial Forecasts andProjections

Financial forecastis a set of prospective financial statements

that present, a companys expected financial position, results of

operations, and cash flows.

Financial projectionsare prospective financial statements

that present, given one or more hypothetical assumptions, an

entitys expected financial position, results of operations, andcash flows. Regulators have established a Safe Harbor Rule.

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Which of the following best characterizes the difference between a

financial forecast and a financial projection?

a. Forecasts include a complete set of financial statements, while

projections include only summary financial data.

b. A forecast is normally for a full year or more and a projectionpresents data for less than a year.

c. A forecast attempts to provide information on what is expected to

happen, whereas a projection may provide information on what is

not necessarily expected to happen.d. A forecast includes data which can be verified about future

expectations, while the data in a projection is not susceptible to

verification.

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Internet Financial ReportingA large proportion of companies websites contain links to their

financial statements and other disclosures.

Allows firms to communicate more easily and quickly withusers.

Allow users to take advantage of tools such as search

engines.

Can help make financial reports more relevant by allowing

companies to report expanded disaggregated data.

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24-40 LO 8 Describe the professions response to fraudulent financial reporting.


Fraudulent Financial ReportingIntentional or reckless conduct, whether through act or omission,

that results in materially misleading financial statements.

Frauds involving such well-known companies as Enron,WorldCom, Adelphia, and Tycoindicate that more must be

done to address this issue.

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24-41 LO 8 Describe the professions response to fraudulent financial reporting.


Fraudulent Financial Reporting

Causes of Fraudulent Financial Reporting

Common causes are the desire

to obtain a higher stock price,

to avoid default on a loan covenant, or

to make a personal gain of some type (additional

compensation, promotion).

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24-43 LO 9 Understand the approach to f inancial statement analysis.

Perspective on Financial Statement AnalysisA logical approach to financial statement analysis is necessary,

consisting of the following steps.

1. Know the questions for which you want to find answers.

2. Know the questions that particular ratios and comparisons

are able to help answer.

3. Match 1 and 2 above. By such a matching, the statementanalysis will have a logical direction and purpose.

APPENDIX24A BASIC FINANCIAL STATEMENT ANALYSIS

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24-44 LO 9 Understand the appro ach to f inancial statement analysis.

Analysis includes an understanding that

1. Financial statements report on the past.

2. Single ratio by itself is not likely to be very useful.

3. Awareness of the limitations of accounting numbers used in

an analysis.

Perspective on Financial Statement Analysis


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24-45 LO 10 Identify major analyt ic ratios and describ e their calculation.

Ratio Analysis


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Illustration 24A-1

LO 10 Identify major analyt ic ratios and describ e their calculation.

Ratio Analysis


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Illustration 24A-1


Ratio Analysis


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Illustration 24A-1


Ratio Analysis


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Illustration 24A-1


Ratio Analysis


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24-50 LO 11 Explain the limitat ion s of ratio analysis.

Based on historical cost.

Use of estimates.

Achieving comparability among firms in a given industry.

Substantial amount of important information is not

included in a companys financial statements.

Limitations of Ratio Analysis


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24-51 LO 12 Descr ibe techniques of comparat ive analysis.

Illustration 24A-2Comparative Analysis


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24-52 LO 13 Describ e techn iques of percentage analysis .

Percentage (Common Size) Analysis


Illustration 24A-3

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24-53 LO 13 Describ e techn iques of percentage analysis .

Percentage (Common Size) Analysis


Illustration 24A-4

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RELEVANT FACTS

Due to the broader range of judgments allowed in more principles-

based IFRS, note disclosures generally are more expansive under

IFRS compared to GAAP.

GAAP and IFRS have similar standards on post-statement offinancial position (subsequent) events. That is, under both sets of

standards, events that occurred after the statement of financial

position date, and which provide additional evidence of conditions

that existed at the statement of financial position date, are

recognized in the financial statements. Subsequent events underIFRS are evaluated through the date that financial instruments are

authorized for issue. GAAP uses the date when financial

statements are issued. Also, for share dividends and splits in the

subsequent period, IFRS does not adjust but GAAP does.

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RELEVANT FACTS

Like GAAP, IFRS requires that for transactions with related parties,

companies disclose the amounts involved in a transaction; the

amount, terms, and nature of the outstanding balances; and any

doubtful amounts related to those outstanding balances for each

major category of related parties.

Following the recent issuance of IFRS 8, Operating Segments, the

requirements under IFRS and GAAP are very similar.

Neither GAAP nor IFRS require interim reports. Rather, the SEC and

stock exchanges outside the United States establish the rules. In the

United States, interim reports generally are provided on a quarterly

basis; outside the United States, six-month interim reports are

common.

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Subsequent events are reviewed through which date under IFRS?

a. Statement of financial position date.

b. Sixty days after the year-end date.c. Date of independent auditors opinion.

d. Authorization date of the financial statements.

IFRS SELF-TEST QUESTION

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Under IFRS, share dividends declared after the statement of financial

position date but before the end of the subsequent events period are:

a. accounted for similar to errors as a prior period adjustment.

b. adjusted subsequent events, because they are paid from prior

year earnings.

c. not adjusted in the current years financial statements.

d. recognized on a prospective basis from the date of declaration.

IFRS SELF-TEST QUESTION

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