CHAPTER 17

FINANCIAL REPORTING
DISCLOSURE REQUIREMENTS
AND
ETHICAL RESPONSIBILITIES
 Financial Statement
Disclosure
 Chapter focuses on the
special importance of
disclosure in financial SFAC No. 5
reporting.
 Disclosure requirements outlines the various
issued by: methods of disclosure
1. FASB that corporations should
utilize in published
2. SEC financial statements
 Relationship of SFAC No. 5 to Other
Method of Financial Reporting (Adapted)
All information useful for investment, credit, and similar decisions

Financial Reporting

Area directly affected by existing FASB standards

Basic Financial Statements

Scope of
Recognition &
Measurements
Concepts Stmts

Financial Stmts Notes to Supplementary Other Means of Other

Stmt of Earnings & Financial Stmts Information Financial Information
Comprensive Income Examples: Examples: Reporting Examples:
Stmt of Financial Accounting Policies Segment Examples: Analysts’ Reports
Position Information MD&A
General Information Discussion of
Stmt of Cash Flows about the company Auditor’s Notes competition
Stmt of Investments Report
by & Distributions to
Owners
SFAC No. 5

 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
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
 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
APB Opinion No. 22
 requires all companies
to disclose
 the accounting policies
the firm follows
 and the methods it uses
in applying these
 Typically, companies disclose this policies.
information in a Summary of
Significant Accounting Policies
preceding the footnotes.
 Accounting Policies
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.  The APB‘s principal
3. Unusual or innovative objective in issuing
applications of generally Opinion No. 22:
accepted accounting principles.  to provide information
that helps investors
compare firms across
and between
industries.
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
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.
 APB conclusion - adopted integral view
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 rates
2. Currency exchange rates
3. Commodity prices
4. 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

Buy Potential investor decides to purchase a particular security

on the basis of all available disclosed information

Hold Investor decides to retain a particular security basis of all

available disclosed information

Sell Investor decides to dispose of a particular security basis

of all available disclosed information

 Usually accomplished by fundamental analysis

as discussed in Chapter 3
 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 officials
2 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
 Result:
 Americans lost billions of
their investment dollars
 jobs vanished

 thousands of people lost

 Included
their entire retirement
 Enron savings
 WorldCom  Subsequently, corporate
 Xerox reform became a
 Global Crossing
watchword
 Arthur Andersen

 Merrill Lynch

 Tyco International

 Halliburton Oil Services.

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 accountants

1 Independence
2 Scope of service
3 Confidentiality
4 Practice development
5 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 Dingle
1 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 interest

2 Recognize CPA’s paramount role in the

financial reporting process

3 Help assure quality performance and eliminate

substandard performance
4 Help assure objectivity and integrity in public

service
5 Enhance CPA’s prestige and creditability

6 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 conduct
3 Interpretations
4 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 providing
1 Ethical guidance
2 Broad positive statements
3 Specific behavioral rules
4 Proactive monitoring
5 Broader rules application
6 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
 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

 Prepared by
Kathryn Yarbrough, MBA

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