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Chapter 10
Corporate Governance, Explanatory
Notes, and Other Disclosures
McGraw-Hill/Irwin
McGraw-Hill/Irwin
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The ©
McGraw-Hill
Companies,
Inc., All
Reserved.
Copyright
2011 by The McGraw-Hill
Companies,
Inc.,Rights
All Rights
Reserved.
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Significance of Corporate
Governance
LO1
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McGraw-Hill/Irwin
Business ethics
Social responsibility
Equitable treatment of shareholders
Disclosures and transparency
Board of directors’ responsibility
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Recent Financial Reporting
Misstatements
LO2
Recording
revenue
too
soon
Recording
bogus
revenue
Shifting
current
expenses
to a later
or earlier
period
Boosting
income with
one time
sales
Failure to
record or
improperly
reducing
liabilities
Shifting
current
revenue
to a later
period
Shifting future
expenses to the
current period
as a special
charge
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LO4
Explanatory Notes
Summary of
Significant Accounting Policies
Typical accounting policies that are disclosed in the
notes to the financial statements include:
1. Depreciation method used.
2. Inventory valuation method used.
3. Basis of consolidation of subsidiary
information.
4. Reconciliation of taxes paid to tax expense.
5. The cost of employee benefit plans.
6. Treatment of goodwill and intangible assets.
7. Earnings per share information.
8. Stock option and stock purchase plans.
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Depreciation Method
LO4
Sum-of-the-Years’Digits Method
Straight-Line
Method
Impact
of
Income
Declining Balance
Method
Units-of-Production
Method
Disclosure of the depreciation method permits
informed readers to make comparisons of
companies in the same industry.
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LO4
Inventory Valuation
FIFO
LIFO
WeightedAverage
Impact on Income Statement
and Balance Sheet
The selection of an inventory valuation method
may influence the reported income and the
inventory amount shown on the balance sheet.
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LO4
Income Taxes
A reconciliation of the statutory income
tax rate with the effective tax rate.
GAAP is the set of
rules for preparing
financial statements.
The Internal
Revenue Code is
the set of rules for
preparing tax returns.
Results in . . .
Usually. . .
Results in . . .
financial statement
IRS income taxes
income tax expense.
payable.
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LO5
Other Disclosures
A change in accounting principle
may have a significant impact
on reported income. To
promote comparability,
companies with accounting
changes are required to show
what income would have been
reported if the new principle
had been used all the time.
This is referred to “proforma
Mergers and acquisitions are
accounted for using purchase
accounting. Under this method,
net assets are recorded at fair
value on the date of acquisition. Any
amount paid in excess of fair value
is the intangible asset goodwill.
income.”
Contingencies: Claims or rights to receive or pay assets whose existence is
uncertain but which may become valid eventually.
Typical loss contingencies include:
 Possible payments resulting from
litigation.
 Possible additional payments
resulting from tax disputes.
 Possible fines or penalties.
McGraw-Hill/Irwin
Typical gain contingencies include:
 Possible receipts of monies from
gifts or donations.
 Possible refunds from the
government in tax disputes.
 Pending court cases with probable
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McGraw-Hill
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favorable
outcome.
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LO5
Impact of Inflation
Reporting the effects of inflation is a
controversial and complex area of
accounting. If the economy experiences high
rates of inflation in the future, efforts to
reflect the impact of inflation directly in the
financial statements are likely to be renewed.
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LO5
Segment Information
Most large corporations operate in
several lines of business and operate in
many geographical areas.
Segment information should include:
1. Sales to unaffiliated customers,
2. Operating profit,
3. Capital expenditures,
4. Depreciation expense,
5. Identifiable assets.
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LO6
Reporting to the SEC
Instead of an annual report, companies
that are registered with the SEC file an
annual Form 10-K. The Form 10-K includes
most of the information in the company’s
annual report and must also comply with
additional SEC reporting requirements.
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LO7
Management’s Statement of
Responsibility
The company’s management bears ultimate
responsibility for the financial statements and notes,
not the auditors who express an opinion on the
fairness of the presentation of the financial
statements.
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LO8
Management Discussion and
Analysis
A corporation is required to include
a section called “Management
Discussion and Analysis” in its
annual report. This section
describes the firm’s activities for
the year, including comments
about its financial condition and
results of operations.
1. Nature of operations.
2. Economic outlook for
the company.
3. Important factors that
may influence
profitability.
4. Summary of operating
results.
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LO9
Summary of Financial Data
Most corporate annual reports contain a
5-year or 10-year summary of key
financial data. This information often
includes significant ratios and stock
market prices of it common stock.
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L O 10
Independent Auditors’ Report
Standard format contains four paragraphs.
1
Introductory Paragraph – Describes the financial statements
audited and states that management is responsible for the
financial statements and that the auditors’ task is to express
an opinion about the financial statements.
2
Scope Paragraph – Describes the nature and extent of the audit
process. Auditors wish to obtain reasonable assurance that the
financial statements are free from material misstatements.
3
Opinion Paragraph – Auditors express an opinion on the fairness
of the financial presentation. Corporations wish to receive an
unqualified report.
4
Internal Control Opinion Paragraph – Auditors make reference to
the internal control effectiveness audit and the opinion issued by
the auditors that accompanies the auditors’ report as required by
the Public Company Accounting Oversight Board.
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L O 10
Compilation Engagement
For companies that are not registered with the
SEC and do not have publicly traded
securities, accountants may provide a service
by compiling financial statements.
A compilation is merely the presenting, in the
form of financial statements, information that
has been prepared by management.
A compilation report does not provide any
assurance from the auditors about the
fairness of the financial information.
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