Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Chapter 10Chapter 10Corporate Governance, Notes to the

Financial Statements, and Other DisclosuresPowerPoint Authors:

Susan Coomer Galbreath, Ph.D., CPA

Charles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPA

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Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning ObjectivesAfter studying this chapter you should understand and be able to:

1. Discuss the significance of corporate governance.

2. Identify the types of financial reporting misstatements that have occurred in recent years.

3. Explain why the notes are an integral part of the financial statements.

4. Discuss the kinds of significant accounting policies that are explained in the notes.

5. Describe the nature and content of various note disclosures.

6. Explain the role of the Securities and Exchange Commission and some of its reporting requirements.

7. Explain why a statement of management’s responsibility is included with the notes.

8. Describe the significance of management’s discussion and analysis of the firm’s financial condition and results of operations.

9. Identify what is included in the five-year (or longer) summary of financial information.

10.Discuss the meaning and content of the independent auditors’ report.

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Corporate GovernanceCorporate Governance

Business ethicsBusiness ethics Social responsibilitySocial responsibility Equitable treatment of Equitable treatment of

shareholdersshareholders Disclosures and transparency Disclosures and transparency Board of directorsBoard of directors’’ responsibility responsibility

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Corporate GovernanceCorporate GovernanceL O 1

The most powerful legislation to date has been the Sarbanes–Oxley Act (SOX) of 2002, which created the Public Company Accounting Oversight Board (PCAOB) as the authoritative watchdog over the accounting and auditing profession.

The SOX legislation was aimed primarily to curtail the misbehavior of senior management of corporateentities: Chief executive officers (CEOs) and chief financial officers (CFOs) are required under SOX to attest (in front of a notary) to the correctness of their company’s financial statements.

The registrant must also report in a separate section of its annual10-K report any “Changes in and Disagreements with Accountants on Accounting and Financial Disclosure” as an added measure of transparency and management accountability.

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Corporate GovernanceCorporate GovernanceL O 1

In response to the financial crisis of 2007–2008, Congress passed the Wall Street Reform and Consumer Protection Act of 2010 (referred to as the Dodd-Frank Act ). Although most of the act deals with financial regulation, several Dodd-Frank provisions impose new corporate governance rules not just on Wall Street banks but also on MainStreet public corporations.Dodd-Frank Act contains the “say on pay” mandate requiring periodicshareholder advisory votes on executive compensation and golden parachute provisions.

Dodd-Frank provision requires companies to disclose the reasons that they have chosen to have either the same person or separate people serve as the CEO and chairman of the board.

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Recent Financial MisstatementsRecent Financial MisstatementsL O 2

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Recent Financial MisstatementsRecent Financial MisstatementsL O 2

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Because of theBecause of the complexitiescomplexities related to related to financial reporting and because of the financial reporting and because of the

number ofnumber of alternativealternative generally accepted generally accepted accounting principles that can be used, accounting principles that can be used, explanatory notes are included as anexplanatory notes are included as an

integral partintegral part of the financial statements.of the financial statements.

Because of theBecause of the complexitiescomplexities related to related to financial reporting and because of the financial reporting and because of the

number ofnumber of alternativealternative generally accepted generally accepted accounting principles that can be used, accounting principles that can be used, explanatory notes are included as anexplanatory notes are included as an

integral partintegral part of the financial statements.of the financial statements.

L O 3 Notes to the Financial Notes to the Financial StatementsStatements

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Summary of Significant Accounting PoliciesSummary of Significant Accounting Policies

Typical accounting policies that are disclosed in the Typical accounting policies that are disclosed in the notes to the financial statements include:notes to the financial statements include:

1. Depreciation method used.2. Inventory valuation method used.3. Basis of consolidation of subsidiaries.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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Other DisclosuresOther Disclosures

1.1. Accounting changes.Accounting changes.2.2. Business combinations.Business combinations.3.3. Contingencies and commitments.Contingencies and commitments.4.4. Events subsequent to the balance sheet Events subsequent to the balance sheet

date.date.5.5. Impact of inflation.Impact of inflation.6.6. Segment information.Segment information.

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Depreciation MethodDepreciation Method

Disclosure of the depreciation method permits Disclosure of the depreciation method permits informed readers to make comparisons of informed readers to make comparisons of

companies in the same industry.companies in the same industry.

Disclosure of the depreciation method permits Disclosure of the depreciation method permits informed readers to make comparisons of informed readers to make comparisons of

companies in the same industry.companies in the same industry.

ImpactImpactofof

IncomeIncome

ImpactImpactofof

IncomeIncome

Sum-of-the-YearsSum-of-the-Years’’--Digits MethodDigits Method

Sum-of-the-YearsSum-of-the-Years’’--Digits MethodDigits Method

Units-of-ProductionUnits-of-ProductionMethodMethod

Units-of-ProductionUnits-of-ProductionMethodMethod

Straight-LineStraight-LineMethodMethod

Straight-LineStraight-LineMethodMethod

Declining BalanceDeclining BalanceMethodMethod

Declining BalanceDeclining BalanceMethodMethod

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Inventory ValuationInventory Valuation

The selection of an inventory valuation method The selection of an inventory valuation method influences the reported income and the inventory influences the reported income and the inventory

amount shown on the balance sheet.amount shown on the balance sheet.

The selection of an inventory valuation method The selection of an inventory valuation method influences the reported income and the inventory influences the reported income and the inventory

amount shown on the balance sheet.amount shown on the balance sheet.

Impact on Income StatementImpact on Income Statementand Balance Sheetand Balance Sheet

LIFOLIFOLIFOLIFOFIFOFIFOFIFOFIFO Weighted-Weighted-AverageAverage

Weighted-Weighted-AverageAverage

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Basis of ConsolidationBasis of Consolidation

The basis of consolidation disclosure requires that The basis of consolidation disclosure requires that consolidated financial statements include data consolidated financial statements include data

from substantially all subsidiary companies.from substantially all subsidiary companies.

The basis of consolidation disclosure requires that The basis of consolidation disclosure requires that consolidated financial statements include data consolidated financial statements include data

from substantially all subsidiary companies.from substantially all subsidiary companies.

ParentCompany

$

$

Subsidiary Company 1

$

$

Subsidiary Company 2

$

$

Subsidiary Company 3

$

$

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Income TaxesIncome TaxesA reconciliation of the statutory income A reconciliation of the statutory income

tax rate with the effective tax rate.tax rate with the effective tax rate.

The Internal The Internal Revenue Code is Revenue Code is the set of rules for the set of rules for

preparing tax returns.preparing tax returns.

The Internal The Internal Revenue Code is Revenue Code is the set of rules for the set of rules for

preparing tax returns.preparing tax returns.

financial statement financial statement income tax expense.income tax expense.financial statement financial statement

income tax expense.income tax expense.IRS income taxes IRS income taxes

payable.payable.IRS income taxes IRS income taxes

payable.payable.

GAAP is the set of GAAP is the set of rules for preparing rules for preparing

financial statements.financial statements.

GAAP is the set of GAAP is the set of rules for preparing rules for preparing

financial statements.financial statements.

Usually. . . Usually. . . Results in . . .Results in . . . Results in . . .Results in . . .

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Employee BenefitsEmployee Benefits

The cost of employee pension plans included as The cost of employee pension plans included as an expense in the income statement is disclosed.an expense in the income statement is disclosed.The cost of employee pension plans included as The cost of employee pension plans included as an expense in the income statement is disclosed.an expense in the income statement is disclosed.

Present value of Present value of benefits at benefits at present present

pay levelspay levels..

Present value of Present value of nonvested benefitsnonvested benefits

at present pay at present pay levels.levels.

Present value of Present value of additional benefits additional benefits related to related to projected projected

pay increasespay increases..

Accumulated Accumulated Benefit ObligationBenefit Obligation

Projected Benefit Projected Benefit ObligationObligation

Vested Benefit Vested Benefit ObligationObligation

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Intangibles Including GoodwillIntangibles Including Goodwill

When the balance sheet contains intangible assets, When the balance sheet contains intangible assets, including goodwill arising from business including goodwill arising from business

acquisitions, the method of recognizing initial cost acquisitions, the method of recognizing initial cost will be described. Any amortization or impairment will be described. Any amortization or impairment

in value of the intangibles must be shown.in value of the intangibles must be shown.

When the balance sheet contains intangible assets, When the balance sheet contains intangible assets, including goodwill arising from business including goodwill arising from business

acquisitions, the method of recognizing initial cost acquisitions, the method of recognizing initial cost will be described. Any amortization or impairment will be described. Any amortization or impairment

in value of the intangibles must be shown.in value of the intangibles must be shown.

©©CopyrightCopyright

PatentPatent

®®TrademarkTrademark

™™

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An explanation of the calculation of An explanation of the calculation of EPS may include the details of the EPS may include the details of the computation of weighted-average computation of weighted-average

number of common shares number of common shares outstanding and the adjustments outstanding and the adjustments made to net income for preferred made to net income for preferred

stock, stock options, and convertible stock, stock options, and convertible securities.securities.

Earnings Per ShareEarnings Per ShareL O 4

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Segment InformationSegment Information

Most large corporations operate in several Most large corporations operate in several lines of business and operate in many lines of business and operate in many

geographical areas.geographical areas.

Segment information should include:Segment information should include:1.1. Sales to unaffiliated customers,Sales to unaffiliated customers,2.2. Operating profit,Operating profit,3.3. Capital expenditures,Capital expenditures,4.4. Depreciation expense,Depreciation expense,5.5. Identifiable assets.Identifiable assets.

Segment information should include:Segment information should include:1.1. Sales to unaffiliated customers,Sales to unaffiliated customers,2.2. Operating profit,Operating profit,3.3. Capital expenditures,Capital expenditures,4.4. Depreciation expense,Depreciation expense,5.5. Identifiable assets.Identifiable assets.

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Reporting to the SECReporting to the SEC

Instead of an annual report, companies Instead of an annual report, companies that are registered with the SEC file an that are registered with the SEC file an

annual Form 10-K. The Form 10-K annual Form 10-K. The Form 10-K includes most of the information in the includes most of the information in the company’s annual report and must also company’s annual report and must also

comply with additional SEC reporting comply with additional SEC reporting requirements.requirements.

Instead of an annual report, companies Instead of an annual report, companies that are registered with the SEC file an that are registered with the SEC file an

annual Form 10-K. The Form 10-K annual Form 10-K. The Form 10-K includes most of the information in the includes most of the information in the company’s annual report and must also company’s annual report and must also

comply with additional SEC reporting comply with additional SEC reporting requirements.requirements.

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Management’s Statement of Management’s Statement of ResponsibilityResponsibility

The company’s management bears ultimate The company’s management bears ultimate responsibility for the financial statements and notes, responsibility for the financial statements and notes,

not the auditors who express an opinion on the not the auditors who express an opinion on the fairness of the presentation of the financial fairness of the presentation of the financial

statements.statements.

The company’s management bears ultimate The company’s management bears ultimate responsibility for the financial statements and notes, responsibility for the financial statements and notes,

not the auditors who express an opinion on the not the auditors who express an opinion on the fairness of the presentation of the financial fairness of the presentation of the financial

statements.statements.

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End of Chapter 10End of Chapter 10

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