Chapter 23
Other Measurement and Disclosure Issues
Prepared by:
Dragan Stojanovic, CA
Rotman School of Management, University of Toronto
Other Measurement and
Disclosure Issues
Disclosure
Issues
•Full disclosure
principle revisited
•Increase in
reporting
requirements
•Accounting
policies
•Illegal acts
•Segmented
reporting
Other
Measurement
Issues
•Related-party
transactions
•Subsequent
events
•Reporting on
financial
forecasts and
projections
Auditor’s
Reports
•Unqualified
opinions
•Qualified
opinions
Unincorporated
Businesses
IFRS/Private
Enterprise
GAAP
Comparison
•Comparison of
IFRS and private
enterprise GAAP
•Looking ahead
•Adverse
opinions
•Interim reporting
•Internet financial
reporting and
continuous
disclosures
2
Other Measurement and
Disclosure Issues
Disclosure
Issues
•Full disclosure
principle revisited
•Increase in
reporting
requirements
•Accounting
policies
•Illegal acts
•Segmented
reporting
Other
Measurement
Issues
•Related-party
transactions
•Subsequent
events
•Reporting on
financial
forecasts and
projections
Auditor’s
Reports
•Unqualified
opinions
•Qualified
opinions
Unincorporated
Businesses
IFRS/Private
Enterprise
GAAP
Comparison
•Comparison of
IFRS and private
enterprise GAAP
•Looking ahead
•Adverse
opinions
•Interim reporting
•Internet financial
reporting and
continuous
disclosures
3
The Full Disclosure Principle
• The full disclosure principle calls for financial
reporting of significant facts affecting the
judgement of an informed reader
• The problems of implementing this principle are
costs of disclosure or information overload
• The profession continues to develop guidelines:
– should a given transaction be disclosed
– what format this disclosure should take
4
Increase in
Reporting Requirements
• Reasons for increasing reporting requirements
of public companies:
– Complexity of the business environment (e.g.
derivatives, business combinations, pensions)
– Need for timely information (e.g. interim data,
financial forecasts)
– Accounting used as a control and monitoring
device (e.g. disclosure of management
compensation, related-party transactions, errors
and irregularities)
5
Types of Financial Information
Financial Statements
•
•
•
•
Balance Sheet
Statement of Income
Statement of Cash Flows
Statement of Changes in
Shareholders’
Equity/Retained
Earnings
Notes to the Financial
Statements
Examples:
• Accounting Policies
• Contingencies
• Inventory Methods
• Number of Shares
Outstanding
• Alternative Measures
(market values of items
carried at historical cost)
6
Types of Financial Information
Other Means of
Financial Reporting
Examples:
• Management
Discussion and Analysis
• Letters to Shareholders
Other Information
Examples:
• Discussion of
Competition and
Industry
• Analysts’ Report
• Economic Statistics
• News Articles about
Company
7
Notes to Financial Statements
• Notes amplify or explain items presented in
the body of the financial statements
• The accounting policies of the entity must be
disclosed as the first note or in a separate
section preceding the notes (called Summary
of Significant Accounting Policies)
• Notes to the financial statements include:
– Inventory valuation method
– Amortization policy followed
– Changes in accounting policies
8
Illegal Acts
• Illegal acts are defined by the CICA as “a
violation of a domestic or foreign statutory law
or government regulation attributable to the
entity…or to management or employees
acting on the entity’s behalf.”
• The item may require recognition in the
balance sheet or income statement
• Note disclosure may be required
9
Segmented Business Reporting
Requirements
•
•
•
•
Information on how the segment contributes to
the total business operations
Investors want information from the income
statement, balance sheet, and cash flow
statement on individual segments
Reporting segmented information helps users:
1. Better understand the enterprise’s
performance
2. Better assess future net cash flows prospects
3. Make more informed judgements about the
company
PE GAAP does not provide guidance for
reporting segmented information
10
Segmented Business Reporting
Requirements
• IFRS requires that the financial statements
include selected information on a single basis
of segmentation
• The segments are evident from their
organizational structure (operating segments)
• This method is called the management
approach
11
Segmented Business Reporting
Requirements
What is an operating segment?
Any component of an enterprise that:
1. Engages in business activities from which
it earns revenues and incurs expenses
2. Has senior management regularly review
results
• Assess performance
• Review resource allocation decisions
made
3. Has discrete financial information available
12
Aggregation of
Operating Segments
•
Operating segments may be aggregated if they
have the same basic characteristics
1. The nature of the products and services
provided
2. The nature of the production process
3. The type or class of customer
4. The methods of product or service distribution
5. The nature of the regulatory environment, if
applicable
13
Reportable Segments
An operating segment is identified as a reportable
segment if it satisfies one or more of the following
criteria:
1. The revenue criterion
2. The profit or loss criterion
3. The identifiable assets criterion
Three other factors are considered in addition to the
above tests
1. Segment results are 75 percent or more of
combined sales to unrelated customers
2. No more than 10 segments are required to be
disclosed
3. Segment may be presented separately on
grounds that separate information would be
useful to users (even if not meet any of the tests)
14
Reportable Segments
Criterion
Revenue
Profit or loss
Identifiable assets
Thresholds
10 percent or more of the combined
revenue of all operating segments
10 percent or more of the greater of:
(a) the combined profit of all operating
segments not showing a loss or
(b) the combined loss of all operating
segments reporting a loss
10 percent or more of the combined
assets of all operating segments
15
Measurement Principles
• The accounting principles used for segment
reporting and for consolidated statements
need not be the same
• Some accounting principles may not apply at
the segment level
– Common costs are not required to be
allocated among the segments
– Such allocation is arbitrary and may not
produce an objective division of costs among
segments
16
Required Segmented Information
•
IFRS requires reporting of the following:
1.
2.
3.
4.
5.
6.
General information about its reportable
segments
Segment profit and loss, assets, liabilities, and
related information
Reconciliation of segment revenues, profits and
losses, and segment assets
Products and services – amount of revenues from
external customers
Information about geographical areas – if
amounts are material, foreign information (e.g.
revenue) must be disclosed by country
Major customers – if 10% or more of revenue
from one customer, must disclose
17
Interim Reporting
• PE GAAP does not provide guidance on interim
reporting
• IFRS provides guidance but does not mandate
which entities need to provide interim information
• Annual reports and interim reports must use the
same accounting principles (e.g. inventory cost
formula, revenue recognition)
• Costs and expenses other than product costs (i.e.
period costs) are often recorded in the interim
period as they are incurred
18
Interim Reporting
• At a minimum, condensed balance sheet,
comprehensive income statement, statement of
changes in equity, statement of cash flows, and
notes are required
• Earnings per share (EPS) information is also
required if the company must present this
information in its annual information
19
Interim Reporting
• The balance sheet should be presented as at the
end of the current interim period with a
comparative balance sheet as of the end of the
immediately preceding fiscal year
• The income statement should be presented for
the current interim period and interim year to date
with comparatives
• The statement of changes in equity should be
presented cumulatively for the current fiscal year
to date with comparatives, and
• The statement of cash flows should be presented
cumulatively for the current fiscal year to date
with comparatives
20
Interim Reporting
Minimum disclosure requirements include:
1. Whether statements are in compliance with
GAAP
2. Accounting policies and methods
3. Any seasonal or cyclical period considerations
4. Nature and amount of unusual items
5. Nature and amount of estimate changes
6. Issuances, repurchased, and repayments of
debt and equity securities
21
Interim Reporting
Minimum disclosure requirements include (cont’d):
7. Dividends paid
8. Information about reportable segments
9. Subsequent events
10. Changes in composition of entity
11. Contingencies
12. Any other information required for fair
presentation and/or material to understanding
of period
22
Interim Reporting Problem Areas
1.
Changes in Accounting
• Changes applied retroactively to prior interim
periods
• Comparable interim periods from previous fiscal
years also restated
2. Earnings per share
• Each interim period EPS is stand alone
3. Seasonality
• Problem related to matching principle
4. Continuing Controversy
• Auditor’s involvement in the interim reporting
process
• Timeliness of information
23
Internet Financial Reporting
• Companies are increasingly disclosing financial
information through websites
• Corporations can reach more users by the Internet
• Internet reporting can make traditional reports
more useful:
• Corporations can report more timely information
• They can also report disaggregated data,
therefore financial reports are more relevant
• There is concern about security on the Internet
(i.e. hackers), equality of access to electronic
reports, and reliability of information distributed via
the Internet
24
Other Measurement and
Disclosure Issues
Disclosure
Issues
•Full disclosure
principle revisited
•Increase in
reporting
requirements
•Accounting
policies
•Illegal acts
•Segmented
reporting
Other
Measurement
Issues
•Related-party
transactions
•Subsequent
events
•Reporting on
financial
forecasts and
projections
Auditor’s
Reports
•Unqualified
opinions
•Qualified
opinions
Unincorporated
Businesses
IFRS/Private
Enterprise
GAAP
Comparison
•Comparison of
IFRS and private
enterprise GAAP
•Looking ahead
•Adverse
opinions
•Interim reporting
•Internet financial
reporting and
continuous
disclosures
25
Related Party Transactions
• Related-party transactions arise when a business
engages in transactions with another party that
can significantly influence its policies
• Related party transactions are individually
assessed
• Related parties include the following:
a)Companies or individuals with control
b)Investors and investees with significant
influence or joint control
c)Company management
d)Members of immediate family
26
Related Party Transactions
• Measurement is a major accounting and
reporting issue
• A basic assumption is that the transactions are
between arm’s length parties
• If this condition not met, should disclose that
transaction is between related parties
• Should report economic substance rather than
legal form of transactions
• Under PE GAAP/ASPE, some related-party
transactions must be remeasured to the
carrying amount of assets or services
exchanged (see following decision tree)
27
Related Party Transactions –
Decision Tree
Related party transaction occurs
Is transaction in the
normal course of
operations?
No
Is there a substantive
change in the ownership interests of the
item transferred?
Yes
Is the amount of the
Yes exchange supported
by independent
evidence?
Yes
Yes
No
Commercial substance
and value supported
No
No
Measure at carrying amount
Is the
transaction
non-monetary?
No
Yes
Measure at exchange amount
28
Related Party Transactions
• Example: Assume Knudson Limited sells land worth
$20,000 (with a carrying value of $15,000) to a Bay
Limited (a related party)
• In exchange, Bay Limited transfers a building that
has a NBV of $12,000
• This transaction is not in normal operations and
does not change ownership interests
• Therefore, must be measured at carrying value;
journal entry required by Knudson:
Building
12,000
Retained Earnings 3,000
Land
15,000
29
Related Party Transactions
The following disclosures are recommended:
1.
2.
3.
4.
5.
The nature of the relationship
Description of the transactions
The recorded amounts of transactions
Measurement basis used
Amounts due from or due to related parties at the
balance sheet date, and terms and conditions
6. Contractual obligations with related parties
7. Contingencies involving related parties
8. Under IFRS, management compensation and name
of parent company (as well as ultimate controlling
entity/individual)
30
Subsequent Events
• Notes to the financial statements must explain
any significant financial events that occurred
after the balance sheet date, but before the
date of issue (under IFRS, date authorized for
issue)
Financial statement period
Post balance sheet events
Balance
sheet date
Issue date
31
Subsequent Events
Two types of post-balance sheet events must
be disclosed
1. Events that provide additional evidence
about conditions that existed at balance
sheet date and require adjustment
•
Examples:
– loss on accounts receivable due to
customer’s bankruptcy, where customer’s
poor financial condition existed at the
balance sheet date
– Settlement of litigation if event giving rise
to litigation existed prior to balance sheet
date
32
Subsequent Events
2. Events that provide evidence about
conditions that did not exist at balance
sheet date and do not require adjustment
•
Examples:
– A bond or share issuance
– A fire or flood resulting in a loss
– Changes in foreign exchange rates
– A purchase of a business
33
Financial Forecasts
and Projections
•
•
The investing public needs a greater
quantity and quality of information about
corporate expectations
The disclosures take one of two forms:
1. Financial forecast of an entity’s expected
financial position, results of operations, and
cash flows
2. Financial projection based on hypothetical
assumptions
•
The difference is one of likelihood of
happening
34
Forecast Arguments
Arguments For
• Information about the
future facilitates better
decisions
• Corporate disclosures
limit the speculation
about forecasts that are
informally circulated
• Historical information
may not be adequate in a
world of frequently
changing circumstances
Arguments Against
• Information about the
future may be misleading
and unreliable
• Corporations may strive to
meet published projections
regardless of shareholders’
interests
• Incorrect projections may
lead to legal actions
• Forecasts may provide
information to competitors
that may be detrimental to
corporate interests
35
Other Measurement and
Disclosure Issues
Disclosure
Issues
•Full disclosure
principle revisited
•Increase in
reporting
requirements
•Accounting
policies
•Illegal acts
•Segmented
reporting
Other
Measurement
Issues
•Related-party
transactions
•Subsequent
events
•Reporting on
financial
forecasts and
projections
Auditor’s
Reports
•Unqualified
opinions
•Qualified
opinions
Unincorporated
Businesses
IFRS/Private
Enterprise
GAAP
Comparison
•Comparison of
IFRS and private
enterprise GAAP
•Looking ahead
•Adverse
opinions
•Interim reporting
•Internet financial
reporting and
continuous
disclosures
36
Auditor’s Report
• Another important source of information is
the Auditor’s report
• The auditor conducts an independent
examination of a company’s accounting data
to determine whether the financial
statements are prepared fairly in
accordance with GAAP
• The auditor’s report reflects the auditor’s
conclusions
• In most cases, the auditor issues a standard
unqualified or clean opinion
37
Auditor’s Reporting Standards
Based on Canadian Auditing Standards:
1. Auditor’s report shall be in writing
2. Report should have a title
3. Report should be addressed as required by
engagement
4. Introductory paragraph should identify entity, state
that statements have been audited, refer to
significant accounting policies and specify period
covered
5. Repot should articulate management’s
responsibility for financial statements
38
Auditor’s Reporting Standards
(cont’d)
Based on Canadian Auditing Standards:
6. Report should articulate auditor’s responsibilities
7. Report should describe what audit entails
8. Report should obtain audit opinion
9. Report should be signed and dated
39
Auditor’s Opinion
The auditor can render or provide:
1. An Unqualified (clean) opinion
2. A Qualified opinion
3. An Adverse opinion (circumstances)
4. A disclaimer of an opinion (no opinion can
be given)
40
Unqualified Auditor’s Report
• If the auditor is satisfied that the financial
statements present fairly, in all material
respects, the financial position, results of
operations, and cash flows in accordance with
GAAP, an unqualified opinion is expressed
41
Qualified Opinion
• A qualified opinion contains an exception to the
standard opinion
• That is, except for the effects of the matter
related to the qualification, the financial
statements are fairly presented in accordance
with GAAP
• It may also relate to a scope limitation; that is,
where the auditor has not been able to obtain
sufficient and appropriate audit evidence
42
Adverse Opinion
• An adverse opinion is required if exceptions to
fair presentation are so material that, in the
independent auditor’s judgement, a qualified
opinion is not justified
43
Other Measurement and
Disclosure Issues
Disclosure
Issues
•Full disclosure
principle revisited
•Increase in
reporting
requirements
•Accounting
policies
•Illegal acts
•Segmented
reporting
Other
Measurement
Issues
•Related-party
transactions
•Subsequent
events
•Reporting on
financial
forecasts and
projections
Auditor’s
Reports
•Unqualified
opinions
•Qualified
opinions
Unincorporated
Businesses
IFRS/Private
Enterprise
GAAP
Comparison
•Comparison of
IFRS and private
enterprise GAAP
•Looking ahead
•Adverse
opinions
•Interim reporting
•Internet financial
reporting and
continuous
disclosures
44
Unincorporated Businesses
Key accounting issues include:
1. Clear definition of the business entity
– Statements should clearly report the
business name and that the business is
not incorporated
2. Clear reporting of any amounts accruing to
the owners
3. There is no provision for income taxes
45
Other Measurement and
Disclosure Issues
Disclosure
Issues
•Full disclosure
principle revisited
•Increase in
reporting
requirements
•Accounting
policies
•Illegal acts
•Segmented
reporting
Other
Measurement
Issues
•Related-party
transactions
•Subsequent
events
•Reporting on
financial
forecasts and
projections
Auditor’s
Reports
•Unqualified
opinions
•Qualified
opinions
Unincorporated
Businesses
IFRS/Private
Enterprise
GAAP
Comparison
•Comparison of
IFRS and private
enterprise GAAP
•Looking ahead
•Adverse
opinions
•Interim reporting
•Internet financial
reporting and
continuous
disclosures
46
Looking Ahead
• IFRS has developed own standards for
private enterprises
47
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48