24-1
CHAPTER 24
Full Disclosure in Financial Reporting
ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)
Topics
Questions
Brief
Exercises
Exercises
Problems
Concepts
for Analysis
* 1. The disclosure principle; type
of disclosure.
2, 3
1, 2, 3
* 5. Discussion and analysis.
12, 13
* 6. Interim reporting.
16, 17,
18, 19
8, 9
* 7. Audit opinions and fraudulent
reporting.
20, 21
* 8. Earnings forecasts.
14, 15
10
22, 23, 24
4, 5, 6
5
*10. Impact of transactions on ratios.
8
4, 5, 6
3
13
*11. Liquidity ratios.
8
4, 5, 6
3, 5
*12. Profitability ratios.
28
4, 5, 6
3, 5
*13. Coverage ratios.
4, 5, 6
*14. Activity ratios.
25, 26
8, 9
4, 5, 6
3
*15. Comprehensive ratio problems.
4, 5, 6
3, 5
*16. Percentage analysis.
24, 27
3, 4
* 3. Subsequent events.
6
3
1, 2
1
4, 12
* 4. Segment reporting; diversified
firms.
7, 8, 9,
10, 11
4, 5, 6, 7
3
2
5, 6, 7
24-2
ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Learning Objectives
Brief
Exercises
Exercises
Problems
1. Review the full disclosure principle and describe
implementation problems.
4. Describe the accounting problems associated with
interim reporting.
5. Identify the major disclosures in the auditor’s report.
6. Understand management’s responsibilities
for financials.
7. Identify issues related to financial forecasts and
projections.
8. Describe the profession’s response to fraudulent
financial reporting.
*9. Understand the approach to financial statement
analysis.
calculation.
8, 9
4, 5, 6
3, 5
3
4
2. Explain the use of notes in financial statement
preparation.
1, 2, 3
1, 2
1
3. Discuss the disclosure requirements for major
business segments.
4, 5, 6, 7
3
2
ASSIGNMENT CHARACTERISTICS TABLE
Description
Level of
Difficulty
Time
(minutes)
Post-balance-sheet events.
Moderate
10–15
Post-balance-sheet events.
Moderate
10–15
Segmented reporting.
Moderate
5–10
Ratio computation and analysis; liquidity.
Simple
20–30
Analysis of given ratios.
Moderate
20–30
Ratio analysis.
Moderate
30–40
Subsequent events.
Difficult
40–50
Segmented reporting.
Moderate
24–30
Ratio computations and additional analysis.
Moderate
35–45
Horizontal and vertical analysis.
Simple
40–60
Dividend policy analysis.
Difficult
40–50
General disclosures, inventories, property, plant,
and equipment.
Simple
10–20
Disclosures required in various situations.
Moderate
20–25
Disclosures, conditional and contingent liabilities.
Simple
24–30
Post-balance-sheet events.
Moderate
20–25
Segment reporting.
Moderate
30–35
Segment reporting—theory.
Simple
20–25
Segment reporting—theory.
Moderate
24–30
Interim reporting.
Simple
20–25
Treatment of various interim reporting situations.
Moderate
30–35
Financial forecasts.
Moderate
24–30
Disclosure of estimates—ethics.
Moderate
15–20
Reporting of subsequent events—ethics.
Simple
10–15
Effect of transactions on financial statements and ratios.
Moderate
24–35
24-4
SOLUTIONS TO CODIFICATION EXERCISES
CE24-1
Master Glossary
(a) Ordinary income (or loss) refers to income (or loss) from continuing operations before income
taxes (or benefits) excluding significant unusual or infrequently occurring items. Extraordinary
(b) An error in recognition, measurement, presentation, or disclosure in financial statements resulting
from mathematical mistakes, mistakes in the application of generally accepted accounting principles
(GAAP), or oversight or misuse of facts that existed at the time the financial statements were
prepared. A change from an accounting principle that is not generally accepted to one that is
generally accepted is a correction of an error.
(c) The amount of earnings attributable to each share of common stock. For convenience, the term is
used to refer to either earnings or loss per share.
CE24-2
According to FASB ASC Glossary:
Related parties include:
a. Affiliates of the entity
d. Principal owners of the entity and members of their immediate families
e. Management of the entity and members of their immediate families
f. Other parties with which the entity may deal if one party controls or can significantly influence
the management or operating policies of the other to an extent that one of the transacting
parties might be prevented from fully pursuing its own separate interests
24-5
CE24-3
According to FASB ASC 280-10–50-12 (Segment Reporting—Overall—Disclosure):
A public entity shall report separately information about an operating segment that meets any of the
following quantitative thresholds (see Example 2, Cases C, D, and E [paragraphs 280–10–55-39 through
55-45]):
(c) Its assets are 10 percent or more of the combined assets of all operating segments.
CE24-4
According to FASB ASC 270-10-S99-2 (Interim Reporting— Overall—SEC Materials):
Question 2: The staff believes disclosure of inventory components is important to investors. In reaching
this decision the staff recognizes that registrants may not take inventories during interim periods and
ANSWERS TO QUESTIONS
1. As indicated in the text, the major advantages are: (1) additional information pertinent to specific
financial statements can be explained in qualitative terms, or supplementary data of a quantitative
2. The full disclosure principle in accounting calls for reporting in financial statements any financial
facts significant enough to influence the judgment of an informed reader. Disclosure has increased
because of the complexity of the business environment, the necessity for timely information, and
the desire for more information on the enterprise for control and monitoring purposes.
3. The benefit of reconciling the effective tax rate and the federal statutory rate is that an investor can
determine the actual taxes paid by the enterprise. Such a determination is particularly important if
4. (a) The increased likelihood that the company will suffer a costly strike requires no disclosure in
the financial statements. The possibility of a strike is an inherent risk of many businesses. It,
5. Transactions between related parties are disclosed to insure that the users of the financial state–
ments understand the basic nature of some of the transactions. Because it is often difficult to
6. “Subsequent events” are of two types:
(1) Those which affect the financial statements directly and should be recognized therein through
appropriate adjustments.
(2) Those which do not affect the financial statements directly and require no adjustment of the
account balances but whose effects may be significant enough to be disclosed with appropriate
figures or estimates shown.
24-7
Questions Chapter 24 (Continued)
7. Diversified companies are enterprises whose activities are segmented into unrelated industries. The
accounting problems related to diversified companies are: (1) the problem of defining a segment
8. After the company decides on the segments for possible disclosure, a quantitative test is made to
determine whether the segment is significant enough to warrant actual disclosure. A segment is
1. the combined operating profit of all industry segments that did not incur an operating
loss, or
2. the combined operating loss of all industry segments that did incur an operating loss.
(c) Its identifiable assets are 10% or more of the combined identifiable assets of all segments.
In applying these tests, two additional factors must be considered. First, segment data must explain
9. GAAP requires that a company report:
(a) General information about its operating segments.
10. An operating segment is a component of an enterprise:
(a) That engages in business activities from which it earns revenues and incurs expenses.
(b) Whose operating results are regularly reviewed by the company’s chief operating decision
maker to assess segment performance and allocate resources to the segment.
Questions Chapter 24 (Continued)
11. One of the major reasons for not providing segment information is that competitors will then be
able to determine the profitable segments and enter that product line themselves. If this occurs
12. The management discussion and analysis section covers three financial aspects of an enterprise’s
13. Management has the primary responsibility for the preparation, integrity, and objectivity of the com-
pany’s financial statements. If management wishes to present information in a certain way, it may
do so. If the auditor objects because GAAP is violated, some type of audit exception is called for.
14. Arguments against providing earnings projections:
(a) No one can foretell the future. Therefore forecasts, while conveying an impression of precision
15. Arguments for providing earnings forecasts are:
(a) Investment decisions are based on future expectations; therefore, information about the future
16. Interim reports are unaudited financial statements normally prepared four times a year. Interim
balance sheets are often not provided because this information is not deemed crucial over a short
period of time; the income figure has much more relevance to interim reporting.
17. The accounting problems related to the presentation of interim data are as follows:
(a) The proper handling of extraordinary items.
18. The problem when a LIFO base is used for quarterly reporting is that the LIFO base might be
reduced in a given quarter, but for the year, this base is not reduced. If the inventory base will be
replaced before the year ends, then a purchase reserve (equalization account) should be set up
to reflect a higher cost of sales and to achieve a more realistic interim statement for net income.
24-9
Questions Chapter 24 (Continued)
19. One suggestion has been to normalize the fixed nonmanufacturing costs on the basis of predicted
sales. The problem with this method is that future sales are unknown and hence a great deal of
subjectivity is involved. Another approach is to charge as a period charge those costs that are
20. The CPA expresses a “clean” or unqualified opinion when the client’s financial statements present
fairly the client’s financial position and results of operations on the basis of an examination made
21. Fraudulent financial reporting is intentional or reckless conduct, whether by act or omission, that
results in materially misleading financial statements. Fraudulent financial reporting can involve
many factors and take many forms. It may entail gross and deliberate distortion of corporate records,
such as inventory count tags, or falsified transactions, such as fictitious sales or orders. It may entail
the misapplication of accounting principles. Company employees at any level may be involved, from
top to middle management to lower-level personnel. If the conduct is intentional, or so reckless
that it is the legal equivalent of intentional conduct, and results in fraudulent financial statements,
it comes within the operating definition of the term fraudulent financial reporting.
Fraudulent financial reporting usually occurs as the result of certain environmental, institutional,
or individual forces and opportunities. These forces and opportunities add pressures and incentives
that encourage individuals and companies to engage in fraudulent financial reporting and are present
to some degree in all companies. If the right combustible mixture of forces and opportunities is
present, fraudulent financial reporting may occur.
24–10
Questions Chapter 24 (Continued)
Situational pressures on the company or an individual manager also may lead to fraudulent
financial reporting. Examples of these situational pressures include:
Sudden decreases in revenue or market share. A single company or an entire industry can
experience these decreases.
Opportunities for fraudulent financial reporting are present when the fraud is easier to commit and
when detection is less likely. Frequently these opportunities arise from:
The absence of a board of directors or audit committee that vigilantly oversees the financial
reporting process.
*22. It has been said that “everything is relative,” and this is certainly true of financial statement data.
The chief significance of financial statement data is not so much in the absolute amounts
*23. Your friend should be advised that in order to interpret adequately and to evaluate financial statement
data, an individual must:
(a) Understand the nature and limitations of accounting.
(b) Understand the terminology of accounting and business.
(c) Have some knowledge of business.
(d) Be acquainted with the nature and tools of financial statement analysis.
*24. Percentage analysis consists of reducing a series of related amounts to a series of percentages
of a given base while ratio analysis is the computation of any specific ratio of one figure to
24–11
Questions Chapter 24 (Continued)
*25. Cost of goods sold is used for two reasons: first, cost must be used rather than retail value
because the average inventory figures are on a cost basis. Second, since measurement of the
*26. The relationship of asset turnover to the rate of return on assets is as follows:
Sales
X
Net Income
=
Net Income
*27. (a) Common-size analysis is reduction of all dollar amounts in the financial statements to a
percentage of a base amount.
*28. Some believe that the FASB should not be involved in developing standards related to the
presentation of ratios. A basic concern expressed by this group is: how far should the FASB go?
That is, where does financial reporting end and financial analysis begin? Furthermore, we know
24–12
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 24-1
The reader should recognize that the firm has an annual obligation for lease
payments of approximately $5,711,000 for the next three years. In certain
BRIEF EXERCISE 24-2
The reader should recognize that there are dilutive securities outstanding
which may have an effect on earnings per share. In addition, the purchase
of treasury stock enabled the company to increase its earnings per share.
The important point concerning this note is that information is provided
about potential dilution related to some dilutive securities outstanding.
BRIEF EXERCISE 24-3
BRIEF EXERCISE 24-4
It should be emphasized that because a company discloses its segmental
results, this does not diminish the necessity for providing consolidated results
as well. Sometimes individuals become confused because they believe that
24–13
BRIEF EXERCISE 24-5
$600 + $650 + $250 + $275 + $225 + $200 + $700 = $2,900 = total revenue.
$2,900 X 10% = $290.
Penley, Konami, and Molina meet this test, since their revenues equaled or
exceeded $290.
BRIEF EXERCISE 24-7
$500 + $550 + $250 + $400 + $200 + $150 + $475 = $2,525 = total assets.
$2,525 X 10% = $252.50.
Penley, Konami, Red Moon, and Molina meet this test, since their identifiable
assets equal or exceed $252.50.
(c) $ 90,000 ÷ $40,000 = Current ratio of 2.25:1
$ 50,000 ÷ $40,000 = Acid-test ratio of 1.25:1
$105,000 ÷ $55,000 = Current ratio of 1.91:1
$ 65,000 ÷ $55,000 = Acid-test ratio of 1.18:1
*BRIEF EXERCISE 24-9
Cost of Goods Sold
= Inventory Turnover
Average Inventory
= 9
24–15
SOLUTIONS TO EXERCISES
EXERCISE 24-1 (10–15 minutes)
(a) The issuance of common stock is an example of a subsequent event
which provides evidence about conditions that did not exist at the
balance sheet date but arose subsequent to that date. Therefore, no
EXERCISE 24-2 (10–15 minutes)
1.
(a)
4.
(b)
7.
(c)
10.
(c)
2.
(c)
5.
(c)
8.
(c)
11.
(a)
EXERCISE 24-3 (5–10 minutes)
(a) Revenue test: 10% X $102,000 = $10,200.
Segments W ($60,000) and Y ($23,000) both meet this test.
24–16
*EXERCISE 24-4 (20–30 minutes)
Computations are given below which furnish some basis of comparison of
the two companies:
Plunkett
Co.
Herring
Co.
Composition of current assets
Cash
13%
28%
Receivables
24%
27%
Inventories
63%
45%
100%
100%
a($930 X .70) ÷ $570 b($1,500 X .60) ÷ $518
Herring Co. appears to be a better short-term credit risk than Plunkett Co.
Analysis of various liquidity ratios demonstrates that Herring Co. is stronger
*EXERCISE 24-5 (20–30 minutes)
(a) The acid-test ratio is the current ratio with the subtraction of inventory
Computation of various ratios
Current ratio ($910 ÷ $300)
($1,140 ÷ $350)
Acid-test ratio ($120 + $220) ÷ $300
($320 + $302) ÷ $350
Accounts receivable turnover ($930 ÷ $220)
($1,500 ÷ $302)
Inventory turnover
Cash to current liabilities ($120 ÷ $300)
($320 ÷ $350)
24–17
*EXERCISE 24-5 (Continued)
(b) Financial leverage has definitely declined during the three-year period.
This is shown by the steady drop in the long-term debt-to-total-assets
ratio, and the total-debt-to-total-assets ratio. Apparently the decline of
debt as a percentage of this firm’s capital structure is accounted for by
a reduction in the long–term portion of the firm’s indebtedness. This
reduction of leverage accounts for the decrease in the return on stock–
holders’ equity ratio. This conclusion is reinforced by the fact that net
income to sales and return on total assets have both increased.
*EXERCISE 24-6 (30–40 minutes)
(a) The current ratio measures overall short-term liquidity and is an indicator
of the short-term debt-paying ability of the firm.
Inventory turnover is an indicator of the number of times a firm sells
its average inventory level during the year. A low inventory turnover
may indicate excessive inventory accumulation or obsolete inventory.
24–18
*EXERCISE 24-6 (Continued)
Net income to stockholders’ equity is a profitability ratio. It measures the
return on stockholders’ investment and is used to evaluate the com–
pany’s success in generating income for the benefit of its stockholders
(i.e., management effectiveness).
(b) The two ratios that each of the four entities would specifically use to
examine Howser Inc. are as follows:
Shannon Financial might employ net sales to stockholders’ equity and
net income to stockholders’ equity.
The Working Capital Management Committee might review the current
or quick ratio and the inventory turnover ratio.
Howser’s profitability is good as indicated by the profitability ratios that
have been increasing. Both profitability ratios are greater than the
industry average. The net profit margin (net income to net sales) can be
derived from these two ratios (net income to stockholders’ equity and
net sales to stockholders’ equity), and Howser’s margin has increased
each year (2011: 5.09%; 2012: 5.36%; 2013: 5.76%) and exceeds the
industry average (3.86%).
24–19
*EXERCISE 24-6 (Continued)
TIME AND PURPOSE OF PROBLEMS
Problem 24-2 (Time 24–30 minutes)
Purpose—to provide the student with an understanding of the rules for segment reporting. The student
must determine which of five segments are subject to segment reporting rules and describe the
required disclosures.
*Problem 24-3 (Time 35–45 minutes)
Purpose—to provide the student with an understanding of certain key ratios. In addition, the student is
asked to identify and explain what other financial reports or financial analysis might be employed. Also,
the student is to determine whether the company can finance the plant expansion internally and whether
an extension on the note should be made.