CH. 2.

FINANCIAL DISCLOSURES
TEXT BOOK PAGES 62-72

Intermediate Accounting I
Spring 2019

Dr. Nafis Rahman

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Required Disclosures

Financial Statements contain more than just

numbers and tables!!
Required Disclosure Notes
o Summary of significant accounting policies
o Subsequent events
o Noteworthy events and transactions

Additional Required Sections of the Financial Statements

o Management Report / Management Discussion & Analysis
o Auditors’ Report
o Disclosure on Compensation on Directors & Executives

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Required Disclosure Notes
• Explain the data presented in the financial
statements themselves, or
– Provide information not directly related to any
specific elements in the financial statements.

• Two types of disclosure notes

1. Required disclosure notes
2. Other common disclosure notes

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Required Disclosure Notes
1. Summary of significant accounting policies
2. Descriptions of subsequent events
3. Noteworthy events and transactions

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Example: Singapore Airlines

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Required Disclosure Notes
2. Descriptions of subsequent events
• Subsequent events = Significant events
between the date of the financial statements
and the date the statement is issued

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Required Disclosure Notes
2. subsequent events that should be
disclosed in a note

Rule of Thumb: Any event in the subsequent period

that has material effects on operations:
– Debt refinancing or debt restructuring
– New developments associated with litigation
– New development that affects operations (for
example, a natural disaster) and its estimated
impact on income
– Changes in the status of a proposed merger or
acquisition
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Post financial year-end events

• Determine the appropriate treatment for

each of the following events in the 2013
financial statements of Northwest
Distribution Corporation. The financial
year end for this company is Dec. 31.

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Post financial year-end events

1) On Jan. 22, 2014, the company

negotiated a major merger with Blandon
industries. The merger will be completed
by the middle of 2014.
– Details of the merger should be disclosed in a
note to the financial statements.

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Post financial year-end events

2) On Feb. 3, 2014, Northwest negotiated a

$10 million long-term note with the
National Credit Bank. The amount of the
note is material.

– Details of the issuance of the new debt should

be described in a note to the financial
statements.

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Post financial year-end events

3) On Feb 25, 2014, a flood destroyed one

of the company’s manufacturing plants,
causing $6 million of uninsured
damage. The damage amounts to 10%
of net income.

– The event should be described in a note to

the financial statements along with the
amount of uninsured damage.
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 Required Disclosure Notes
3. Noteworthy events and transactions
1) Related third-party transactions
 Transactions with owners, management, families of owners
or management, affiliated companies, and other parties that
can significantly influence or be influenced by the company.
 These transactions frequently use favorable terms of trade,
violating the arm’s length principle.

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 Required Disclosure Notes
3. Noteworthy events and transactions
1) Related third-party transactions
 Example: Connected lending
• An interest rate for lending to family members of a
founder-CEO is often significantly less than the
market interest rate for an independent third party
with similar credit risk.
• This lending transfers income (wealth) from the
company to the family members of the founder-
CEO, to the detriment of the interests of other
shareholders.

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Required Disclosure Notes
3. Noteworthy events and transactions
1) Related third-party transactions
 The following should be disclosed in a note:
• The nature of the relationship, a
description of the transaction, and any
dollar amounts involved, etc.

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Required Disclosure Notes
3. Noteworthy events and transactions
2) Frauds and Errors
 Misstatements in the financial statements
 Frauds: intentional misstatements in a financial
statement to obtain an unjust or illegal advantage
 Errors: unintentional misstatements in a financial
statement

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 Required Disclosure Notes

Investors view misstatements (especially the

fraudulent ones) very negatively

Research shows that following revelation of misstatements:

 the stock price goes down sharply (Palmrose et al. 2004)
 and investors’ trust in the company’s future disclosure goes
down (Chen et al.2014)
 Companies often fire managers and auditors to regain investor
trust (Hennes et al. 2008, Chen et al.2014, Chakravarthy et al.
2014)

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 Management Reports (required
disclosure)
• Financial statements contain a comprehensive discussion and analysis
of the company’s operations by the management (termed as the
‘Management Discussion and Analysis / Operating and Financial
Overview / Management Report, and etc.)

• Let’s look at the CNOOC 2015 and find their Management Discussion
and Analysis (MD & A) section

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Auditor’s Report (required
disclosure)
• Some of you will become public auditors
• Auditors audit the financial statements and give
assurance about their validity

• Unqualifed Opinion (positive report)

– report means auditors found no problems

• Emphasis on Matter—Going Concern, uncertain lawsuit

outcome
• Qualified Opinion – some disagreement with management
• Disclaimer – the scope of audit is limited
• Adverse Opinion – statement is not dependable
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Compensation of Directors and
Executives (Required disclosure)
• Pubic companies are required to disclose the
compensation
• Lets the investors know about management
incentives
• Different countries have different requirements

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Other Common Disclosure Notes
• Details about elements of financial
statements
– Earnings per share calculations
– Property, plant, and equipment
– Fair values of financial instruments
– Debts, leases, provisions, inventory, etc.

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