Intermediate Accounting

Intermediate Accounting
kieso weygandt warfield INTERMEDIATE ACCOUNTING Intermediate Accounting team for success F I F T E E N T H E D I T I O N Intermediate Accounting Prepared by Coby Harmon University of California, Santa Barbara Westmont College Prepared by Coby Harmon University of California, Santa Barbara Westmont College Prepared by Coby Harmon University of California, Santa Barbara

Intermediate Accounting Kieso Weygandt Warfield
PREVIEW OF CHAPTER 24 Intermediate Accounting 15th Edition Kieso Weygandt Warfield

24 Full Disclosure in Financial Reporting LEARNING OBJECTIVES
After studying this chapter, you should be able to: Review the full disclosure principle and describe implementation problems. Explain the use of notes in financial statement preparation. Discuss the disclosure requirements for related-party transactions, post-balance-sheet events, and major business segments. Describe the accounting problems associated with interim reporting. Identify the major disclosures in the auditor’s report. Understand management’s responsibilities for financials. Identify issues related to financial forecasts and projections. Describe the profession’s response to fraudulent financial reporting.

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. LO 1

Illustration 24-1 Types of Financial Information LO 1

Increase in Reporting Requirements Reasons: Complexity of business environment. Necessity for timely information. Accounting as a control and monitoring device. LO 1

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. LO 1

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. LO 2

Which of the following should be disclosed in a Summary of Significant Accounting Policies? Types of executory contracts. Amount for cumulative effect of change in accounting principle. Claims of equity holders. Depreciation method followed. LO 2

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 LO 2

Disclosure Issues Disclosure of Special Transactions or Events
Related-party transactions 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. LO 3

Disclosure Issues If a business entity entered into certain related party transactions, it would be required to disclose all the following information except the nature of the relationship between the parties to the transactions. nature of any future transactions planned between the parties and the terms involved. dollar amount of the transactions for each of the periods for which an income statement is presented. amounts due from or to related parties as of the date of each statement of financial position presented. LO 3

Disclosure Issues Post-Balance Sheet-Events (Subsequent Events)
Illustration 24-3 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. LO 3

Advance slide in presentation mode to reveal answers.
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. ______ 1. Settlement of federal tax case at a cost considerably in excess of the amount expected at year-end. ______ 2. Introduction of a new product line. ______ 3. Loss of assembly plant due to fire. ______ 4. Sale of a significant portion of the company’s assets. ______ 5. Retirement of the company president. ______ 6. Issuance of a significant number of ordinary shares. a c b b c b Advance slide in presentation mode to reveal answers. LO 3

Disclosure Issues c c a c a b
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. ______ 7. Loss of a significant customer. ______ 8. Prolonged employee strike. ______ 9. Material loss on a year-end receivable because of a customer’s bankruptcy. ______ 10. Hiring of a new president. ______ 11. Settlement of prior year’s litigation. ______ 12. Merger with another company of comparable size. c c a c a b LO 3

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 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: Better understand the enterprise’s performance. Better assess its prospects for future net cash flows. Make more informed judgments about the enterprise as a whole. LO 3

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). LO 3

Disclosure Issues Identifying Operating Segments
An operating segment is a component of an enterprise: That engages in business activities from which it earns revenues and incurs expenses. Whose operating results are regularly reviewed by the company’s chief operating decision-maker. For which discrete financial information is available. LO 3

Quantitative Materiality Test: Must satisfy one to determine whether the segment is significant enough to warrant actual disclosure. Its revenue is 10 percent or more of the combined revenue of all the company’s operating segments. 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. Its identifiable assets are 10 percent or more of the combined assets of all operating segments. LO 3

Quantitative Materiality Test: In applying these tests, the company must consider two additional factors. Segmented results must equal or exceed 75 percent of the combined sales to unaffiliated customers for the entire company. FASB decided that 10 is a reasonable upper limit for the number of segments that a company must disclose. LO 3

Disclosure Issues Materiality Test Illustration Illustration 24-6 Data for Different Possible Reporting Segments Advance slide in presentation mode to reveal answers. 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. LO 3

Disclosure Issues Materiality Test Illustration Illustration 24-6 Data for Different Possible Reporting Segments Advance slide in presentation mode to reveal answers. The 75 percent test is computed as follows. 75% of combined sales test: 75% x $2,150 = $1, The sales of A, C, D, and E total $2,000 ($100 + $700 + $300 + $900); therefore, the 75 percent test is met. LO 3

Disclosure Issues Segmented Information Reported
General information about operating segments. Segment profit and loss and related information. Segment assets. Reconciliations. Information about products and services and geographic areas. Major customers. LO 3

Disclosure Issues Revenue of a segment includes
only sales to unaffiliated customers. sales to unaffiliated customers and intersegment sales. sales to unaffiliated customers and interest revenue. sales to unaffiliated customers and other revenue and gains. LO 3

Disclosure Issues The profession requires disaggregated information in the following ways: products or services. geographic areas. major customers. all of these. LO 3

Disclosure Issues Interim Reports Cover periods of less than one year.
Two viewpoints exist: Discrete approach Integral approach Companies should use the same accounting principles for interim reports that they use for annual reports. LO 4

Disclosure Issues Unique Problems of Interim Reporting
Advertising and Similar Costs Expenses Subject To Year-end Adjustment Income Taxes Extraordinary Items Earnings per Share Seasonality LO 4

Disclosure Issues In considering interim financial reporting, how does the profession conclude that such reporting should be viewed? As a "special" type of reporting that need not follow generally accepted accounting principles. As useful only if activity is evenly spread throughout the year so that estimates are unnecessary. As reporting for a basic accounting period. As reporting for an integral part of an annual period. LO 4

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 LO 5

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 LO 5

Auditor’s Report Qualified opinion contains an exception to the standard opinion. Usual circumstances may include: Scope limitation. Statements do not fairly present financial position or results of operations because of: Lack of conformity with GAAP. Inadequate disclosure. LO 5

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. LO 6

Illustration 24-15 Management’s Discussion and Analysis LO 6

The MD&A section of a company's annual report is to cover the following three items: income statement, balance sheet, and statement of owners' equity. income statement, balance sheet, and statement of cash flows. liquidity, capital resources, and results of operations. changes in the stock price, mergers, and acquisitions. LO 6

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. LO 6

Illustration 24-16 Report on Management’s Responsibilities LO 6

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. LO 7

Which of the following best characterizes the difference between a financial forecast and a financial projection? Forecasts include a complete set of financial statements, while projections include only summary financial data. A forecast is normally for a full year or more and a projection presents data for less than a year. 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. A forecast includes data which can be verified about future expectations, while the data in a projection is not susceptible to verification. LO 7

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. LO 7

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. LO 8

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 LO 8

A wide range of economic crimes are reported. Illustration 24-18 Trends in Reported Fraud LO 8

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). LO 8

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. LO 8

Perspective on Financial Statement Analysis
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. Know the questions for which you want to find answers. Know the questions that particular ratios and comparisons are able to help answer. Match 1 and 2 above. By such a matching, the statement analysis will have a logical direction and purpose. LO 9 Understand the approach to financial statement analysis.

Perspective on Financial Statement Analysis
APPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS Perspective on Financial Statement Analysis Analysis includes an understanding that Financial statements report on the past. Single ratio by itself is not likely to be very useful. Awareness of the limitations of accounting numbers used in an analysis. LO 9

Ratio Analysis APPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS
LO 10 Identify major analytic ratios and describe their calculation.

Ratio Analysis APPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS LO 10
Illustration 24A-1 LO 10

Ratio Analysis APPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS
Illustration 24A-1

Ratio Analysis APPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS LO 10
Illustration 24A-1 LO 10

Limitations of Ratio Analysis
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. LO 11 Explain the limitations of ratio analysis.

Comparative Analysis APPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS
Illustration 24A-2 LO 12 Describe techniques of comparative analysis.

Percentage (Common Size) Analysis
APPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS Percentage (Common Size) Analysis Illustration 24A-3 LO 13 Describe techniques of percentage analysis.

Percentage (Common Size) Analysis
APPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS Percentage (Common Size) Analysis Illustration 24A-4 LO 13

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. LO 14 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. LO 14

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. LO 14

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. LO 14

IFRS SELF-TEST QUESTION
Which of the following is false? In general, IFRS note disclosures are more expansive compared to GAAP. GAAP and IFRS have similar standards on subsequent events. Both IFRS and GAAP require interim reports although the reporting frequency varies. Segment reporting requirements are very similar under IFRS and GAAP. LO 14

Subsequent events are reviewed through which date under IFRS? Statement of financial position date. Sixty days after the year-end date. Date of independent auditor’s opinion. Authorization date of the financial statements. LO 14

Under IFRS, share dividends declared after the statement of financial position date but before the end of the subsequent events period are: accounted for similar to errors as a prior period adjustment. adjusted subsequent events, because they are paid from prior year earnings. not adjusted in the current year’s financial statements. recognized on a prospective basis from the date of declaration. LO 14

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