1. Prepared by Gabriela H. Schneider, CMA; Grant MacEwan College INTERMEDIATE ACCOUNTING INTERMEDIATE ACCOUNTING Sixth Canadian Edition KIESO, WEYGANDT, WARFIELD, IRVINE, SILVESTER, YOUNG, WIECEK

2. C H A P T E R 24 Full Disclosure in Financial Reporting

3. Learning Objectives 1. Review the full disclosure principle and describe problems of implementation. 2. Explain the use of notes in financial statement preparation. 3. Describe the disclosure requirements for major segments of a business. 4. Describe the accounting problems associated with interim reporting.

4. Learning Objectives 5. Identify the major disclosures found in the auditor’s report. 6. Understand management’s responsibilities for financials. 7. Identify issues related to financial forecasts and projections. 8. Describe the profession’s response to fraudulent financial reporting.

5. Full Disclosure in Financial Reporting Full Disclosure Principle Increase in reporting require- ments Differential disclosure Current Reporting Issues Reports Forecasts or projections Internet financial reporting Fraudulent financial reporting Criteria for accounting and reporting choices Notes to Financial Statements Accounting policies Common notes Disclosure Issues Special transactions or events Post balance sheet events Auditors and Management Auditor’s report Management’s reports Diversified companies Interim reports

6. The Full Disclosure Principle The full disclosure principle calls for financial reporting of significant facts affecting the judgment of an informed reader The problems of implementing this principle are costs of disclosure or information overload The profession is still in the process of developing guidelines as to whether a given transaction should be disclosed what format this disclosure should take

7. Increase in Reporting Requirements Reasons for increasing reporting requirements: Complexity of the business environment (derivatives, business combinations, pensions) Need for timely information (interim data, forecasts) Accounting used as a control and monitoring device

8. Differential Disclosure The OSC requires that companies report certain important information items (if not found in the annual report) Nonpublic enterprises are exempt from certain reporting requirements (e.g., segment reporting) Arguments are also made for excluding small companies from certain complex reporting requirements (e.g., pensions, deferred taxes) CICA is proposing a simplified GAAP; FASB maintains the position of a single GAAP

9. Notes to the Financial Statements Notes amplify or explain items presented in the body of the financial statements A statement that identifies the accounting policies of the entity must be disclosed (Summary of Significant Accounting Policies) Notes to the financial statements include: Inventory Contingencies and commitments Changes in accounting policies

10. Notes to the Financial Statements Major disclosures Inventory Property, Plant and Equipment Liabilities Equity Contingencies and Commitments Taxes, Pensions and Leases Changes in Accounting Policies Special Transactions or Events Subsequent events Segment reporting Interim reporting Related party transactions Accounting errors Illegal acts

11. Related Party Transactions Can significantly influence policies Measurement is a major accounting and reporting issue Related party transactions are individually assessed

12. Related Party Transactions – Decision Tree Is there a substantive change in the owner- ship interests of the item transferred? No Yes Related party transaction occurs Is transaction in the normal course of operations? Yes Measure at carrying amount No Is there culmination of the earnings process? Is the amount of the exchange supported by independent evidence? Is the transaction non-monetary? Measure at exchange amount Yes No Yes No

13. Related Party Transactions The following disclosures are recommended: The nature of the relationship Description of the transactions The recorded amounts of transactions Measurement basis used Amounts due from or due to related parties at the balance sheet date, and terms and conditions Contractual obligations with related parties Contingencies involving related parties

14. Post-Balance Sheet Events Notes to the financial statements must explain Any significant financial events that occurred after the balance sheet date, but before the issue of the financial statements Financial statement periodPost balance sheet events Balance sheet date Issue date

15. Types of Transactions to be Disclosed Two types of post-balance sheet events must be disclosed Events that provide additional evidence about conditions that existed at balance sheet date and require adjustment e.g., customer’s bankruptcy Events that provide evidence about conditions that did not exist at balance sheet date and do not require adjustment e.g., bond or share issuance

16. Reporting for Diversified (Conglomerate) Companies Information on how the segment contributes to the total business operations Information from the segment income statement, balance sheet, and cash flow statement Information about segment’s contribution or impact on the company’s Profitability Risk Growth potential Considerable arguments both for and against segment reporting

17. Reporting for Diversified (Conglomerate) Companies What is an operating segment? Any component of an enterprise that 1.Engages in business activities Earns revenues, incurs expenses 2.Has senior management regularly review results Assess performance Review resource allocation decisions made 3.Has discrete financial information available

18. Reporting for Diversified (Conglomerate) Companies Objectives of reporting segmented information 1.To better understand performance 2.To better assess future cash flow prospects 3.To make more informed judgments on the whole enterprise

19. Reporting by Conglomerates: Operating Segments CICA Handbook requires that the financial statements include selected information on a single basis of segmentation The segments are evident from their organizational structure (operating segments) This method is called the management approach

20. Aggregation of Operating Segments Operating segments may be aggregated if they have the same basic characteristics the nature of the products and services provided the nature of the production process the type or class of customer the methods of product or service distribution the nature of the regulatory environment, if applicable

21. Reportable Segments An operating segment is identified as a reportable segment if it satisfies one or more of the following criteria 1.The revenue criterion 2.The profit or loss criterion 3.The identifiable assets criterion Two other factors are considered in addition to the above tests 1.Segment results are 75 percent or more of combined sales to unrelated customers 2.No more than 10 segments are required to be disclosed

22. Reportable Segments CriterionThresholds Revenue 10 percent or more of the combined revenue of all operating segments Identifiable assets 10 percent or more of the combined assets of all operating segments Profit or loss 10 percent or more of the greater of: - the combined profit of all operating segments not showing a loss or - the combined loss of all operating segments reporting a loss

23. Measurement Principles The accounting principles used for segment reporting and for consolidated statements need not be the same Some accounting principles may not apply at the segment level Common costs are not required to be allocated among the segments Such allocation is arbitrary and may not produce an objective division of costs among segments

24. Required Segmented Information General information about its reportable segments Segment profit and loss, assets, and related information Reconciliation of segment revenues, profits and losses, and segment assets Information about products and services and geographical areas Major customers

25. Interim Reporting Each interim period considered as separate accounting period Deferrals and accruals recognized for each interim period, without specific consideration of the fiscal year CICA Handbook preferred method – with noted exceptions Each interim period considered a part of the fiscal accounting period Deferrals and accruals recognized in the interim period, based on the respective portion of the fiscal year Discrete ViewIntegral View

26. Interim Reporting Annual reports and interim reports must use the same accounting principles Exceptions regarding certain inventory reporting Minimum disclosure requirements include: 1.Any noncompliance with GAAP 2.Accounting policies and methods 3.Any seasonal or cyclical period considerations 4.Estimate changes 5.Reportable segment information 6.Events subsequent to interim reporting period 7.Notable events (combinations, reorganization) 8.Contingencies

27. Interim Reporting Problem Areas 1.Advertising and similar costs Test is whether the benefits extend beyond the current interim period. If yes, then defer; otherwise expense 2.Changes in Accounting Changes applied retroactively to prior interim periods Comparable interim periods from previous fiscal years also restated 3.Earnings per share Each interim period EPS is stand alone 4.Seasonality 5.Continuing Controversy

28. Auditor’s Reporting Standards CICA Handbook, Section 5100 1.Identify the financial statements Distinguish management and auditor’s responsibilities 2.Describe scope of the auditor’s examination 3.State either an opinion or statement that an opinion cannot be expressed If an opinion is provided, it should state whether the statement fairly presents the financial position, operating results, and cash flows in accordance with GAAP

29. Auditor’s Opinion The auditor can render or provide An Unqualified (clean) opinion A Qualified opinion An Adverse opinion (circumstances) A disclaimer of an opinion (no opinion can be given)

30. Management’s Report Management’s Discussion and Analysis (MD&A) Covers three aspects of an enterprise 1.Liquidity 2.Capital resources 3.Results of operations Identifies favourable or unfavourable trends Identifies any significant events and uncertainties that affect the three aspects

31. Management’s Report MD&A raises continuing discussion and questions 1.Is sufficient forward-looking information disclosed? 2.Should disclosures become more of a risk analysis? 3.Should the report be externally audited?

32. Financial Forecasts and Projections The investing public needs a greater quantity and quality of information about corporate expectations The disclosures take one of two forms Financial forecast of an entity’s expected financial position Financial projection based on hypothetical assumptions The difference is one of likelihood of happening

33. Forecast Arguments Information about the future facilitates better decisions Corporate disclosures limit the speculation about forecasts that are informally circulated Historical information may not be adequate in a world of frequently changing circumstances Information about the future may be misleading and unreliable Corporations may strive to meet published projections regardless of shareholders’ interests Incorrect projections may lead to legal actions Forecasts may provide information to competitors that may be detrimental to corporate interests ForAgainst

34. Internet Financial Reporting Companies are increasingly disclosing financial information through websites Corporations can reach more users by the Internet Internet reporting can make traditional reports more useful Corporations can report more timely information They can also report disaggregated data There is concern about security on the Internet (hackers)

35. Fraudulent Financial Reporting Issues of Fraudulent Financial Reporting How well are accounting practices and disclosures serving the public? Are auditors meeting their obligations? What are the effects of the SEC’s policies? What are the effects of regulatory accounting policies? What legislative proposals are needed to correct perceived weaknesses?

36. Fraudulent Financial Reporting Opportunities exist when: 1.Board of directors or audit committee are absent 2.Internal accounting controls are weak or nonexistent 3.Unusual or complex transactions 4.Accounting estimates made with significant subjective judgment 5.Internal audit staff ineffective

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