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 McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 Learning Objectives 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? ©The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Learning Objectives 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? What is the role of the Securities and Exchange Commission, and what are some of its reporting requirements? ©The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Learning Objectives Why is a statement of management’s responsibility included with the notes? What is the significance of management’ discussion and analysis of the firm’s financial condition and results of operations? What is included in the five-year (or longer) summary of financial information? What are the meaning and content of the independent auditor’s report? McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 Learning Objective • 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? McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 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 McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 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 ©The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Learning Objective • What are the kinds of significant accounting policies that are explained in the notes? ©The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 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 McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 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 McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 Learning Objective • 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? ©The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 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 dispositions will be reported ©The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 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 ©The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 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 ©The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Learning Objective • What is the role of the Securities and Exchange Commission, and what are some of its reporting requirements? ©The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 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 ©The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Learning Objective • Why is a statement of management’s responsibility included with the notes? ©The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 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 ©The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Learning Objective • What is the significance of management’ discussion and analysis of the firm’s financial condition and results of operations? ©The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 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 ©The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Learning Objective • What is included in the fiveyear (or longer) summary of financial information? ©The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 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 McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 Learning Objective • What are the meaning and content of the independent auditor’s report? ©The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 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 signature ©The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 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 McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 ... and analysis of the firm’s financial condition and results of operations? What is included in the five-year (or longer) summary of financial information? What are the meaning and content of the. .. full understanding of the financial statements? McGraw-Hill/Irwin ? ?The McGraw-Hill Companies, Inc., 2002 General Organization ã The explanatory notes refer to specific items in the financial statements... in the ? ?other income” category • Details of long-term debt may be provided • Details of other costs and expenses ? ?The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Learning Objective • What