FINANCIAL

ACCOUNTING
THEORY AND
ANALYSIS:
TEXT AND CASES
11TH EDITION

RICHARD G.
SCHROEDER
MYRTLE W. CLARK

CHAPTER 17
FINANCIAL REPORTING
DISCLOSURE
REQUIREMENTS AND
ETHICAL
RESPONSIBILITIES

Financial Statement
Disclosure
Chapter focuses on the
special importance of
disclosure in financial
reporting.
Disclosure requirements
issued by:

1.
2.

FASB
SEC

SFAC No. 5
outlines the
various
methods of
disclosure

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
Financial Stmts

Supplementary
Information

Notes to
Financial Stmts
Examples:

Stmt of Earnings &

Comprensive Income

Accounting Policies

Stmt of Financial
Position

Schedules and
Exhibits

Stmt of Cash Flows

Explanation of
Financial Statement
Items

Stmt of Investments
by & Distributions to
Owners

General Information
about the company

Examples:
Segment
Information
Changing Price Disclosures (SFAS
No.33
Oil and Gas
Reserve
Liquidation Basis
of Accounting SFAS No, 69
Auditors
Report
Interim Financial
Statements
Liquidation Basis
of Accounting

Other Means of
Financial
Reporting

Other
Information

Examples:

Analysts Reports

MD&A

News Articles
about Company

Letter to
Stockholders

Examples:

SFAC No. 5
Summarizes the building blocks
to disclosure as:

1.

2.
3.

4.
5.

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

The Scope of Recognition and

Measurement

Discussed earlier throughout the text.

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

t es
o
n
t
foo

supplementary
schedules

pa
re
dis nthe
clo tic
su al
res

Footnotes
The most common examples
of footnotes are:

Accounting policies
Schedules and exhibits

1.
2.

Explanations of financial statement items

3.

4.

Example: schedules or exhibits concerning long-term debt

and income tax
Example: Pensions and post-retirement benefits

General information about the company

Accounting Policies
APB Opinion No. 22
(FASB ASC 235)

requires all companies

to disclose

Typically, companies disclose this

information in a Summary of
Significant Accounting Policies
preceding the footnotes.

the accounting policies

the firm follows
and the methods it uses
in applying these
policies.

Accounting Policies
APB Opinion No. 22

requires that the accounting

methods and procedures involving
the following be disclosed:
1.
A selection from existing
acceptable alternatives.
2.
Principles and methods peculiar
to the industry in which the
reporting entity operates.
3.
Unusual or innovative
applications of generally
accepted accounting principles.

The APBs principal

objective in issuing
Opinion No. 22:

to provide information
that helps investors
compare firms across
and between
industries.

Subsequent Events

During the period between the end of a

companys fiscal year and the issuance of its
financial statements, events might occur that
arent 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

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:
1.
Segment information (Chapter 16)
2.
The effects of price-level changes
3.
The auditors report
4.
Interim financial reports

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

Auditors Report

Informs users of the reliability of the

financial statements
The following guidelines for preparing the
auditors 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.

Auditors Report

Types of opinions:

Unqualified
Qualified
Disclaimer
Adverse
Auditors Report on Internal Control
Going Concern

Interim Financial
Statements

Two views
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.

APB conclusion - adopted integral view

Liquidation Basis of
Accounting

July 2012 FASB issued proposed

amendment to FASB ASC Top 205
April 2013 FASB issued ASU 2013-07
Required when liquidation is deemed to be
imminent
Statements required:

Statement of Changes in Net Assets in Liquidation

Statement of Net Assets in Liquidation

Financial Reporting: Other

Means of Financial Reporting
Other relevant information

Can assist in understanding the financial

report
Presented in narrative form

Examples:
1.

2.

Managements discussion and

analysis
Letter to stockholders

Managements Discussion and

Analysis

Required by the SEC

Explains the reasons for a companys
performance during the preceding annual
period, including:

Liquidity, capital resources and results of

operations
Favorable and unfavorable trends
Significant events and uncertainties

Managements 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

Managements 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:
1.
Interest rates
2.
Currency exchange rates
3.
Commodity prices
4.
Equity prices

Managements Discussion and

Analysis

The quantitative information about market risk

sensitive instruments is to be disclosed by using one
or more of the following alternatives:
1.
Tabular presentation
of fair value information and contract terms
relevant to determining future cash flows,
categorized by expected maturity dates
2.
Sensitivity analysis
expressing the potential loss in future earnings, fair
values, or cash flows from selected hypothetical
changes in market rates and prices
3.
Value at risk
disclosures expressing the potential loss in future
earnings, fair values, or cash flows from market

Managements 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

Managements Discussion and

Analysis

1.

2.

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

3.

either the primary market risk exposures

b)
or how those exposures are managed
when compared to the most recent reporting period
and what is known or expected in future periods
a)

Managements 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

Letter To
Stockholders
Four main purposes. It indicates that
management:

1.

2.

3.

4.

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

All Information Useful for

Investment, Credit and Similar
Decisions: Other Information

Includes information about companies

Also available outside the companys
annual report and 10-K.
Examples of these types of information
include

1.
2.

Analysts reports
News articles about the company.

Analysts Reports

Individual investors make essentially

three investment decisions

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

Usually accomplished by fundamental analysis

as discussed in Chapter 4

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:
1.
Sell side - Work for full-service broker dealer and make
recommendations on securities they cover
2.
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
3.
Independent - Not associated with firms that underwrite the securities
they cover. Often sell their recommendations on a subscription basis

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 longterm investors are the key to the
firms reputation and success

Analysts Reports

Several factors can create pressure on an analysts

independence and objectivity
An analysts firm may be underwriting a companys
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 analysts firm

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

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

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

The Sarbanes-Oxley Act of 2002

Congress passed in 2002

Major provisions are:
1.
The creation of a Public Company Accounting
Oversight Board (PCAOB)
2.
The Establishment of Auditing, Quality Control,
and Independence Standards
3.
The Inspection of CPA Firms
4.
The Establishment of Accounting Standards
5.
The Delineation of Prohibited Services
6.
Prohibition of Acts that Influence the Conduct of
an Audit
7.
Requiring Specified Disclosures
8.
Requiring CEO and CFO Certification

The Sarbanes-Oxley Act of

2002:
Sec. 404
Controversial

404(a)

Managements responsibilities

Internal control report by management

Establishing and maintaining

Assessment

404(b)

Independent auditors responsibility

Report on managements internal control

assessment
Assessment of companys internal controls on
financial reporting

2 separate opinions required

The Sarbanes-Oxley Act of

2002:
Sec.
Higher audit
fees404
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

Recent Developments
July 2007: SEC chartered Advisory
Committee on Improvements to Financial
Reporting
August 2008: final committee report included
following recommendations

1.
2.
3.
4.
5.

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

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

Ethical Conduct of
Accountants

Ethical issues for accountants

Independence
Scope of service
Confidentiality
Practice development
Differences on accounting issues

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

The Ethical-Legal
Question

Just because something is

legal it is not necessarily
ethical

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
3

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

AICPA Code of Professional

Conduct

Society viewed accounting favorably until the late 1960s

Watergate
Accountants argued they shouldnt 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

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

AICPA Code of Professional

Conduct

The Anderson Report indicated that efficient

performance should meet six criteria:
Safeguard public interest
Recognize CPAs paramount role in the
financial reporting process
Help assure quality performance and eliminate
substandard performance
Help assure objectivity and integrity in public
service
Enhance CPAs prestige and creditability
Provide guidance as to proper conduct

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

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

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 publics concern by providing

Ethical guidance
Broad positive statements
Specific behavioral rules
Proactive monitoring
Broader rules application
Guidance on dealing with the changing environment

The professions image by the public has suffered but

has recently recovered.

International Accounting
Standards
IAS No. 1
Presentation of
Financial Statements
Addressed disclosure
l
requirements and ethica
responsibilities

IAS No. 3
4
Interim F
inancial
Reporting

Described
the
preferred
format fo
r
interim fin
ancial
statemen
ts

IAS No. 1:
Presentation of
Requires
Financial
Statements
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

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

End of Chapter 17
Prepared by Kathryn Yarbrough, MBA
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