Lecture Accounting: What the numbers mean (5/e) - Chapter 10: Explanatory notes and other financial information

After reading this chapter, you should be able to answer the following questions: Are the explanatory notes an integral part of the financial statements? Do the notes provide detailed disclosure needed by users wishing to gain a full understanding of the financial statements? What are the kinds of significant accounting policies that are explained in the notes?...

CHAPTER 10

EXPLANATORY NOTES AND OTHER FINANCIAL

INFORMATION

Learning Objectives

1 Are the explanatory notes an integral

part of the financial statements? Do

the notes provide detailed disclosure

needed by users wishing to gain a full

understanding of the financial

statements?

2 What are the kinds of significant

accounting policies that are explained

in the notes?

Learning Objectives

3 What are the nature and content of

disclosures relating to accounting

changes, business combinations,

contingencies and commitments,

events subsequent to the balance

sheet date, impact of inflation, and

segment information?

4 What is the role of the Securities and

Exchange Commission, and what are

some of its reporting requirements?

Learning Objectives

5 Why is a statement of management’s

responsibility included with the notes?

6 What is the significance of

management’ discussion and analysis

of the firm’s financial condition and

results of operations?

7 What is included in the five-year (or

longer) summary of financial

information?

8 What are the meaning and content of

the independent auditor’s report?

Learning Objective 1

• Are the explanatory notes an

integral part of the financial statements? Do the notes provide detailed disclosure needed by users wishing to gain a full understanding of the financial statements?

General Organization

• The explanatory notes refer to specific items

in the financial statements

• The financial statement sequence is usually

as follows:

– Income statement

– Balance Sheet

– Statement of cash flows

• The placement of the statement of changes

in owners’ equity depends on the complexity

of the statement

Explanatory Notes

• Full disclosure requires that firms

report all information necessary for a

reasonably astute user not to be

misled

• Explanatory notes generally require

more pages than the statements

themselves

Learning Objective 2

• What are the kinds of significant accounting policies that are explained

in the notes?

Significant Accounting

Policies

• Management may choose from a

number of choices among generally

accepted accounting practices

• Each firm must disclose the policies

chosen

• Disclosure enables users to make

intelligent comparisons among firms

Types of Significant Accounting Policies

• Depreciation method – method used

and useful lives are disclosed

• Inventory valuation method – methods

for each category of inventory are

disclosed If LIFO used, the difference

between it and what inventory would

have been under FIFO is disclosed

• Basis of consolidation – discloses which subsidiaries are consolidated, if any

More Types of Significant

Accounting Policies

• Income taxes – a reconciliation of the

statutory rate and the effective tax rate is

provided An explanation of deferred taxes

also is included

• Employee benefits – the cost of employee

benefit is disclosed, along with actuarial

assumptions

• Amortization of intangible assets – method

of amortization is disclosed

More Types of Significant

Accounting Policies

• Earnings per share of common stock –

an explanation of the calculation is

provided

• Stock option and stock purchase plans

– officers and key employees are given

the right to purchase stock at some time

in the future Details of such plans are

provided

Details of Other Financial

Statement Amounts

• May include the amount of research

and development expenses

• May include what items are included in

the “other income” category

• Details of long-term debt may be

provided

• Details of other costs and expenses

Learning Objective 3

• What are the nature and content of

disclosures relating to accounting

changes, business combinations,

contingencies and commitments,

events subsequent to the balance

sheet date, impact of inflation, and

segment information?

Other Disclosures

• Accounting change – a change in

accounting principle that has a

material effect on the comparability

of the current period with prior

periods Example: changing from

FIFO to LIFO

• Business combinations – the effect

on the financial statements from

mergers, acquisitions, or

More Disclosures

• Contingencies and commitments –

firms involved in lawsuits must

disclose the facts of the lawsuit

Must also disclose if a guarantor of

the indebtedness of another entity

• Events subsequent to the balance

sheet date – a significant event that

will materially impact the financial

statement s must be disclosed

More Disclosures

• Impact of inflation – a firm must

report the effect of inflation on the

financial statements

• Segment information – must

disclose line of business and

geographic segment operating

profit, capital expenditures,

depreciation and amortization,

identifiable assets, and sales to

unaffiliated customers

Learning Objective 4

• What is the role of the Securities

and Exchange Commission, and

what are some of its reporting

requirements?

Reporting to the Securities

and Exchange Commission

• The SEC was created to administer securities

laws

• Securities that are offered for sale to more than

a few investors must be registered with the SEC

• A prospectus is provided to investors prior to

their purchase of securities

• Firms must file annual reports, 10-Ks, with the

SEC

Learning Objective 5

• Why is a statement of

management’s responsibility included with the notes?

Management’s Statement of

Responsibility

• Explains that the responsibility for the

financial statements lies with the

management of the firm

• Usually refers to the firm’ internal

control, the internal audit function, the

audit committee of the board of

directors, and other ethical conduct

matters

Learning Objective 6

• What is the significance of

management’ discussion and analysis of the firm’s financial condition and results of

operations?

Management’s Discussion and Analysis

• A discussion by management of the

firm’s activities during the year, its

financial condition, and the results of

operations

• Required by the SEC in annual reports

to them, but now included in most firm’s annual reports to stockholders

Learning Objective 7

• What is included in the

five-year (or longer) summary of financial information?

Five-Year (or Longer) Summary of Financial Data

• Includes key income statement data

• Includes significant ratios such as

earnings as a percent of sales

• Includes earnings and dividends per

share

• May include stock prices

Learning Objective 8

• What are the meaning and

content of the independent auditor’s report?

Independent Auditors’ Report

• Brief (usually three paragraphs) report

• Usually addressed to board of directors and

stockholders

• Identifies the statements that were audited

• Describes the nature and extent of the

auditors’ work

• Contains an opinion about fair presentation

• Contains the name of the audit firm and a

Financial Statement

Compilations

• A report that states that the financial

statements have not been audited

• Does not provide any assurance as to

the fairness of the financial statements

• Less costly than an audit