CH 3 - The Statement of Financial Position and Financial Disclosures

Chapter 3
THE STATEMENT OF FINANCIAL POSITION AND FINANCIAL DISCLOSURES
2013 The McGraw-Hill Companies, Inc.
Slide 2
Coverage
LO(Learning Objective)5,6,7 Page 121-129
Slide 3
Basic Principles or Underlying Guidelines of Accounting
Including: 4 Qualities 4 Principles 2 Constraints
Slide 4
C5
4 Qualities: GAAP identify major characteristics of information

Relevant Information Reliable Information Comparable Information Consistent Information Affects the decision of its users. Is trusted by users. Is helpful in contrasting organizations.
requires a company to use the same accounting methods period after period so that financial statements are comparable across periods
Slide 5
C5
4 PRINCIPLES OF ACCOUNTING
Revenue Recognition Principle

Recognize revenue when it is earned.
Cost Principle
Accounting information is based on actual cost. Actual cost is considered objective.
Matching Principle
A company must record its expenses incurred to generate the revenue reported.
Full Disclosure Principle

A company is required to report the details behind financial statements that would impact users decisions.
Slide 6
2 CONSTRAINTS: CONSTRAINT 1: MATERIALITY
Concept of materiality: An item is material if knowledge of the item might reasonably influence the decisions of users of financial statements.
Slide 7
C1
GOODS DAMAGED OR 2 CONSTRAINTS: OBSOLETE(chapter 6) CONSTRAINT 2: CONSERVATISM
Concept of CONSERVATISM (is also known as PRUDENCE concept): the general concept of
recognizing expenses and liabilities as soon as possible when there is uncertainty about the outcome, but to only recognize revenues and assets when they are assured of being received. Example of application or use of conservatism in accounting: assets valuation and write-off
Learning Objective 5
Explain the purpose of financial statement disclosures
3-8
Disclosure Notes
What is the basic accounting principle guiding the Disclosure Notes? Any constraint of this accounting principle?
Disclosure Notes
1.Summary of Significant Accounting Policies
Conveys valuable information about the companys choices from among various alternative accounting methods. *
2.Subsequent Events
A significant development that takes place after the companys financial year-end but before the financial statements are issued.
3. Noteworthy Events and Transactions
Transactions or events that are potentially important to evaluating a companys financial statements
2. Subsequent Events

Example 1: Wal-Mart Stores, Inc.: Dividends Declared On March 3, 2011, our Board of Directors approved an increase in the annual dividend for fiscal 2012 to $1.46 per share, an increase of approximately 21% over the dividends paid in fiscal 2011. Dividends per share were $1.21 and $1.09 in fiscal 2011 and 2010, respectively. For the fiscal year ending January 31, 2012, the annual dividend will be paid in four quarterly installments.
Example 2: Earthquake in Japan

On March 11, 2011, an earthquake of 9.0 magnitude occurred near the Northeastern coast of Japan, creating extremely destructive tsunami waves. The earthquake and tsunami waves caused extensive damage in Northeastern Japan and also affected other regions in Japan through a lack of electricity, water and transportation. We are currently unable to estimate the value of damages and the corresponding insurance recovery regarding our business in Japan, although we do not believe that any damages would be material to our financial position.
2. Discussion: Accounting of Subsequent Events
Situation 1: The IASB requires that companies

adjust the reported amount of assets and liabilities (in the financial statements table) if events occurring after the balance sheet date provide additional information about conditions that existed at the balance sheet date.
2. Discussion: Accounting of Subsequent Events
Situation 2: Disclosure Notes should be

made of significant subsequent events even if those events do not impact the valuations reported in the balance sheet.
Situation 3: No need of Disclosure Notes for

non-significant subsequent events
2. Subsequent Events--Discussion
Which situation is the following subsequent
events? Major customer went bankrupt due to a deteriorating financial condition
events? Company sustained extensive hurricane damage to one of its plants
events? Company lost a major lawsuit that had been pending for two years
events? Increasing U.S. trade deficit may have impact on companys overseas sales.
events? Company sold a large block of preferred stock
events? Companys controller resigned and was replaced by an audit manager from the companys audit firm

Transactions or events that are potentially important to evaluating a companys financial statements, including: 1. related-party transactions 2. errors, and fraud 3. Any important information not included in the financial statements tables, e.g., additional information to support summary totals; contingent liability; segment information
Related-Party Transactions Disclosure

Related-party transactions require disclosure of the nature of the relationship, a description of the transaction, and any dollar amounts involved .
Example of Notes of Related-Party Transactions Disclosure-- GlaxoSmithKline plc
GSK held a 18.1% interest in Quest Diagnostics Inc. at 31st December 2010 (2009 16.8%). The Group and Quest Diagnostics are parties to a long-term contractual relationship under which Quest Diagnostics is the primary provider of clinical laboratory testing to support the Groups clinical trials testing requirements worldwide. During 2010, Quest Diagnostics provided services of 41 million (2009 47 million) to the Group. At 31st December 2010, the balance payable by GSK to Quest Diagnostics was 10 million (2009 10 million). Subsequent to the year-end, GSK sold its entire shareholding in Quest Diagnostics Inc. The sale comprised a secondary public offering and an accompanying repurchase of shares by Quest Diagnostics which together are expected to generate gross proceeds of 0.7 billion after tax.
Errors, and Fraud Both result in misstatement in financial statements. What is the main difference between Errors and Fraud?

Additional information to support summary totals, e.g.

Breakdown of property, plant, and equipment (PPE), long-term debt Main difference between financial accounting income and tax income Notes of long-term leases: length of the lease and future payments Pension plan and plan for coverage of medical benefits
C3

Contingent Liabilities: Potential obligation that depends on a future event arising out of a past transaction or event, e.g., Potential Legal Claims, Debt Guarantees
Probability of future sacrifice . . . Reasonably Probable Possible Remote
Slide 27
Amount . . .
Can be Estimated
Record the contingent liability.

Disclose the
Disclose the liability in the notes to the financial stmts. Disclose the liability in the No action. No action.
Cannot be liability in the Estimated notes to the
notes to the financial stmts. financial stmts.
Segment Information
Firm should disclose geographic segment information and segment information of major product or customer
Explain the purpose of the management discussion and analysis disclosure.
3-29
Slide 30
Management Discussion and Analysis
Provides a biased but informed perspective of a companys operations, liquidity, and capital resources.
Managements Responsibilities
Preparing the financial statements and other information in the annual report. Included in annual reports to assert the responsibility of management and directors
Explain the purpose of an audit and describe the content of the audit report.
3-32
Auditors Report
Expresses the auditors opinion as to the fairness of presentation of the financial statements in conformity with accounting standards.
Must comply with the auditing standards of the specific jurisdictions over which the company operates.
Auditors Opinions
Unqualified
Issued when the financial statements present fairly the financial position, results of operations, and cash flows are in conformity with accounting standards.
Qualified
Issued when there is an exception to the standard unqualified opinion but is not of sufficient seriousness to invalidate the financial statements as a whole. Issued when the exceptions are so serious that a qualified opinion is not justified.
Adverse
Disclaimer
Issued when there is insufficient information on which to express an opinion.
Slide 35
Compensation of Directors & Top Executives
Disclosure Directors remuneration Remuneration policies and practices Auditors report on remuneration policies
In the U.S., a proxy statement is sent each year to all shareholders, usually in the same mailing with the annual report.
Homework
Discussion Questions (no need to hand in) E3-10 E3-11
End of Chapter 3
2013 The McGraw-Hill Companies, Inc.

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Chapter 3

THE STATEMENT OF FINANCIAL POSITION AND FINANCIAL DISCLOSURES

2013 The McGraw-Hill Companies, Inc.

LO(Learning Objective)5,6,7 Page 121-129

Basic Principles or Underlying Guidelines of Accounting

Including: 4 Qualities 4 Principles 2 Constraints

4 Qualities: GAAP identify major characteristics of information

Revenue Recognition Principle

Full Disclosure Principle

2 CONSTRAINTS: CONSTRAINT 1: MATERIALITY

GOODS DAMAGED OR 2 CONSTRAINTS: OBSOLETE(chapter 6) CONSTRAINT 2: CONSERVATISM

Explain the purpose of financial statement disclosures

3. Noteworthy Events and Transactions

Example 2: Earthquake in Japan

2. Discussion: Accounting of Subsequent Events

Situation 1: The IASB requires that companies

2. Discussion: Accounting of Subsequent Events

Situation 2: Disclosure Notes should be

Situation 3: No need of Disclosure Notes for

3. Noteworthy Events and Transactions

3. Noteworthy Events and Transactions

Related-Party Transactions Disclosure

Example of Notes of Related-Party Transactions Disclosure-- GlaxoSmithKline plc

3. Noteworthy Events and Transactions

3. Noteworthy Events and Transactions

3. Noteworthy Events and Transactions

Record the contingent liability.

Cannot be liability in the Estimated notes to the

notes to the financial stmts. financial stmts.

3. Noteworthy Events and Transactions

Explain the purpose of the management discussion and analysis disclosure.

Management Discussion and Analysis

Issued when there is insufficient information on which to express an opinion.

Compensation of Directors & Top Executives

Discussion Questions (no need to hand in) E3-10 E3-11

2013 The McGraw-Hill Companies, Inc.

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