1. RICHARD G. SCHROEDER MYRTLE W. CLARK JACK M. CATHEY
FINANCIAL ACCOUNTING
THEORY AND ANALYSIS: TEXT AND CASES
11TH EDITION
RICHARD G. SCHROEDER
MYRTLE W. CLARK
JACK M. CATHEY 4

2. CHAPTER 17
FINANCIAL REPORTING DISCLOSURE REQUIREMENTS AND ETHICAL RESPONSIBILITIES

3. Financial Statement Disclosure
Chapter focuses on the special importance of disclosure in financial reporting.
Disclosure requirements issued by:
FASB
SEC
SFAC No. 5
outlines the various methods of disclosure that corporations should utilize in published financial statements

4. Relationship of SFAC No
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
Supplementary Information
Examples:
Segment Information
Changing Price -
Disclosures (SFAS No.33
Oil and Gas Reserve Liquidation Basis of Accounting - SFAS No, 69
Auditor’s Report
Interim Financial Statements
Liquidation Basis of Accounting
Notes to Financial Stmts
Examples:
Accounting Policies
Schedules and Exhibits
Explanation of Financial Statement Items
General Information about the company
Financial Stmts
Stmt of Earnings & Comprensive Income
Stmt of Financial Position
Stmt of Cash Flows
Stmt of Investments by & Distributions to Owners
Other Means of Financial Reporting
Examples:
MD&A
Letter to Stockholders
Other Information
Examples:
Analysts’ Reports
News Articles about Company

5. SFAC No. 5 Summarizes the building blocks to disclosure as:
The scope of recognition and measurement
Basic financial statements
Areas directly affected by existing FASB standards
Financial reporting
All information useful for investment, credit and similar decisions

6. The Scope of Recognition and Measurement
Discussed earlier throughout the text.

7. supplementary schedules parenthetical disclosures
Financial Statements
The financial statements described in SFAC No. 5 were discussed previously in chapters 6 and 7.
In addition to the four basic statements, a full set of financial statements also includes
supplementary schedules
parenthetical disclosures
footnotes

8. Footnotes The most common examples of footnotes are:
Accounting policies
Schedules and exhibits
Example: schedules or exhibits concerning long-term debt and income tax
Explanations of financial statement items
Example: Pensions and post-retirement benefits
General information about the company

9. Accounting Policies APB Opinion No. 22 (FASB ASC 235)
requires all companies to disclose
the accounting policies the firm follows
and the methods it uses in applying these policies.
Typically, companies disclose this information in a Summary of Significant Accounting Policies preceding the footnotes.

10. Accounting Policies APB Opinion No. 22
requires that the accounting methods and procedures involving the following be disclosed:
A selection from existing acceptable alternatives.
Principles and methods peculiar to the industry in which the reporting entity operates.
Unusual or innovative applications of generally accepted accounting principles.
The APB‘s principal objective in issuing Opinion No. 22:
to provide information that helps investors compare firms across and between industries.

11. 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

12. 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:
Segment information (Chapter 16)
The effects of price-level changes
The auditor’s report
Interim financial reports

13. 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

14. Auditor’s Report
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.
* * * *
Let’s look at an example of the standard audit report

15. Auditor’s Report Types of opinions: Unqualified Qualified Disclaimer
Adverse
Auditor’s Report on Internal Control
Going Concern

16. Interim Financial Statements
Two views
APB conclusion - adopted integral view
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.
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. 45 45

17. Liquidation Basis of Accounting
July 2012 FASB issued proposed amendment to FASB ASC Top 205
April 2013 FASB issued ASU
Required when liquidation is deemed to be imminent
Statements required:
Statement of Changes in Net Assets in Liquidation
Statement of Net Assets in Liquidation

18. Financial Reporting: Other Means of Financial Reporting
Other relevant information
Can assist in understanding the financial report
Presented in narrative form
Examples:
Management’s discussion and analysis
Letter to stockholders

19. 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

20. 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

21. 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:
Interest rates
Currency exchange rates
Commodity prices
Equity prices

22. 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:
Tabular presentation
of fair value information and contract terms relevant to determining future cash flows, categorized by expected maturity dates
Sensitivity analysis
expressing the potential loss in future earnings, fair values, or cash flows from selected hypothetical changes in market rates and prices
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

23. 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

24. Management’s Discussion and Analysis
Specifically, companies must disclose:
Their primary market risk exposures at the end of the current reporting period
How they manage those exposures
such as a description of the objectives
general strategies
and instruments, if any, used to manage those exposures
Changes in
either the primary market risk exposures
or how those exposures are managed
…when compared to the most recent reporting period
and what is known or expected in future periods

25. Management’s Discussion and Analysis
Hershey and Tootsie Roll
Both companies use derivative financial instruments
2003: SEC published new interpretive guidelines
Overall presentation of MD&A
Focus and content
Disclosure of liquidity and capital resources
Disclosure of critical accounting estimates

26. Letter To Stockholders
Four main purposes. It indicates that management:
Is responsible for preparation and integrity of statements
Has prepared statements in accordance with GAAP
Has used their best estimates and judgment
States that the company maintains a system of internal controls

27. 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
Analysts’ reports
News articles about the company.

28. Analysts’ Reports Buy Hold Sell
Individual investors make essentially three investment decisions
Usually accomplished by fundamental analysis as discussed in Chapter 4
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

29. 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:
Sell side - Work for full-service broker dealer and make recommendations on securities they cover
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
Independent - Not associated with firms that underwrite the securities they cover. Often sell their recommendations on a subscription basis

30. 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

31. 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

32. 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
* The SEC is the agency responsible fro administering federal securities laws and also has issued disclosure requirements
The 1993 Act regulates the initial public distribution of securities. It requires
* *
* The 1934 Act deals with the information contained in annual and interim reports. Its provisions also attempt to insure that corporate insiders do not achieve any advantage in the sale of securities.
*The FCPA requires ethical behavior and has two main aspects. It makes the payment of bribes to foreign officials illegal and requires companies to maintain an adequate system of internal control.
*The SEC integrated disclosure system
*Deals with the content of audited financial statements
*Requirements for highlighting trends and management discussion and analysis

33. Foreign Corrupt Practices Act of 1977
Provisions:
Makes it a criminal offense to offer bribes to foreign officials
Requires detailed financial records and a system of internal control

34. The Sarbanes-Oxley Act of 2002
Early 2000s: dozens of major corporations either went bankrupt or faced extreme financial difficulties 
Included
Enron
WorldCom
Xerox
Global Crossing
Arthur Andersen
Merrill Lynch
Tyco International
Halliburton Oil Services.
Result:
Americans lost billions of their investment dollars
jobs vanished
thousands of people lost their entire retirement savings
Subsequently, corporate reform became a watchword

35. The Sarbanes-Oxley Act of 2002
Congress passed in 2002
Major provisions are:
The creation of a Public Company Accounting Oversight Board (PCAOB)
The Establishment of Auditing, Quality Control, and Independence Standards
The Inspection of CPA Firms
The Establishment of Accounting Standards
The Delineation of Prohibited Services
Prohibition of Acts that Influence the Conduct of an Audit
Requiring Specified Disclosures
Requiring CEO and CFO Certification

36. 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

37. The Sarbanes-Oxley Act of 2002: Sec. 404
Higher audit fees for accelerated filers
June 2007: PCAOB released Auditing Standard No. 5
Integrated top-down, risk-based, materiality-focused approach to audit
One opinion: whether management has maintained internal control over financial reporting
Compliance date extended for non-accelerated filers

38. Recent Developments
July 2007: SEC chartered Advisory Committee on Improvements to Financial Reporting
August 2008: final committee report included following recommendations
Usefulness of information in SEC reports should be increased
Accounting standards-setting process should be enhanced
Substantive design of new accounting standards should be improved
Authoritative interpretive guidance should be delineated
Guidance on financial restatements and accounting judgments should be clarified

39. 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

40. Ethical Conduct of Accountants
Ethical issues for accountants
Independence
Scope of service
Confidentiality
Practice development
Differences on accounting issues

41. 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

42. The Ethical-Legal Question
Just because something is legal it is not necessarily ethical
Let’s look more closely at the development of the Professonal Code of Ethics

43. AICPA Code of Professional Conduct
The AICPA represents itself as an ethical professional body practicing an art rather than a science
Accounting should be viewed as practicing a service function rather than as a profit-making function
As an art, accounting requires judgment which encompasses ethical conduct
To assist in satisfying its responsibilities to society, the accounting profession has developed a code of professional conduct
A Code of Ethics has been a part of the accounting profession since the early 1900s. It has been developed because * * * *
The development of the Code of Ethics has also been impacted by various events over the years. Let’s look at some of these issues

44. 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
Not material in many cases anyway
Also concern over audit failures for such companies as Penn Central, National Student Marketing and Equity Funding

45. AICPA Code of Professional Conduct
The role of Congress and Congressmen Moss and Dingle
Were the rules deficient?
Were the qualifications to be a CPA sufficient?
Was self-policing working?
In response the Cohen Commission
The Expectations Gap

46. AICPA Code of Professional Conduct
The Anderson Report indicated that efficient performance should meet six criteria:
Safeguard public interest
Recognize CPA’s paramount role in the financial reporting process
Help assure quality performance and eliminate substandard performance
Help assure objectivity and integrity in public service
Enhance CPA’s prestige and creditability
Provide guidance as to proper conduct

47. AICPA Code of Professional Conduct
As a result new ethical standards were developed in response to the expectations gap
The effect was:
Broader auditor responsibility to consider reliability of internal control system in planning an audit
Delineate audit responsibility for reporting errors, irregularities and illegal acts by clients
Evaluate ability of a firm to continue as a going concern

48. AICPA Code of Professional Conduct
The new Code of Professional Conduct contains four sections:
Principles
Responsibility
The public interest
Integrity
Objectivity and independence
Due care
Scope and nature of services
Rules of conduct
Interpretations
Ethical rulings

49. 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
Ethical guidance
Broad positive statements
Specific behavioral rules
Proactive monitoring
Broader rules application
Guidance on dealing with the changing environment
The profession’s image by the public has suffered but has recently recovered.

50. International Accounting Standards
IAS No. 1 “Presentation of Financial Statements” Addressed disclosure requirements and ethical responsibilities
IAS No “Interim Financial Reporting” Described the preferred format for interim financial statements

51. 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

52. 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 51

53. Prepared by Kathryn Yarbrough, MBA
End of Chapter 17
Prepared by Kathryn Yarbrough, MBA
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