Intermediate Accounting

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Prepared by Coby Harmon University of California, Santa Barbara

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Full Disclosure in Financial Reporting

Intermediate Accounting 14th Edition

Kieso, Weygandt, and Warfield

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Learning Objectives
1. Review the full disclosure principle and describe implementation problems. Explain the use of notes in financial statement preparation. Discuss the disclosure requirements for major business segments. Describe the accounting problems associated with interim reporting.

2. 3. 4.

5.
6. 7.

Identify the major disclosures in the auditors report.

Understand managements responsibilities for financials. Identify issues related to financial forecasts and projections.

8.

Describe the professions response to fraudulent financial reporting.

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Full Disclosure in Financial Reporting

Full Disclosure Principle

Notes to Financial Statements Accounting policies Common notes

Disclosure Issues

Auditors and Managements Report Auditors report

Managements reports

Current Reporting Issues Reporting on forecasts and projections Internet financial reporting Fraudulent financial reporting Criteria for accounting and reporting choices

Increase in reporting requirements Differential disclosure

Special transactions or events Post-balancesheet events Diversified companies

Interim reports

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1. Full Disclosure Principle

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.

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

Full Disclosure Principle

Illustration 24-1 Types of Financial Information

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

Full Disclosure Principle

Increase in Reporting Requirements
Reasons:

Complexity of business environment. Necessity for timely information.

Accounting as a control and monitoring device.

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

Full Disclosure Principle

Differential Disclosure
Big GAAP versus Little GAAP. FASB takes the position that there should be one set of GAAP.

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

2. Notes to the Financial Statements

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

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

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

Notes to the Financial Statements

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.

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

Notes to the Financial Statements

Common Notes

Inventory Property, Plant, and Equipment

Creditor Claims
Equityholders Claims Contingencies and Commitments

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Fair Values
Deferred Taxes, Pensions, and Leases Changes in Accounting Principles
LO 2 Explain the use of notes in financial statement preparation.

3. Disclosure Issues
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.

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Amounts due from or to related parties.

Errors and fraud.

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

Disclosure Issues
If a business entity entered into certain related party transactions, it would be required to disclose all 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

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

Disclosure Issues
Post-Balance Sheet-Events (Subsequent Illustration 24-3 Events) Time Periods for
Subsequent Events

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.

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

Disclosure Issues
E24-2 (Post-Balance-Sheet Events): For each of the following subsequent 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.

a ______ 1.
______ 2. c

Settlement of federal tax case at a cost considerably in excess of the amount expected at year-end. Introduction of a new product line.

______ 3. b
______ 4. b ______ 5. c ______ 6. b
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Loss of assembly plant due to fire.

Sale of a significant portion of the companys assets. Retirement of the company president. Issuance of a significant number of ordinary shares.
LO 2 Explain the use of notes in financial statement preparation.

Disclosure Issues
E24-2 (Post-Balance-Sheet Events): For each of the following subsequent 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. c Loss of a significant customer. Prolonged employee strike. Material loss on a year-end receivable because of a

c ______ 8.
______ 9. a

customers bankruptcy.
______ 10. Hiring of a new president. c ______ 11. Settlement of prior years litigation. a ______ 12. Merger with another company of comparable size. b
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LO 2 Explain the use of notes in financial statement preparation.

Disclosure Issues
Reporting for Diversified Companies
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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LO 3

Disclosure Issues
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. 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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LO 3 Discuss the disclosure requirements for major business segments.

Disclosure Issues
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

companys operations are managed (management approach).

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LO 3 Discuss the disclosure requirements for major business segments.

Disclosure Issues
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

companys chief operating decision maker. c. For which discrete financial information is available.

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LO 3 Discuss the disclosure requirements for major business segments.

Disclosure Issues
Identifying Operating Segments
Quantitative Materiality Test: Must satisfy one to 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. The absolute amount of its profit or loss is 10 percent or more of the

2.

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.

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LO 3

Disclosure Issues
Identifying Operating Segments
Quantitative Materiality Test: In applying these tests, the company must consider two additional factors.
1. Segment data must explain a significant portion of the companys 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.

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LO 3 Discuss the disclosure requirements for major business segments. LO 3

Disclosure Issues
Materiality Test Illustration
Illustration 24-6 Data for Different Possible Reporting Segments

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.
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LO 3

Disclosure Issues
Materiality Test Illustration
Illustration 24-6 Data for Different Possible Reporting Segments

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.

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LO 3 Discuss the disclosure requirements for major business segments. LO 3

Disclosure Issues
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.

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LO 3 Discuss the disclosure 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 revenue and gains.

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LO 3 Discuss the disclosure requirements for major business segments.

Disclosure Issues
The profession requires disaggregated information in the

following ways:
a. products or services. b. geographic areas.

c. major customers.
d. all of these.

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LO 3 Discuss the disclosure requirements for major business segments.

Disclosure Issues
Interim Reports
Cover periods of less than one year.

Two viewpoints exist:

1. Discrete approach 2. Integral approach Companies should use the same accounting principles for interim reports that they use for annual reports.

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LO 4 Describe the accounting problems associated with interim reporting.

Disclosure Issues
Unique Problems of 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

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LO 4 Describe the accounting problems associated with interim reporting.

Disclosure Issues
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.

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LO 4 Describe the accounting problems associated with interim reporting.

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:

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Qualified Adverse Disclaim

Illustration 24-13 Auditors Report

LO 5

Auditors and Managements Reports

Auditors Report
Certain circumstances, although they do not affect the
auditors unqualified opinion, may require the auditor to add an explanatory paragraph to the audit report.

Going Concert Lack of Consistency Emphasis of a Matter

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LO 5 Identify the major disclosures in the auditors report.

Auditors and Managements Reports

Auditors Report
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.
LO 5 Identify the major disclosures in the auditors report.

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Auditors and Managements Reports

Managements Report
The SEC mandates inclusion of managements discussion
and analysis (MD&A). Management highlights favorable or unfavorable trends

related to liquidity, capital resources, and results of

operations.

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LO 5 Identify the major disclosures in the auditors report.

Auditors and Managements Reports

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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LO 5 Identify the major disclosures in the auditors report.

Auditors and Managements Reports

Managements Responsibilities for Financial Statements
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.

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LO 6 Understand managements responsibilities for financials.

Current Reporting Issues

Reporting on Financial Forecasts and Projections
Financial forecast is a set of prospective financial statements that present, a companys expected financial position, results of operations, and cash flows. Financial projections are prospective financial statements that present, given one or more hypothetical assumptions, an entitys expected financial position, results of operations, and cash flows. Regulators have established a Safe Harbor Rule.

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LO 7 Identify issues related to financial forecasts and projections.

Current Reporting Issues

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.
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LO 7 Identify issues related to financial forecasts and projections.

Current Reporting Issues

Internet Financial Reporting
A large proportion of companies websites contain links to their financial statements and other disclosures.

Allows firms to communicate more easily and quickly with users. 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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LO 7 Identify issues related to financial forecasts and projections.

Current Reporting Issues

Fraudulent Financial Reporting
Intentional 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 Tyco indicate that more must be done to address this issue.

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LO 8 Describe the professions response to fraudulent financial reporting.

Current Reporting Issues

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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LO 8 Describe the professions response to fraudulent financial reporting.

Current Reporting Issues

Fraudulent Financial 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.

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LO 8 Describe the professions response to fraudulent financial reporting.

APPENDIX

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BASIC FINANCIAL STATEMENT 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.

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LO 9 Understand the approach to financial statement analysis.

APPENDIX

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BASIC FINANCIAL STATEMENT 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.

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LO 9 Understand the approach to financial statement analysis.

APPENDIX

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BASIC FINANCIAL STATEMENT ANALYSIS

Ratio Analysis

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LO 10 Identify major analytic ratios and describe their calculation.

APPENDIX

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BASIC FINANCIAL STATEMENT ANALYSIS

Ratio Analysis

Illustration 24A-1

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LO 10 Identify major analytic ratios and describe their calculation.

APPENDIX

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BASIC FINANCIAL STATEMENT ANALYSIS

Ratio Analysis

Illustration 24A-1

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LO 10 Identify major analytic ratios and describe their calculation.

APPENDIX

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BASIC FINANCIAL STATEMENT ANALYSIS

Ratio Analysis

Illustration 24A-1

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LO 10 Identify major analytic ratios and describe their calculation.

APPENDIX

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BASIC FINANCIAL STATEMENT ANALYSIS

Ratio Analysis

Illustration 24A-1

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LO 10 Identify major analytic ratios and describe their calculation.

APPENDIX

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BASIC FINANCIAL STATEMENT 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 companys financial statements.

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LO 11 Explain the limitations of ratio analysis.

APPENDIX

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BASIC FINANCIAL STATEMENT ANALYSIS

Comparative Analysis
Illustration 24A-2

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LO 12 Describe techniques of comparative analysis.

APPENDIX

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BASIC FINANCIAL STATEMENT ANALYSIS

Percentage (Common Size) Analysis

Illustration 24A-3

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LO 13 Describe techniques of percentage analysis.

APPENDIX

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BASIC FINANCIAL STATEMENT ANALYSIS

Percentage (Common Size) Analysis

Illustration 24A-4

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LO 13 Describe techniques of percentage analysis.

RELEVANT FACTS

Due to the broader range of judgments allowed in more principlesbased IFRS, note disclosures generally are more expansive under IFRS compared to GAAP. GAAP and IFRS have similar standards on post-statement of financial 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 under IFRS 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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IFRS SELF-TEST QUESTION

Which of the following is false?
a. In general, IFRS note disclosures are more expansive compared to GAAP. b. GAAP and IFRS have similar standards on subsequent events. c. Both IFRS and GAAP require interim reports although the reporting frequency varies.

d. Segment reporting requirements are very similar under IFRS and GAAP.

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IFRS SELF-TEST QUESTION

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.

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IFRS SELF-TEST QUESTION

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.

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