CHAPTER 17

FINANCIAL REPORTING
DISCLOSURE
REQUIREMENTS
AND
ETHICAL
RESPONSIBILITIES
 Financial Statement
Disclosure
Chapter focuses on
the special importance
of disclosure in SFAC No. 5
financial reporting.
Disclosure outlines the various
methods of disclosure
requirements issued that corporations should
by: utilize in published
financial statements
1. FASB
2. SEC
 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 Notes to Supplementary Other Means of Other

Stmt of Earnings & Financial Stmts Information Financial Information
Comprensive Income Examples: Examples: Reporting Examples:
Stmt of Financial Accounting Policies Segment Examples: Analysts’ Reports
Position Information MD&A
General Information Discussion of
Stmt of Cash Flows about the company Auditor’s Notes competition
Stmt of Investments Report
by & Distributions to
Owners
SFAC No. 5
Summarizes the building blocks
to disclosure as:
1. The scope of recognition and
measurement
2. Basic financial statements
3. Areas directly affected by existing
FASB standards
4. Financial reporting
5. 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 4
and 5.
In addition to the four basic statements, a full
set of financial statements also includes

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

APB Opinion No. 22

requires all
companies to
disclose
the accounting
policies the firm
Typically, companies follows
disclose this information in and the methods it
a Summary of Significant uses in applying
Accounting Policies these policies.
preceding the footnotes.
 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 The APB‘s principal
peculiar to the industry in objective in issuing
which the reporting entity
operates. Opinion No. 22:
3. Unusual or innovative to provide
applications of generally information that helps
accepted accounting investors compare
principles. firms across and
between industries.
 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
 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 auditor’s 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
 Auditor’s Certificate

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.
Auditor’s Certificate

Types of opinions:
Unqualified
Qualified
Disclaimer
Adverse
 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.
APB conclusion - adopted integral view
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.
 Financial Reporting: Other
Means of Financial
Reporting

Other relevant information

can assist in understanding the
financial report
presented in narrative form
Examples:
1. Management’s discussion and
analysis
2. Letter to stockholders
 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
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
 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:
1. Interest rates
2. Currency exchange rates
3. Commodity prices
4. Equity prices
 Letter To Stockholders

Four main purposes. It indicates that

management:
1. Is responsible for preparation and
integrity of statements
2. Has prepared statements in accordance
with GAAP
3. Has used their best estimates
and judgment
4. 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 company’s
annual report and 10-K.
Examples of these types of
information include
1. Analysts’ reports
2. 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 3
 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
There are three 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 long-term investors are
the key to the firm’s reputation
and success
 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
 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 of 1977
The Sarbanes-Oxley Act of 2002
Foreign Corrupt Practices
Act of 1977

Provisions:
1 Makes it a criminal
offense to offer bribes to
foreign officials
2 Requires detailed
financial records and a
system of internal control
 The Sarbanes-Oxley Act of 2002

Early 2000s: dozens of Result:

major corporations either Americans lost billions of
went bankrupt or faced their investment dollars
extreme financial jobs vanished
difficulties thousands of people lost
Included their entire retirement
savings
Enron
WorldCom
Subsequently, corporate
reform became a
Xerox watchword
Global Crossing
Arthur Andersen
Merrill Lynch
Tyco International
Halliburton Oil Services.
 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
 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

1 Independence
2 Scope of service
3 Confidentiality
4 Practice development
5 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
 The AICPA Code of
Professional Conduct

1 The AICPA represents itself as an ethical professional

body practicing an art rather than a science
2 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
4 To assist in satisfying its
responsibilities to society,
the accounting profession
has developed a code of
professional conduct
 The 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
and not material in many cases anyway
Also concern over audit failures for
such companies as Penn Central,
National Student Marketing and
Equity Funding
 The AICPA Code of
Professional Conduct

The role of Congress and

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

The Anderson Report indicated that efficient

performance should meet six criteria:
1 Safeguard public interest
2 Recognize CPA’s paramount role in the financial
reporting process
3 Help assure quality performance and eliminate
substandard performance
4 Help assure objectivity and integrity in public service
5 Enhance CPA’s prestige and creditability
6 Provide guidance as to proper conduct
 The AICPA Code of
Professional Conduct

As a result new ethical standards were

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

The new Code of Professional

Conduct contains four sections:
1 Principles
 Responsibility
 The public interest
 Integrity
 Objectivity and independence
 Due care
 Scope and nature of services
2 Rules of conduct
3 Interpretations
4 Ethical rulings
 The 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
1 Ethical guidance
2 Broad positive statements
3 Specific behavioral rules
4 Proactive monitoring
5 Broader rules application
6 Guidance on dealing with the changing environment
The profession’s image by the public has
suffered but has recently recovered.
International Accounting
Standards
 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
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
 Prepared by
Richard Schroeder, DBA
Kathryn Yarbrough, MBA

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