BUS103: Introduction to Financial Accounting

The SEC requires businesses to file an annual report known as a Form 10-K in order to disclose relevant financial information.

Events that trigger disclosure should be based on an accountant's assessment of materiality.

Learning Objective

• Name some events that would require disclosure on the financial statement and state how the decision to disclose an item is made
  
  

Key Points

• Events that trigger disclosure should be based on an accountant's assessment of materiality, especially when facing decisions related to the full disclosure principle.
• Another event that can trigger a disclosure is prior period adjustments.
• Voluntary disclosure in accounting is the provision of information by a company's management beyond requirements.
  
  

Term

• consistency

  reliability or uniformity; the quality of being consistent
  
  

Example

• Real Company Example of a Disclosure of Contingent Liability:
  • "Various lawsuits and claims, including those involving ordinary routine litigation incidental to its business, to which the Company is a party, are pending, or have been asserted, against the Company. In addition, the Company was advised...that the United States Environmental Protection Agency had determined the existence of PCBs in a river and harbor near Sheboygan, Wisconsin, USA, and that the Company, as well as others, allegedly contributed to that contamination. It is not presently possible to determine with certainty what corrective action, if any, will be required, what portion of any costs thereof will be attributable to the Company, or whether all or any portion of such costs will be covered by insurance or will be recoverable from others. Although the outcome of these matters cannot be predicted with certainty, and some of them may be disposed of unfavorably to the Company, management has no reason to believe that their disposition will have a materially adverse effect on the consolidated financial position of the Company".

Events Trigger Disclosure

Events that trigger disclosure should be based on materiality and the full disclosure principle

Consistency generally requires that a company use the same accounting principles and reporting practices through time. This concept prohibits indiscriminate switching of accounting principles or methods, such as changing inventory methods every year. However, consistency does not prohibit a change in accounting principles if the information needs of financial statement users are better served by the change. When a company makes a change in accounting principles, it must make the following disclosures in the financial statements (in the Notes to the Financial Statements):

1. Nature of the change.
2. Reasons for the change;
3. Effect of the change on current net income, if significant
4. Cumulative effect of the change on past income

Another event that can trigger a disclosure is prior period adjustments. Events that trigger disclosure should be based on an accountant's assessment of materiality, especially when facing decisions related to the full disclosure principle. Disclosures will normally include details to materiality decisions in the notes to financial statements.

Voluntary Disclosure

Voluntary disclosure in accounting is the provision of information by a company's management beyond requirements such as generally accepted accounting principles and Securities and Exchange Commission rules, where the information is believed to be relevant to the decision-making of users of the company's annual reports.

Voluntary disclosures can include strategic information such as company characteristics and strategy, non-financial information such as socially-responsible practices, and financial information such as stock price information.

FASB classified voluntary disclosures into six categories below, while Meek, Roberts, and Gray (1995) classified them into three major groups: strategic, nonfinancial, and financial information.

1. Business data - e.g. breakdown of market share growth and information on new products
2. Analysis of business data - e.g. trend analysis and comparisons with competitors
3. Forward-looking information - e.g. sales forecast breakdown and plans for expansion
4. Information about management and shareholders - e.g. information on stockholders and creditors and shareholding breakdown
5. Company background - e.g. product description and long-term objectives
6. Information about intangible assets - e.g. research and development and customer relations.

The determinants of the extent and type of voluntary disclosures of firms have been explored in the financial reporting literature. Meek, Roberts and Gray (1995) found that the extent and type of voluntary disclosure differ by geographic region, industry, and company size, and other research has found that the extent of voluntary disclosure is affected by the firm's corporate governance structure and ownership structure.