chapter 24-1. chapter 24-2 c h a p t e r 24 full disclosure in financial reporting intermediate...

Chapter 24-1

Chapter 24-2

C H A P T E R C H A P T E R 2424

FULL DISCLOSURE IN FULL DISCLOSURE IN FINANCIAL REPORTINGFINANCIAL REPORTING

Intermediate Accounting13th Edition

Kieso, Weygandt, and Warfield

Chapter 24-3

Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

Chapter 24-4

Accounting Accounting policiespolicies

Common Common notesnotes

Full Full Disclosure Disclosure PrinciplePrinciple

Notes to Notes to Financial Financial

StatementsStatements

Disclosure Disclosure IssuesIssues

Auditor’s and Auditor’s and Management’s Management’s

ReportReport

Current Current Reporting Reporting

IssuesIssues

Increase in Increase in reporting reporting requirementsrequirements

Differential Differential disclosuredisclosure

Special Special transactions transactions or eventsor events

Post-balance-Post-balance-sheet eventssheet events

Diversified Diversified companiescompanies

Interim Interim reportsreports

Auditor’s Auditor’s reportreport

Management’s Management’s reportsreports

Reporting on Reporting on forecasts and forecasts and projectionsprojections

Internet financial Internet financial reportingreporting

Fraudulent Fraudulent financial financial reportingreporting

Criteria for Criteria for accounting and accounting and reporting reporting choiceschoices

Full Disclosure in Financial ReportingFull Disclosure in Financial ReportingFull Disclosure in Financial ReportingFull Disclosure in Financial Reporting

Chapter 24-5

Full disclosure principle calls for financial reporting of any financial facts significant enough to influence the judgment of an informed reader.

Financial disasters at Microstrategy, PharMor, WorldCom, and AIG highlight the difficulty of implementing the full disclosure principle.

LO 1 Review the full disclosure principle and describe implementation problems.

Full Disclosure PrincipleFull Disclosure PrincipleFull Disclosure PrincipleFull Disclosure Principle

Chapter 24-6 LO 1 Review the full disclosure principle and describe

implementation problems.


The full disclosure principle, as adopted by the accounting

profession, is best described by which of the following?

a. All information related to an entity's business and operating

objectives is required to be disclosed in the financial

statements.

b. Information about each account balance appearing in the

financial statements is to be included in the notes to the

financial statements.

c. Enough information should be disclosed in the financial

statements so a person wishing to invest in the stock of the

company can make a profitable decision.

d. Disclosure of any financial facts significant enough to influence

the judgment of an informed reader.

Chapter 24-7

ExamplesExamples

Accounting Accounting PoliciesPolicies

ContingenciesContingencies

Inventory Inventory MethodsMethods

Shares Shares OutstandingOutstanding

Alternative Alternative MeasuresMeasures

Financial Financial StatementsStatements

Notes to Notes to Financial Financial

StatementsStatements

Supplementary Supplementary InformationInformation

Other Means of Other Means of Financial Financial ReportingReporting

Other Other InformationInformation

Balance sheetBalance sheet

Statement of Statement of IncomeIncome

Statement of Statement of Cash FlowsCash Flows

Statement of Statement of Changes in Changes in Stockholders’ Stockholders’ EquityEquity

Examples:Examples:

Changing Changing Prices Prices DisclosuresDisclosures

Oil and Gas Oil and Gas Reserves Reserves InformationInformation

Examples:Examples: Management Management

Discussion Discussion and Analysisand Analysis

Letters to Letters to StockholdersStockholders

Examples:Examples: Competition Competition

and Order and Order Backlog in SEC Backlog in SEC FormsForms

Analysts' Analysts' reportsreports

Economic Economic StatisticsStatistics

ArticlesArticles



Basic Financial Basic Financial StatementsStatements

Affected by Existing FASB StandardsAffected by Existing FASB Standards

Financial Financial ReportingReporting

All Information Useful for Investment, Credit, and Similar All Information Useful for Investment, Credit, and Similar DecisionsDecisions

Illustration 24-1

Chapter 24-8

Increase in Reporting Requirements

Reasons:

Complexity of Business Environment.

Necessity for Timely Information.

Accounting as a Control and Monitoring Device.



Chapter 24-9

Differential Disclosure

“Big GAAP versus Little GAAP”.

FASB takes the position that there should be one set of GAAP.



Chapter 24-10

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

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

Notes to the Financial StatementsNotes to the Financial StatementsNotes to the Financial StatementsNotes to the Financial Statements

Accounting Policies

Companies should present a statement identifying the accounting policies adopted (Summary of Significant Accounting Policies).

Chapter 24-11 LO 2 Explain the use of notes in financial statement preparation.


Which of the following should be disclosed in a

Summary of Significant 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

Chapter 24-12

Common Notes

Inventory

Property, Plant, and Equipment

Creditor Claims

Equity Holders’ Claims

Contingencies and Commitments

Fair Values

Deferred Taxes, Pensions, and Leases

Changes in Accounting Principles



Chapter 24-13

Disclosure of Special Transactions or Events

Related-party transactions

Nature of relationship

Description of the transaction

Dollar amounts

Amounts due from or to related parties

Illegal acts


Disclosure IssuesDisclosure IssuesDisclosure IssuesDisclosure Issues

Chapter 24-14 LO 2 Explain the use of notes in financial statement preparation.


If a business entity entered into certain related party

transactions, it would be required to disclose all of the

following information except the

a. nature of the relationship between the parties to the

transactions.

b. nature of any future transactions planned between the

parties and the terms involved.

c. dollar amount of the transactions for each of the periods

for which an income statement is presented.

d. amounts due from or to related parties as of the date of

each balance sheet presented.

Chapter 24-15

Post-Balance-Sheet Events (Subsequent Events)



Illustration 24-4

1 - Events that provide additional evidence about conditions that existed at the balance sheet date.

2 - Events that provide evidence about conditions that did not exist at the balance sheet date.

Chapter 24-16

______ 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 company’s

assets.

______ 5. Retirement of the company president.

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

stock.

E24-2 (Post-Balance-Sheet Events): For each of the

following subsequent (post-balance-sheet) 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.



aa

ccbb

bb

ccbb

Chapter 24-17

E24-2 (Post-Balance-Sheet Events): For each of the

following subsequent (post-balance-sheet) 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.



______ 7. Loss of a significant customer.

______ 8. Prolonged employee strike.

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

customer’s bankruptcy.

______ 10. Hiring of a new president.

______ 11. Settlement of prior year’s litigation.

______ 12. Merger with another company of comparable size.

cc

cc

aa

cc

aa

bb

Chapter 24-18

Reporting for Diversified Companies

LO 3 Discuss the disclosure requirements for major business segments.


Investors and investment analysts income statement, balance sheet, and cash flow information on the individual segments that compose the total income figure.

Chapter 24-19

Objective of Reporting Segmented Information



To provide information about the different types

of business activities in which an enterprise

engages and the different economic

environments in which it operates.

A company can meet objective by providing

financial statements segmented based on how the

company’s operations are managed (Operating

Segment).

Chapter 24-20

Basic Principles



GAAP requires that general-purpose financial

statements include selected information on a single

basis of segmentation.

A company can meet the segmented reporting

objective by providing financial statements

segmented based on how the company’s operations

are managed (management approach).

Chapter 24-21

Identifying Operating Segments



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 company’s chief operating decision maker.

c. For which discrete financial information is available.

Chapter 24-22

Quantitative Materiality Test: Must satisfy one to

determines 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 company’s 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


Chapter 24-23

Quantitative Materiality Test:

In applying these tests, the company must consider two

additional factors.

1. Segment data must explain a significant portion of the

company’s 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 the number of segments that a company must

disclose.


LO 3



Chapter 24-24

Materiality Test Illustration

LO 3


Illustration 24-7

Solution on Solution on note pagenote page

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.

Chapter 24-25

Materiality Test Illustration

LO 3


Illustration 24-7


Chapter 24-26

Segmented Information Reported



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.

Chapter 24-27 LO 3 Discuss the disclosure requirements for major business

segments.


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

revenue and gains.

Chapter 24-28 LO 3 Discuss the disclosure requirements for major business

segments.


The profession requires disaggregated

information in the following ways:

a. products or services.

b. geographic areas.

c. major customers.

d. all of these.

Chapter 24-29

Interim Reports

LO 4 Describe the accounting problems associated with interim reporting.


Cover periods of less than one year.

Two viewpoints exist:

1. The discrete approach

2. The integral approach

Companies should use the same accounting

principles for interim reports that they use for

annual reports.

Chapter 24-30

Unique Problems of Interim Reporting

LO 4 Describe the accounting problems associated with interim reporting.


(1) Advertising and similar costs

(2) Expenses subject to year-end adjustment

(3) Income taxes

(4) Extraordinary items

(5) Earnings per share

(6) Seasonality

Chapter 24-31 LO 4 Describe the accounting problems associated with interim

reporting.


In considering interim financial reporting, how does the

profession 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.

Chapter 24-32 LO 5 Identify the major disclosures in the auditor’s report.

Auditor’s and Management’s ReportsAuditor’s and Management’s ReportsAuditor’s and Management’s ReportsAuditor’s and Management’s Reports

Auditor’s Report

Standard Unqualified Opinion – auditor expresses the opinion that the financial statements are presented fairly, in all material respects, in conformity with GAAP.

Other opinions:

Qualified

Adverse

DisclaimIllustration 24-14



Auditor’s Report

Certain circumstances, although they do not

affect the auditor’s unqualified opinion, may

require the auditor to add an explanatory

paragraph to the audit report.

Going Concert

Lack of Consistency

Emphasis of a MatterIllustration 24-14

Chapter 24-34

A qualified opinion contains 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.


Auditor’s Report

LO 5 Identify the major disclosures in the auditor’s report.



Management’s Report

The SEC mandates inclusion of management’s discussion and analysis (MD&A).

Management highlights favorable or unfavorable trends related to liquidity, capital resources, and results of operations.



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.

Chapter 24-37 LO 6 Understand management’s responsibilities for financials.


Management’s Responsibilities for Financial Statements

The Sarbanes-Oxley Act requires the SEC to develop guidelines for all publicly traded companies to report on management’s responsibilities for, and assessment of, the internal control system.

Chapter 24-38 LO 7 Identify issues related to financial forecasts and projections.

Current Reporting IssuesCurrent Reporting IssuesCurrent Reporting IssuesCurrent Reporting Issues

Reporting on Financial Forecasts and ProjectionsFinancial forecast is a set of prospective

financial statements that present, a company’s expected financial position, results of operations, and cash flows.

Financial projections are prospective financial statements that present, given one or more hypothetical assumptions, an entity’s expected financial position, results of operations, and cash flows. SEC Safe Harbor Rule



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

projection presents 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.



Internet Financial Reporting

All large companies have Internet sites, and a large proportion of companies’ websites contain links to their financial statements and other disclosures.

Chapter 24-41 LO 8 Describe the profession’s response to fraudulent financial

reporting.


Fraudulent Financial Reporting

Intentional or reckless conduct, whether through

act or omission, that results in materially

misleading financial statements.

The Sarbanes-Oxley Act has numerous

provisions intended to help prevent fraudulent

financial reporting.


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).


reporting.



Causes of Fraudulent Financial Reporting

Common opportunities for fraudulent financial

reporting

Absence of a board of directors or audit committee

Weak or nonexistent internal accounting controls.

Unusual or complex transactions

Accounting estimates requiring significant judgment

Ineffective internal audit staffs resulting

Chapter 24-44

Due to the broader range of judgments allowed in more principle-based iGAAP, note disclosures generally are more expansive under iGAAP compared to U.S. GAAP.

Like U.S. GAAP, iGAAP requires similar disclosure for transactions with related parties.

iGAAP and U.S. GAAP have similar standards on post-balance-sheet events. That is, under both sets of GAAP, events that occurred after the balance sheet date that provide additional evidence of conditions that existed at the balance sheet date are recognized in the financial statements.

Chapter 24-45

Following the recent issuance of IFRS 8, “Operating =Segments,” the requirements under iGAAP and U.S. GAAP are very similar. That is, both GAAPs use the management approach to identify reportable segments, and similar segment disclosures are required.

Neither U.S. GAAP nor iGAAP requires interim reports. Rather the SEC and stock exchanges outside the U.S. establish the rules. In the U.S., interim reports generally are provided on a quarterly basis; outside the U.S., 6-month interim reports are common.

Chapter 24-46 LO 9 Understand the approach to financial statement LO 9 Understand the approach to financial statement

analysis.analysis.

Perspective on Financial Statement Analysis

A 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

statement analysis will have a logical direction and

purpose.

Chapter 24-47 LO 9 Understand the approach to financial statement LO 9 Understand the approach to financial statement

analysis.analysis.

Perspective on Financial 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.

Chapter 24-48

Ratio 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.

LO 10 Identify major analytic ratios and describe their LO 10 Identify major analytic ratios and describe their calculation.calculation.

Chapter 24-49

Ratio Analysis


Chapter 24-50

Ratio AnalysisIllustration 24A-

1


Chapter 24-51


1


Chapter 24-52


1


Chapter 24-53 LO 10 Identify major analytic ratios and describe their LO 10 Identify major analytic ratios and describe their

calculation.calculation.


1

Chapter 24-54 LO 11 Explain the limitations of ratio analysis.LO 11 Explain the limitations of ratio analysis.

Limitations 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 company’s financial statements.

Chapter 24-55 LO 12 Describe techniques of comparative analysis.LO 12 Describe techniques of comparative analysis.

Comparative AnalysisIllustration 24A-

2

Chapter 24-56 LO 13 Describe techniques of percentage analysis.LO 13 Describe techniques of percentage analysis.

Percentage (Common Size) Analysis

Illustration 24A-3

Chapter 24-57 LO 13 Describe techniques of percentage analysis.LO 13 Describe techniques of percentage analysis.

Percentage (Common Size) AnalysisIllustration 24A-

4

Chapter 24-58 LO 14 Describe the current international accounting LO 14 Describe the current international accounting

environment.environment.

The Present Environment

Multinational corporations.

Mergers and acquisitions.

Information technology.

Financial markets.



Reasons to Understand International Standards

Convergence.

Investors’ expectations

Competitive factors



The Challenge of International Accounting

High quality standards must

1. Permit few alternative practices.

2. Be clearly stated, to allow for easy interpretation and

consistent application.

3. Be comprehensive, covering the major transactions

facing companies, and must provide an effective

system for responding to new transactions.

4. Provide transparency of information to make that

information relevant for making effective decisions.



Who Are the Key Players

IASB – International Accounting Standards Board

develops the standards, which are referred to as

International Financial Reporting Standards

(IFRS) or iGAAP.

Other Organizations

National Standard-Setters

IOSCO – International Organization of Securities

Commissions



Who Are the Key PlayersIllustration 24B-

1



Accounting Standard-Setting and Convergence

The FASB and the IASB are working together toward

the goal of a single set of high quality accounting

standards that will be used both domestically and

internationally.Illustration 24B-

2

Chapter 24-64

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