Full Disclosure in Financial Reporting

Non-recognized subsequent events

- Events that provide evidence about conditions that did not exist at the balance sheet date but arise subsequent to that date - Do not require adjustment of the financial statements

Fair Values

- FV assets or liabilities must be disclosed at both the cost and the FV of all instruments in the notes to the financial statements

The segmented financial data objective helps users do what?

1. Better understand the enterprise's performance 2. Better assess its prospects or future net cash flows 3. Make more informed judgments about the enterprise as a whole

2 Forms of disclosure of Corporate Expectations for the future

1. Financial Forecast 2. Financial Projections

Interim guidelines for seasonality

Disclose the seasonal nature of their business and consider supplementing their interim reports with information for 12-month periods ended at the interim date for the current and preceding years

An operating segment is deemed significant if it satisfies one or more of the following quantitative thresholds:

1. Its revenue (including both sales to external customers and intersegment sales or transfers) is 10% or more of the combined revenue of all the company's operating segments 2. The absolute amount of its profit or loss is 10% or more of the great in absolute amount of (a) the combined operating profit of all operating segments that did incur a loss or (b) the combined loss of all operating segments hat did not report a loss 3. Its identifiable assets are 10% or more of the combined assets of all operating segments

Treatment of errors and fraud

Correcting financial statements whey they discover the errors and/or fraud

Interim Period Tax

Difference between the amount so computed and the amounts reported for previous interim periods of the fiscal period

Common-size analysis

- AKA vertical analysis - Reduces all of the statement items to a common size - All the elements within each statement are expressed in percentages of some common number and always add up to 100% - Reveals the composition of each of the financial statements

Companies should use the same what for interim reports and for annual reports?

- Accounting Principles - Revenues on the same basis - Inventory pricing methods

Management Approach

- Allows companies to meet segmented reporting objective by providing financial statements segmented based on how the company's operations are managed - Reflects how management segments the company for making operating decisions

Qualified Opinion

- An exception to the standard opinion - Not of sufficient magnitude to invalidate the statements as a whole - States that, except for the effects of the matter to which the qualification relates, the financial statements present fairly, in all material respects, the financial position, results of operations and cash flows in conformity with GAAP.

Related Party Transactions

- Arise when a company engages in transactions in which one of the parties has the ability to significantly influence the policies of the other - May also occur when a non-transacting party has the ability to influence the policies of the two transacting parties - Arm's length basis cannot be assumed

Discrete Approach

- Believes that companies should treat each interim period as a separate accounting period - Companies would follow the principles of deferrals and accruals used for annual reports

Integral Approach

- Believes that the interim report is an integral part of the annual report and that deferrals and accruals should take into consideration what will happen for the entire year

Examples of indicators of related party transactions

- Borrowing or lending money at abnormally low or high interest rates - Real estate sales at amounts that differ significantly from appraised value - Exchanges of nonmonetary assets - Transactions involving enterprises that have no economic substance (shell corporations)

Big GAAP vs. little GAAP

- Certain types of companies (small or nonpublic) should not have to follow complex GAAP requirements

When non-recognized subsequent events are disclosed to keep the financial statements from being misleading what must be done

- Companies disclose the nature of the event and an estimate of its financial effect

Interim guidelines for advertising and similar costs

- Companies should defer in an interim period costs such as advertising if the benefits extend beyond the period; otherwise, the company should expense those costs as incurred

Inventory

- Companies should report the basis upon which inventory amounts are stated (LCM) - Method used in determining cost (LIFO, FIFO, etc) - Inventory composition (balance sheet or separate schedule in notes)

PPE

- Companies should state the basis of valuation for PPE (usually historical cost) - Disclose pledges, liens and other commitments related to these assets - Depreciation expense for the period - Balances of major classes of depreciable assets by nature and function - Accumulated Depreciation - General description of the method or methods used in computing depreciation

Reasons for increase in disclosure requirements

- Complexity of business environment - Necessity for timely information - Accounting as a control and monitoring device

Operating Segments

- Component of an enterprise that: 1. Engages in business activities from which it earns revenues and incurs expenses 2. Whose operating results are regularly reviewed by the company's chief operating decision-maker to assess segment performance and allocate resources to the segment 3. For which discrete financial information is available that is generated by or based on the internal financial reporting system

Percentage Analysis

- Consists of reducing a series of related amounts to a series of percentages of a given basis - Facilitates comparison and is helpful in evaluating the relative size of items or the relative change in items

Management's Discussion and Analysis

- Covers 3 financial aspects of an enterprise's business - liquidity, capital resources and results of operations - Management highlights favorable or unfavorable trends and identifies significant events and uncertainties that affect these three factors - Also discusses company's critical accounting policies

Changes in Accounting Principles

- Discussed in either the summary of significant accounting policies or in the other notes, changes in accounting principles (as well as material changes in estimates and corrections of errors)

Quantitative Materiality Test

- Done after a company decides on the possible segments for disclosure - Test determines whether the segment is significant enough to warrant actual disclosure

Interim guidelines for EPS

- Each interim period should stand alone and therefore, all applicable tests should be made for that single period

Disclosures of material related-party transactions

- Economic substance - Nature of the relationships involved - Description of the transactions for each of the periods for which income statements are presented - The dollar amounts of transactions for each of the periods for which income statements are presented - Amounts due from or to related parties as of the date of each balance sheet presented

Illegal Acts

- Encompasses such items as illegal political contributions, bribes, kickbacks, and other violations of laws and regulations - Accountants/auditors must evaluate the adequacy of disclosure in the financial statements

Recognized subsequent events

- Events that provide additional evidence about conditions that existed in the balance sheet date, including the estimates inherent int he process of preparing financial statements - Require adjustments to the financial statements - Companies must adjust the financial statements if the events that gave rise to litigation or other event took place prior to the balance sheet date

Differential Disclosure

- Ex. SEC requires that companies report to it certain substantive information that is not found in annual reports to stockholders - Ex. FASB recognizing that certain disclosure requirements are costly and unnecessary for certain companies, has eliminated reporting requirements for nonpublic enterprises in such areas as FV of financial instruments and segment reporting.

Interim guidelines for income taxes

- For income taxes GAAP requires the annualized approach where at the end of each interim period the company should make its best estimate of the effective tax rate expected to be applicable for the full fiscal year - Also required is the estimated annual effective tax rate to be applied to the YTD ordinary income at the end of each interim period

Circumstances that require an auditor to add an explanatory paragraph to the audit report

- Going concern: if there is substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time and explaining the problem - Lack of consistency: if a company has changed its accounting principle sof methods in a way that has a material effect on the comparability of its financial statements - Emphasis of a matter: when an auditor wants to emphasize a matter about the financial statements but intends to express an unqualified opinion anyways

Examples of fraudulent financial reporting

- Gross and deliberate distortion of corporate records (such as inventory count tags) - Misapplication of accounting principles (failure to disclose material transactions)

Deferred Taxes, Pensions and Leases

- In the notes of the financial statements they should have information about off-balance sheet commitments, future financing needs and the quality of a company's earnings

Equityholders' Claims

- Information about equity securities: number of shares authorized, issued and outstanding and the par value for each type of security

Notes to Financial Statements

- Means of amplifying or explaining the items presented int he main body of the statements

Fraud

- Misappropriation of assets and fraudulent financial reporting - Involves intentional distortions of financial statements

Creditor Claims

- Nature and cost of creditor claims - How a company is financing its operations - Costs that it will bear in future periods - Timing of future cash outflows - Must disclosure for each of the five years following the date of the statements the aggregate amount of maturities and sinking fund requirements for all LT borrowings

Post balance sheet events or subsequent events

- Notes to the financial statements should explain any significant events that took place after the formal balance sheet date but before the statement is issued

Comparative Analysis

- Presents the same information for two or more different dates or periods , so that like items may be compared - Typically include 2 years of balance sheet info and 3 years of income statement info

Financial Projections

- Prospective financial statements that present, to the best of the responsible party's knowledge and belief, given one or more hypothetical assumptions, an entity's expected financial position, results of operations and cash flows - Conditions it expects would exist and the course of action if expects would be taken, given one or more hypothetical assumptions

Interim Reports

- Reports that cover periods of less than one year

Adverse Opinion

- Required in any report in which the exception to fair presentation are so material that in the independent auditor's judgment, a qualified opinion, is not justified - Financial statements taken as a whole are not presented in accordance with GAAP

Financial Forecast

- Set of prospective financial statement that present to the best of the responsible party's knowledge and belief a company's expected financial position, results of operations and cash flows - Conditions it expects to exist and the course of action it expects to take

Interim guidelines for expenses subject to year end adjustements

- Since companies deal with a a lot of uncertainty amounts of bad debts, executive bonuses, pension costs and inventory shrinkage they should estimate these costs and allocate them to interim periods as best they can

Contingencies and Commitments

- Some gain or loss contingencies may not be in the body of the financial statements - These include litigation, debt and other guarantees, possible tax assessments, renegotiation of government contracts and sales of receivables with recourse - Also should be disclosed commitments that related to dividend restrictions, purchase agreements, hedge contracts and employment contracts

Accounting Policies

- Specific accounting principles and methods a company currently uses and considers most appropriate to present fairly its financial statements - Should be presented as integral part of financial statements; should be first note or in a separate Summary of Significant Accounting Policies

Exs. of subsequent events or developments that do not require adjustment of or disclosure in the financial statements

- Typically non-accounting events or conditions that management normally communicates by other means - Legislation - Product changes - Management changes - Strikes - Unionization - Marketing agreements - Loss of important customers

Exceptions appropriate at interim reporting periods

1. Companies may use the gross profit method for interim inventory pricing but they must disclose the method and adjustments to reconcile with annual inventory 2. When a company liquidates LIFO inventories at interim date, and expects to replace them year end, COGS should include the expected cost of replacing the liquidated LIFO base, rather than give effect to the interim liquidation 3. Do not defer inventory market declines beyond the interim period 4. Defer planned variances under a standard cost system - such variances are expected to be absorbed by year end

What does FASB directly affect?

1. Financial Statements 2. Notes to financial statements 3. Supplementary Information

What FASB requires must be reported for an enterprise report:

1. General information about its operating segments 2. Segment P&L and related information 3. Segment Assets 4. Reconciliations 5. Information about products and services and geographic areas 6. Major Customers - those who make up 10% or more of a company revenue

Limitations of Ratios

1. Generally based on historical cost which can lead to distortions in measuring performance 2. Where estimated items such as depreciation and amortization are significant, income ratios lose some of their credibility 3. The difficulty problem of achieving comparability among firms in a given industry

Reasons segmented disclosures should be done

1. Investors need segmented information to make an intelligent investment decision regarding a diversified company 2. Enable investors to evaluate the differences between segments in growth rate, risk and profitability and to forecast consolidated profits 3. Help investors evaluate the company's investment worth by disclosing the nature of a company's businesses and the relative size of the components 4. Conglomerate may obscure information that its competitors must disclose

Objective for reporting segmented financial data

To provide information about the different types of business activities in which an enterprise engages and the different economic environments in which it operates

Activity Ratios

Measures of how effectively the company is using the assets employed

Profitability Ratios

Measures of the degree of success or failure of a given company or division for a given period of time

Common Costs

Those incurred for the benefit of more than one segment and whose interrelated nature prevents a completely objective division of costs amount segments

What approach for interim reports does GAAP prefer?

Integral approach

Seasonality

Occurs when most of a company's sales occur in one short period of the year while certain costs are fairly evenly spread throughout the year

Accounting Errors

Unintentional Mistakes

Standards auditors following in preparing a report

1. Report states whether the financial statements are in accordance with GAAP 2. The report identifies those circumstances in which the company has not consistently observed such principles in the current period in relation to the preceding period 3. Users are to regard the informative disclosures in the financial statements as reasonably adequate unless the report states otherwise 4. The report contains either an expression of opinion regarding the financial statement taken as a whole or an assertion to the effect that an opinion cannot be expressed - if an auditor cannot express an overall opinion, the report should state the reasons 5. The report should also contain a clear-cut indication of the character of the auditor's examination, if any, and the degree of responsibility being taken

At minimum the following should be reported in the interim data:

1. Sales or gross revenues, provision for income taxes, extraordinary items and net income 2. Basic and diluted EPS where appropriate 3. Seasonal revenue, cost or expenses 4. Significant changes in estimates or provisions for income taxes 5. Disposal of a component of a business and extraordinary, unusual or infrequently occurring items 6. Contingent items 7. Changes in accounting principles or estimates 8. Significant changes in financial position

2 additional factors for individual segmented reports

1. Segment data must explain a significant portion of the company's business, specifically, the segmented results must equal or exceed 75% o the combined sales to unaffiliated customers for the entire company 2. Too many segments may overwhelm users with detailed information, therefore, FASB decided that 10 is a reasonable upper limit for the number of segments that a company must disclose

Usual circumstances in which the auditor may deviate from the standard unqualified short-form report on financial statements

1. The scope of the examination is limited or affected by conditions or restrictions 2. The statements do not fairly present financial position or results of operations because of - Lack of conformity with GAAP and standards - Inadequate disclosure

Difference between Financial Forecast and Financial Projection

A forecast provides information on what is expected to happen, whereas a projection provides information on what might take place but is not necessarily expected to happen

Auditor

Accounting professional who conducts an independent examination of a company's accounting data

Annualized Approach

Annualize income to date and accrue the proportionate income tax for the period to date

Information Overload

Reporting requirements being so detailed and substantial that users have a difficult time absorbing the information

Disclaimer of an Opinion

Appropriate when the auditor gathered so little information on the financial statements that no opinion can be expressed

Full Disclosure Principle

Calls for financial reporting of ny financial facts significant enough to influence the judgment of an informed reader

What is the problem with seasonality?

Expense recognition

Interim guidelines for extraordinary items

Required to charge or credit the loss or gain in the quarter in which it occurs, instead of attempting some arbitrary multiple-period allocation

Unqualified Opinion or Clean Opinion

If an auditor is satisfied that the financial statements, in all material respects, present the financial position, results of operations and cash flows fairly in accordance with GAAP it expresses this opinion

Horizontal Analysis

Indicates the proportionate change over a period of time; especially useful in evaluating trends, because absolute changes are often deceiving

Fraudulent Financial Reporting

Intentional or reckless conduct, whether act or omission, that results in materially misleading financial statements

Liquidity Ratios

Measure of the company's short run ability to pay its maturing obligations

Coverage Ratios

Measure of the degree of protection for LT creditors and investors

What other types of information are not subject to FASB rules?

Other types of information found int he annual report such as management's discussion and analysis

Vertical Analysis

Proportional expression of each financial statement item in a given period to a base figure

Safe Harbor Rule

Provides projection to a company that presents an erroneous forecast, as long as the company prepared the forecast on a reasonable basis and disclosed it in good faith