24-1

PREVIEW OF CHAPTER 24

Intermediate Accounting
16th Edition
Kieso ● Weygandt ● Warfield
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 24 Full Disclosure in
Financial Reporting
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1 Review the full disclosure 3 Identify the major disclosures in
principle and describe how it the auditor’s report and
is implemented. understand management’s
2 Discuss the disclosure responsibilities for the financial
requirements for related-party statements.
transactions, post-balance-sheet 4 Identify reporting issues related
events, major business to financial forecasts and
segments, and interim reporting. fraudulent financial reporting.

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 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 Lehman highlight the difficulty of
implementing the full disclosure principle.

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 FULL DISCLOSURE PRINCIPLE

ILLUSTRATION 24-1
24-5 Types of Financial Information LO 1
 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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 FULL DISCLOSURE PRINCIPLE

Differential Disclosure
 “Big GAAP versus Little GAAP”.

 FASB has traditionally taken the position that there

should be one set of GAAP.

 FASB is working with an advisory committee to explore

ways that its standards can be more cost-effective for
all companies, regardless of size.

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 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 and followed.

 Should present the disclosure as

► first note or

► separate Summary of Significant Accounting Policies

section preceding the notes to the financial statements.

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 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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 Notes to the Financial Statements

Common Notes MAJOR

DISCLOSURES
 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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 24 Full Disclosure in
Financial Reporting
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1 Review the full disclosure 3 Identify the major disclosures in
principle and describe how it is the auditor’s report and
implemented. understand management’s
2 Discuss the disclosure responsibilities for the financial
requirements for related-party statements.
transactions, post-balance- 4 Identify reporting issues related
sheet events, major business to financial forecasts and
segments, and interim fraudulent financial reporting.
reporting.

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 DISCLOSURE ISSUES

Disclosure of Special Transactions or Events

 Related Parties
► Nature of the relationship(s) involved.
► 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, fraud, and illegal acts.

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 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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 DISCLOSURE ISSUES

Post-Balance Sheet-Events
(Subsequent Events) ILLUSTRATION 24-3
Time Periods for
Subsequent Events

1 - Events that provide additional 2 - Events that provide

evidence about conditions that evidence about conditions that
existed at the balance sheet date. did not exist at the balance
sheet date.

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 DISCLOSURE ISSUES

Illustration: 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.
______ Settlement of federal tax case at a cost considerably in
excess of the amount expected at year-end.
c 2.
______ Introduction of a new product line.
b 3.
______ Loss of assembly plant due to fire.
b 4.
______ Sale of a significant portion of the company’s assets.
c 5.
______ Retirement of the company president.
b 6.
______ Issuance of a significant number of ordinary shares.

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 DISCLOSURE ISSUES

Illustration: 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.

c 7.
______ Loss of a significant customer.
c 8.
______ Prolonged employee strike.
a 9.
______ Material loss on a year-end receivable because of a
customer’s bankruptcy.
c 10. Hiring of a new president.
______
a 11. Settlement of prior year’s litigation.
______
b 12. Merger with another company of comparable size.
______

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 DISCLOSURE ISSUES

Reporting for Diversified Companies

Investors and investment analysts want 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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 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 enterprise’s 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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 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
company’s operations are managed (management
approach).

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 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

company’s chief operating decision-maker.

c. For which discrete financial information is available.

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 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 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.
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 DISCLOSURE ISSUES

Identifying Operating Segments

Quantitative Materiality Test: In applying these tests, the
company must consider two additional factors.

1. Segmented results must equal or exceed 75 percent of the

combined sales to unaffiliated customers for the entire company.

2. FASB decided that 10 is a reasonable upper limit for the number

of segments that a company must disclose.

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 DISCLOSURE ISSUES
ILLUSTRATION 24-6
Materiality Test Illustration 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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 DISCLOSURE ISSUES
Illustration 24-6
Materiality Test Illustration 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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 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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 DISCLOSURE ISSUES

Question
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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 DISCLOSURE ISSUES

Question
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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 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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 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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 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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 24 Full Disclosure in
Financial Reporting
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1 Review the full disclosure 3 Identify the major disclosures
principle and describe how it is in the auditor’s report and
implemented. understand management’s
2 Discuss the disclosure responsibilities for the
requirements for related-party financial statements.
transactions, post-balance-sheet 4 Identify reporting issues related
events, major business to financial forecasts and
segments, and interim reporting. fraudulent financial reporting.

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 Auditor’s and Management’s Reports

Auditor’s Report
Unqualified Opinion –
auditor expresses the
opinion that the financial
statements are presented
fairly in accordance with
GAAP. Other opinions:
 Qualified
 Adverse
 Disclaim
ILLUSTRATION 24-13
Auditor’s Report

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 Auditor’s and Management’s Reports

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 Concern
 Lack of Consistency
 Emphasis of a Matter

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 Auditor’s and Management’s Reports

Auditor’s 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.

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 Auditor’s and Management’s Reports

Management’s Report
Management’s Discussion and Analysis

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 and identifies significant events and uncertainties
that affect these three factors.

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 ILLUSTRATION 24-15
Management’s
Discussion and Analysis

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

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.

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 ILLUSTRATION 24-16
Report on Management’s
Responsibilities

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 24 Full Disclosure in
Financial Reporting
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1 Review the full disclosure 3 Identify the major disclosures in
principle and describe how it is the auditor’s report and
implemented. understand management’s
2 Discuss the disclosure responsibilities for the financial
requirements for related-party statements.
transactions, post-balance-sheet 4 Identify reporting issues
events, major business related to financial forecasts
segments, and interim reporting. and fraudulent financial
reporting.

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 CURRENT REPORTING ISSUES

Reporting on Financial Forecasts and

Projections
Financial 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.

Regulators have established a Safe Harbor Rule.

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 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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 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
and hyperlinks to quickly find information about the firm.
 Can help make financial reports more relevant by allowing
companies to report expanded disaggregated data and more
timely data.

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 CURRENT REPORTING ISSUES

Fraudulent Financial Reporting

Intentional or reckless conduct, whether 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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 Fraudulent Financial Reporting

Source: Recent
global survey of
over 3,000
executives from
54 countries
documented
the types of
economic
crimes.

ILLUSTRATION 24-17
Types of Economic Crime

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 Fraudulent Financial Reporting

A wide range of
economic
crimes are
reported.

ILLUSTRATION 24-18
Trends in Reported Fraud

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 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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 Fraudulent Financial Reporting

Causes of Fraudulent Financial Reporting

Common opportunities for fraudulent financial reporting
1. Absence of a board of directors or audit committee.

2. Weak or nonexistent internal accounting controls.

3. Unusual or complex transactions.

4. Accounting estimates requiring significant judgment.

5. Ineffective internal audit staffs.

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 APPENDIX 24A 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.

24-49 LO 5 Understand the approach to financial statement analysis.

 APPENDIX 24A 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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 APPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS

RATIO ANALYSIS

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 APPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS

RATIO ANALYSIS ILLUSTRATION 24A-1

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 APPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS

RATIO ANALYSIS ILLUSTRATION 24A-1

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 APPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS

RATIO ANALYSIS ILLUSTRATION 24A-1

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 APPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS

RATIO ANALYSIS ILLUSTRATION 24A-1

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 APPENDIX 24A 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 company’s financial statements.

24-56 LO 7 Explain the limitations of ratio analysis.

 APPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS

COMPARATIVE ANALYSIS
ILLUSTRATION 24A-2

24-57 LO 8 Describe techniques of comparative analysis.

 APPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS

PERCENTAGE (COMMON SIZE) ANALYSIS

Illustration 24A-3

24-58 LO 9 Describe techniques of percentage analysis.

 APPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS

PERCENTAGE (COMMON SIZE) ANALYSIS

ILLUSTRATION 24A-4
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 RELEVANT FACTS - Similarities
 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.
 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.

24-60 LO 10 Compare the disclosure requirements under GAAP and IFRS.

 RELEVANT FACTS - Similarities
 Following the recent issuance of IFRS 8, “Operating Segments,” the
requirements under IFRS and GAAP are very similar. That is, both
standards use the management approach to identify reportable
segments, and similar segment disclosures are required.
 Neither GAAP nor IFRS require interim reports. Rather, the SEC and
securities 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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 RELEVANT FACTS - Differences
 Due to the broader range of judgments allowed in more principles-based
IFRS, note disclosures generally are more expansive under IFRS
compared to GAAP.
 Subsequent (or post-statement of financial position) 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.
 Under IFRS, there is no specific requirement to disclose the name of the
related party, which is this case under GAAP.
 Under IFRS, interim reports are prepared on a discrete basis; GAAP
generally follows the integral approach.

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 ON THE HORIZON
Hans Hoogervorst, chairperson of the IASB, recently noted: “High quality
financial information is the lifeblood of market-based economies. It is the same
with financial reporting. If investors cannot trust the numbers, then financial
markets stop working. For market-based economies, that is really bad news. It
is an essential public good for market-based economies. . . . And in the past 10
years, most of the world’s economies—developed and emerging—have
embraced IFRSs.” While the United States has yet to adopt IFRS, there is no
question that IFRS and GAAP are converging quickly. We have provided
expanded discussion in the International Perspectives and IFRS Insights. After
reading these discussions, you should realize that IFRS and GAAP are very
similar in many areas, with differences in those areas revolving around some
minor technical points. In other situations, the differences are major; for
example, IFRS does not permit LIFO inventory accounting.

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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 auditor’s 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 year’s financial statements.
d. recognized on a prospective basis from the date of declaration.

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 COPYRIGHT

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