CHAPTER 24
2. Discuss the disclosure requirements for related-party transactions, subsequent events,
major business segments, and interim reporting.
4. Describe reporting issues related to financial forecasts and fraudulent financial
reporting.
*6. Identify major analytic ratios and describe their calculation.
*8. Describe techniques of comparative analysis.
*10. State the guidelines for first-time adoption of IFRS.
*12. Review the exemptions to retrospective application in first-time adoption of IFRS.
*13. Describe the presentation and disclosure requirements for first-time adoption of IFRS.
1. Chapter 24 addresses the topic of financial statement disclosure. Accountants and business
executives are fully aware of the importance of full disclosure when presenting financial
2. (L.O. 1) Recent trends in financial reporting reflect an increase in the amount of disclosure
found in financial statements. Numerous reasons can be cited for this increased emphasis
3. The IASB has developed IFRS for small– and medium-sized entities (SMEs). The
standard outlines IFRS designed to meet the needs and capabilities of SMEs. Compared
4. Notes are an integral part of the financial statements of a business enterprise. Although
they are normally drafted in somewhat technical language, notes are the accountant’s
means of amplifying or explaining the items presented in the main body of the
statements. Many of the note disclosures that are common in financial accounting are
d. Creditor Claims. A liability may have numerous covenants that are not conveniently
disclosed in the liability section of the statement of financial position. To avoid a
cumbersome presentation in the body of the statement of financial position, this
additional information is disclosed in the notes.
e. Equity Holders’ Claims. The rights of various equity security issues along with certain
5. (L.O. 2) In some instances, a corporation is faced with a sensitive issue that requires
disclosure in the financial statements. Examples of items that can be characterized as
6. A related-party transaction arises when a company engages in transactions in which
one of the parties has the ability to significantly influence the policies of the other.
Under these circumstances, an “arm’s–length” basis cannot be assumed and the
7. Events or transactions that occur subsequent to the statement of financial position date
but prior to the issuance of the financial statements should be disclosed in the financial
statements are classified as either:
8. With the increase in diversification within business entities, investors are seeking more
information concerning the details of diversified (conglomerate) companies. Particularly,
they have requested revenue and income information on the individual segments that
(2) Better assess its prospects for future net cash flows.
(3) Make more informed judgments about the enterprise as a whole.
b. Basic Principles.
(1) That engages in business activities from which it earns revenues and incurs expenses.
(2) Whose operating results are regularly reviewed by the company’s chief operating
(3) For which discrete financial information is available that is generated by or based
(2) The nature of the production process.
(4) The methods of product or service distribution.
9. Whether a segment is significant enough to disclose depends upon whether it satisfies
one of the following tests: (a) its revenue is 10% or more of the combined revenue of all
the enterprise’s operating segments, (b) the absolute amount of its profit or loss is 10% or
10. The accounting principles to be used for segment disclosure need not be the same as the
principles used to prepare the consolidated statements. Also, allocations of joint, common,
11. Interim reports are financial reports issued by a business enterprise for a period of less
12. The same accounting principles used for annual reports should be applied in preparing
interim reports. However, the general approach used in preparing these reports is the
13.Generally, companies should use the same accounting policies for interim and for annual
reports. For example, if percentage–of-completion is used to recognize revenue on an
annual basis, it should also be used for interim reports. Companies should use the same
14. IFRS does not require a complete set of financial statements at the interim reporting date.
At a minimum, companies should report:
a. Statement that the same accounting policies and methods of computation are followed
in the interim financial statements as compared with the most recent annual financial
statements or, if those policies or methods have been changed, a description of the
j. Other material events subsequent to the end of the interim period that have not been
reflected in the financial statements for the interim period.
15. IFRS requires the annualized approach for income taxes. That is, income tax expense is
16.The fact that many business entities encounter seasonal variations in their operations
poses a problem in the analysis of interim reports. The greater the degree of seasonality
experienced by a company, the greater the possibility for distortion. For example, a seasonal
17. (L.O. 3) An audit report is issued each time an independent auditor performs an audit
of an entity’s financial statements. An audit report is essentially the expression of an
opinion, by the auditor, on the fairness with which the financial statements present the
18. Certain circumstances, although they do not affect the auditor’s unmodified opinion, may
require that an explanatory paragraph be added to the audit report. Some of the most
important circumstances include:
19. If an auditor arrives at the opinion that the financial statements are fairly presented, the
audit report that is issued is known as an unmodified opinion (clean opinion). When an
auditor is unable to express an unmodified opinion (normally as a result of scope
20. Management commentary helps in the interpretation of financial information. In this
section of the annual report, management discusses the company’s financial performance
21. Management is responsible for preparing the financial statements and establishing and
maintaining an effective system of internal controls. The auditor provides an independent
22. (L.O. 4) Prospective financial statements are financial statements based upon the
entity’s expectations about future operation. There are two types of prospective financial
statements: (a) financial forecasts, and (b) financial projections. A financial forecast is
23. Many companies prepare their financial statements using XBRL (Extensible Business
Reporting Language). XBRL is used to “tag” accounting data, once tagged, any company’s
24. Fraudulent financial reporting is defined as intentional or reckless conduct, whether act or
omission, that results in materially misleading financial statements. Situational pressures
(b) weak or non-existent internal accounting controls, (c) unusual or complex transactions,
(d) accounting estimates requiring significant subjective judgment, and (e) ineffective
*25. (L.O. 5) Appendix 24-A focuses on the methodology used in the interpretation and
evaluation of the information presented in financial statements. The chapter discusses the
computational aspects of the various techniques used in the analysis of financial
*26. (L.O. 6) Thus far, the discussion presented in the text has been concerned with the
measurement and reporting functions of accounting. Chapter 24 discusses the communi–
*27. Effective financial statement analysis is a skill that requires knowledge of the available
techniques and extensive experience. The techniques can be learned by studying a
*28. Ratios can be classified as follows:
a. Liquidity Ratios. Measures of the short-run ability of the enterprise to pay its maturing
obligations.
*29. In the following paragraphs, the individual ratios included in the four classifications will be
presented. The method of presentation will include: (a) identification of the ratio, (b) the
manner in which the ratio is computed, and (c) the significance of the ratio. It is
*30. The current ratio (Ch. 13) is the ratio of total current assets to total current liabilities. It is
*31. The acid-test ratio (Ch. 13) relates total current liabilities to the most liquid current assets
*32. The current cash debt coverage ratio (Ch. 5) is computed by dividing net cash
*33. The receivables turnover ratio (Ch. 7) is computed by dividing net sales by net
average receivables (beginning plus ending divided by 2) outstanding during the year.
*34. The inventory turnover ratio (Ch. 9) is a function of average inventory (beginning plus
*35. The asset turnover ratio (Ch. 11) is determined by dividing net sales for the period
by average total assets. This ratio indicates how efficiently the company utilizes its
*36. The profit margin on sales (Ch. 11) is computed by dividing net income by net sales
*37. Dividing net income by total average assets yields the rate of return on assets
(Ch. 11) earned by a company. In computing this ratio, companies sometimes use net
*38. The rate of return on share capital—equity (Ch. 15) is computed by dividing net
income minus preference dividends by average ordinary shareholders’ equity.
*39. As mentioned earlier in the text, many investors consider earnings per share (Ch. 16)
to be the most significant statistic presented by a business entity. A discussion of the
*40. The payout ratio (Ch. 15) is the ratio of cash dividends paid to ordinary shareholders
to net income. This ratio gives investors an indication of the portion of net income a
*41. The extent to which creditors are protected in the event of an entity’s insolvency may be
*42. The times interest earned ratio (Ch. 14) is computed by dividing net income before
*43. The cash debt coverage ratio (Ch. 5) is computed by dividing net cash provided by
operating activities by average total liabilities.
*44. The book value per share (Ch. 15) is the amount each share would receive if
a company were liquidated and the amounts reported on the statement of financial
*45. (L.O. 7) Ratio analysis is not without its limitations. Before placing a great deal of reliance
on ratios alone, an investor must be aware of the fact that any ratio is only as sound as
*46. (L.O. 8) The presentation of comparative financial statements affords an analyst the
opportunity to determine trends and analyze the progress an entity has made over
*47. (L.O. 9) Percentage or common-size analysis is a method frequently used to evaluate a
business enterprise. This type of analysis involves reducing all the dollar amounts to a
percentage of a base amount in the financial statement. All items in an income statement
*48. (L.O. 10) There is a growing acceptance of IFRS around the world. When a company first
converts its financial statements to IFRS, the overriding principle is full retrospective
*49. (L.O. 11) The conversion process involves the following steps: (a) include all assets and
liabilities that IFRS requires, (b) exclude any assets and liabilities that IFRS does not
*50. (L.O. 12) Full retrospective application can be impracticable. With this in mind, the IASB
established required exemptions and elective exemptions from retrospective treatment.