Advanced Issues Lecture 1 Flashcards
(50 cards)
Financial reports should include all financial facts that would influence the judgment of an informed reader
Full Disclosure Principle
- Related Party Transactions
- Post-Balance-Sheet Events (Subsequent Events)
- Reporting for Diversified (Conglomerate) Companies
- Management’s Discussion and Analysis
- Forecasts and Projections
Disclosure Issues
Should all companies have the same reporting requirements?
* Some believe small companies should have less onerous
requirements
* Big GAAP vs. Little GAAP
* FASB has traditionally taken the positon that there should only
be one set of GAAP
Differential Disclosure
Transaction in which one of the parties has significant influence over
the other (or incentive to do the other a favor)
* e.g., car manufacturers and parts suppliers or buying a car from your
parents
Required Disclosures
* Nature of relationship
* Description of transaction
* Dollar amount for each period of income statement presented
* Dollar amount for accrued amounts as of each balance sheet date
presented
Related Party Transactions
Two kinds of subsequent events. Those that…
* …provide additional evidence about a conditions that existed at the
balance sheet date (recognized subsequent events).
* …provide evidence about conditions that did not exist at the balance
sheet date (non-recognized subsequent events).
Post-Balance-Sheet Events
…provide additional evidence about a conditions that existed at the balance sheet date
Recognized Subsequent Events
provide evidence about conditions that did not exist at the balance
sheet date
Non-Recognized Subsequent Events
Adjust the financial statements
* Disclose in the footnotes
* Information that the accountant would have recorded, had it been
known before the books were closed
Recognized Subsequent Events
Do not adjust the financial statements
* Maybe disclose in the footnotes
* Should disclose events when non-disclosure would cause the financial
statements to be misleading
* Disclosure not required for non-accounting events or items disclosed some other
way (e.g., press releases)
Non-Recognized Subsequent Events
For Non-Recognized Subsequent Events, which would be disclosed in the footnote? (Four Things)
- Sale of bond or stock
- Business combinations
- Losses due to natural disasters
- New significant commitments
For Non-Recognized Subsequent Events, which would NOT be disclosed in the footnote? (6 things)
- Legislation
- Product changes
- Management changes
- Strikes
- Unionization
- Loss of important customers
How does management split the company when making
decisions?
- Products and services
- Geography
- Legal entity
- Customer type
For diversified companies, we cannot assume all segments
perform equally well each year
* Disclosure should disaggregate results by operating segment
Management Approach
- Investors can better forecast future profits and cash flows
- Investors can better estimate the overall worth of a company
- Absence of segment disclosure puts non-diversified
companies at disadvantage (no where to hide all the things
management wanted retain the right to hide on previous
slide)
In other words, investors say,
“Please make management
disclose segments!”
Segment Disclosure - Pros
Investor needs to be knowledgeable about more industries to
avoid misinterpretation
2. “Enemies” (e.g., competitors) may use information against
company
3. Managers may avoid risks (even when they are worth it) for
fear of how loss will look when disaggregated
4. Accounting at segment level is not always meaningful
5. Investor should not care about segments if overall
performance is good
6. Preparing disclosures is hard
In other words, management
says, “Please don’t make us
disclose segments!”
Segment Disclosure - Cons
An operating segment is a component of the business that:
- Earns revenues and incurs expenses
- Has its results reviewed regularly by the chief operating decision-maker
(e.g., COO, CEO, etc.) - Generates distinct financial information
An Operating Segment can combine components that are the same across all below:
- Nature of products or services
- Nature of production process
- Type of customer
- Method of product/service distribution
- Regulatory environment
Segment is significant if it passes ONE OR MORE OF the
following tests:
- Revenue Test
- Profit or Loss Test
- Identifiable Assets Test
- AND sum of reported segments’ revenue ≥ 75%
- AND number of segments ≤ 10
18
General rule: report all materially significant segments
Determining Segments to Report
- Sum revenues of individual segments
- Report segments with revenues greater than 10% of (1)
Revenue Test
- Sum profits of all segments with profit
- Sum losses of all segments with loss
- Select larger of (1) or absolute value of (2)
- Report segments with profits greater than 10% of (3) or absolute value of
losses greater than (3)
Profit or Loss Test
- Sum identifiable assets of individual segments
- Report segments with identifiable assets greater than 10% of (1)
Identifiable Assets Test
Unaudited additional information from management
* Additional disclosures related to: liquidity, capital resources, results of operations
Management’s Discussion and Analysis
- Since SOX management must expressly state responsibility for
- Financial statements
- Controls over financial reporting
Management’s Responsibility for Financial Statements
