CHAPTER 6
Full and Fair Reporting
THINKING BEYOND THE QUESTION
How do we ensure that reports to external users fairly present business activities?
Full and fair reporting should help external users understand the deci-
sions made by managers. It is not intended to protect those users from
QUESTIONS
Q6-1 A variety of individuals rely on financial statements to make decisions.
For example, stockholders and creditors make stock purchasing and
Q6-2 Investors need assurance that the shares they are evaluating are reason-
Q6-3 Sarbanes-Oxley is intended to restore investor confidence in the financial
markets by making management more accountable for the accounting re-
170 Chapter 6
Q6-4 The audit committee is responsible for selecting, compensating, and
overseeing the corporation’s auditor. The auditor reports directly to the
Q6-5 Accounting standards are issued through a political process. Groups that
use and prepare financial information must agree that a proposed stand-
Q6-6 The SEC has delegated standard-setting to private organizations such as
Q6-7 Elements include assets, liabilities, equity, investments by owners, distri-
Q6-8 The primary objective of financial reporting is to provide information use-
ful to current and potential investors, creditors, and other users in mak-
Q6-9 The term “unqualified opinion” in no way implies anything about the qual-
ifications of the auditors. In fact, an unqualified opinion is good news, not
Q6–10 There are two primary reasons for notes to financial statements. First, to
keep the financial statements to a reasonable size—say, one page each—
a great deal of combining and aggregation of accounts must occur. One
Full and Fair Reporting 171
Q6–11 An audit is a detailed and systematic investigation of a company’s ac-
counting records. Auditors select a representative sample of transactions
to form an opinion as to whether the company’s controls and systems are
Q6-12 Managers and other decision makers need information upon which to
base decisions. Part of that information is provided by the accounting
system. At the same time, a company’s activities are generally too com-
Q6-13 The two primary purposes of internal controls are (1) to safeguard the or-
Q6-14 Internal controls are used in a computerized accounting system to pro-
tect its data from unauthorized access, improper use, and destruction.
Unauthorized access is prevented by using a system of identification and
Q6-15 A strong system of internal controls begins with a management philoso-
phy that encourages appropriate security and behavior in a company. If
Q6-16 Human resource controls include good hiring practices that involve hir-
ing qualified employees. Background checks help ensure employee in-
Q6-17 Safeguarding assets often involves controlling physical access. Mer-
chandise and materials can be secured in warehouses and display cases.
EXERCISES
E6-2 Development of the New York Stock Exchange (NYSE)—Founded in 1792,
the NYSE facilitated the growing trade in corporate stocks. In later years,
the NYSE required listed companies to provide accounting information to
E6-3 a. Securities Act of 1933—The act required most corporations to file
registration statements before selling stock to investors. Reports
must include a balance sheet and income statement.
Full and Fair Reporting 173
E6-4 a. FASB
E6-5 This is a true statement. Complying with regulations is costly because fi-
nancial information must be collected, summarized, and reported. In addi-
E6-6 Generally accepted accounting principles are financial reporting rules es-
tablished by a political process. The standard-setting process involves a
E6-7 Qualitative characteristics are attributes that make accounting infor-
mation useful. The primary qualitative characteristics are understandabil-
ity and usefulness. Relevance and reliability are considered to be the two
E6-8 The conceptual framework was developed in the 1970s and 1980s. The
E6-9 The first paragraph of an auditors’ report identifies the statements and
174 Chapter 6
E6–10 Management’s discussion and analysis (MD&A) is intended to explain
important events and changes in performance among the years present-
E6–11 a. It’s a little difficult to believe that such a giant company has only nine
b. A judgment has been made by management that a greater level of
c. It is very unlikely that this high level of aggregation would be helpful
to the manager of any General Mills division. First, a manager would
E6–12 Quick is a going concern because it has an indefinite life. This life is suf-
ficiently long that it can engage in long-term transactions, such as issu-
ing long-term debt and purchasing long-term assets. It expects to contin-
Full and Fair Reporting 175
E6–13 Bill, I think you misunderstand some of the basic issues regarding audits
and auditors’ reports. First, an auditor does not prepare the company’s fi-
nancial statements. The audit expresses only an opinion regarding them.
The company’s accounting staff prepares the financial statements and
then asks an independent, outside auditor to express an opinion on them.
E6–14 Accountants work in business organizations to prepare the financial in-
formation contained in companies’ annual reports. They manage the in-
E6–15 Pencils Pens Markers
Division revenues $200,000 $300,000 $100,000
Division expenses 140,000 160,000 60,000
Division profit $ 60,000 $140,000 $ 40,000
E6–16 Internal auditors work for businesses and are responsible for developing
and monitoring internal control systems and for auditing a company’s di-
E6–17 Computer system controls are designed to protect a company’s infor-
mation resources from unauthorized access, improper use, and destruc-
tion. Controls include the following:
• Appropriate identification and passwords—to prevent unauthorized
persons from gaining access to the system
Human resources controls include the following:
• Hiring qualified employees and conducting background checks
Physical controls include the following:
• Securely storing merchandise and materials in warehouses and display
cases
E6–18 Independent CPAs audit business financial reports to ensure that they
fairly present a company’s business activities. The audit is an important
tool in maintaining strong capital markets. If managers fail in their re-
Full and Fair Reporting 177
E6–19 a. The purpose of internal control is to protect the organization’s re-
of the company’s assets or the misstatement of its accounts.
b. Example: If the same person both handles the cash and accounts for
cash, that individual could cover up the theft of cash by charging it
E6–20 Internal control problems include the following: Ima has control of both
assets (cash) and accounting for the assets (sales slips) and there is no
mechanism to prevent her from falsifying information or from stealing
Solving the problems requires that Ima have less discretion over the
sales slips. If possible, the cash register should automatically record the
amount of a sale and produce a prenumbered sales slip. Ima should be
178 Chapter 6
PROBLEMS
P6-1 A. Managers use financial information to evaluate performance of a di-
vision, product line, or geographical area.
B. Stockholders rely on financial information to help them make deci-
P6-2 Accounting regulation is vital to the capital markets because investors
must have confidence in published financial information. If investors are
P6-3 The common theme is that all services are directly related to producing a
company’s financial statements.
Management is responsible for producing the financial statements and an
independent public accounting firm is responsible for expressing an
P6-4 The CEO and CFO are certifying that the financial condition and results of
operations are presented fairly. They use the term “in all material re-
spects.” This means the financial statements are free from mistakes and
P6-5 SOX demands more accountability of corporate executives. Those who
falsely certify the financial statements are subject to a fine of up to $5 mil-
Full and Fair Reporting 179
P6-6 1. The main theme of the certifications is that the annual report does
2. SOX requires these certifications as a result of several high-profile
frauds and bankruptcies that had a negative effect on investor confi-
P6-7 1. Accounting issues are identified and evaluated for consideration.
Primary documents
Discussion memorandum—identifies accounting issues and alternative
P6-8 Students’ responses will vary because the FASB’s website is dynamic.
However, students should find items as follows:
180 Chapter 6
P6-9 Students’ responses will vary because the IASB’s website is dynamic.
However, students should find items as follows:
• Principal news items
P6–10 Conceptual framework components and purpose
1. Objectives of financial reporting provide an overall purpose for fi-
nancial reports.
P6–11
Useful
Reliability
Relevance
Full and Fair Reporting 181
Qualitative characteristics are attributes that make accounting infor-
mation useful. Understandability and usefulness for decision making are
P6–12 Jenny is facing pressure from a client who is attempting to persuade her
to compromise her professional judgment. If she yields to pressure, the
P6–13 A. The report was issued on October 1, 2008. The report was not issued
in a timely manner. It was released nine months after the year-end.
As a result the information in the financial statements may not be
relevant.
B. The balance sheet included management’s estimates of the in-
C. Procedures used to calculate revenues and expenses were different
for 2007 than for 2006 and earlier years. Information about an organi-
zation is more valuable when it can be compared with information
182 Chapter 6
P6-14 A. Responsibility: Users of financial information must understand that
management is responsible for preparing the statements, while audi-
C. Material misstatement and material respects: Materiality is a criterion
for establishing the importance of a potential misstatement in audit-
D. A test basis: Auditors do not examine all transactions. They use sta-
E. Present fairly . . . in conformity with generally accepted accounting
Full and Fair Reporting 183
P6-15 A. and B.
Type of Account
Financial Statement
Asset
Liability
Equity
Revenue
Expense
Income
Statement
Balance
Sheet
1. Wages Payable
X
X
2. Accounts
Receivable
X
X
9. Loan from Bank
X
X
10. Land
X
X
11. Owners’
Investment
X
X
12. Supplies
X
X
13. Sales (on credit)
X
14. Bonds Payable
X
X
15. Unearned
X
X
16. Wages Earned by
Employees
X
17. Utilities
X
Note: The accumulated depreciation account is listed with the asset accounts,
3. Retained
Earnings
X
X
4. Buildings
X
X
5. Supplies Used
X
6. Inventory
X
X
7. Sales (for cash)
X
8. Accumulated
Depreciation
X
184 Chapter 6
P6-16
ASSETS
=
LIABILITIES
+
OWNERS’ EQUITY
Accounts
Cash
Other
Assets
Contributed
Capital
Retained
Earnings
Beginning Amounts
3,200
+119,000
=
52,800
+
43,000
+26,400
1
Cash
+7,500
Accounts Receivable
+400
Service Revenues
+7,900
2
Rent Expense
–1,800
6
Interest Expense
–200
Cash
–200
7
Notes Payable
–9,000
Cash
8
Cash
+5,000
Ending Amounts
=
42,800
+
48,000
Explanations: To solve this problem, it is easiest to start with the income
statement information. Identify the transaction that must have led to each
Transactions
1 Service Revenue during June totaled $7,900 but Accounts Receivable
increased by $400. This means that only $7,500 of the revenue was
collected. The other $400 explains the change in Accounts Receivable
on the balance sheet.
2 Rent must have been paid in cash because there was no change in
Cash
3
Wage Expense
–1,700
Cash
Wages Payable
–1,000
4
Supplies Expense
–700
Cash
–700
5
Depreciation Expense
–500
Accumulated Depreciation
Full and Fair Reporting 185
7 There was a $9,000 decrease in Notes Payable. It was paid off in cash
P6-17 A. The letter was prepared by:
Stephen W. Sanger, Chairman of the Board and Chief Executive Of-
ficer
Stephen R. Demeritt, Vice Chairman
Raymond G. Viault, Vice Chairman
B. The overall tone of the letter is positive.
P6-18 A. General Mills has three business segments.
1. The Retail segment markets ready–to-eat cereals, meals, refrig-
erated and frozen dough products, baking products, snacks,
2. The Bakeries and Foodservice segment markets to retail and
3. The International businesses fundamentally market the same
B. The earnings shortfall was caused primarily by the following:
1. Higher commodity costs
186 Chapter 6
C. Management plans to increase list prices in certain lines, capture
P6–19 A. The company did not fully and accurately disclose the results of its
operations. When investors learned that the reliability of the financial
information was in doubt (as evidenced by an earnings restatement),
P6–20 A. • Specific cash register—Each sales clerk is responsible for one
cash register. If clerks used a variety of cash registers during a
shift, errors and omissions could not be traced to one individual.
• Copy of cash register slip is given to customer. Customers who
receive cash register slips provide another form of internal control
because they help verify that the sale was recorded for the correct
amount.
B. • The movie example illustrates segregation of duties as an internal
control. The ticket seller must produce cash for each ticket that he
Full and Fair Reporting 187
P6–21 The church has no system of internal control. The church did not conduct
an adequate background check before allowing Jay to serve as treasurer.
They have no segregation of duties. Jay has access to resources and in-
P6–22 Yes, such a policy is an example of an internal control to prevent cashiers
from pocketing cash from unrecorded sales. Giving customers receipts is
one way of ensuring that all sales are rung into the cash register. Cus-
tomers will also usually notice if the amounts are incorrect. Therefore, of-
P6–23
1
2
3
4
5
6
7
8
9
10
188 Chapter 6
CASES
C6-1 A. General Mills’ auditor is KPMG LLP. The audit was completed on
June 29, 2004.
B. The auditors’ responsibility is to express an opinion on the financial
statements. Management is responsible for the financial statements.
C6-2 A. Management is responsible for the accounting numbers in the annu-
al report.
B. Companies use a system of internal controls to help safeguard as-
C. The auditor does not state that the amounts are correct. Rather, the
independent public accountant states whether the financial state-