Assessing Financial Statement Presentation and Disclosure

As an auditor you have to assess management’s financial statement presentation and disclosure. The financial statements (income statement, balance sheet, and statement of cash flows) and notes to the financial statements must contain all the necessary information a user needs to avoid being misled. Users of the financial statements are those who obtain the documents in order to make a decision, like whether to invest in a company or to loan it money.

You can’t form an educated opinion about a business’s financial statements without notes that explain what’s going on. Common footnotes to the financial statements, or disclosures, are explanations of how or why a company handles a transaction, including how it writes off its assets, how it values its ending inventory, and how it reconciles the income taxes it owes.

For example, a company can’t opt to exclude an income statement or balance sheet account from the financial statements. So if short-term payables are larger than the cash on hand available to pay them (not a good thing), the company can’t “forget” to list the payables on the balance sheet.

Four specific types of management assertions relate to the presentation and disclosure of the financial statements:

  • Occurrence, rights, and obligations: Transactions or events actually took place and relate to the company. For example, a shoe manufacturing company is in the process of selling its tennis shoe segment. In order for information on this segment’s sale to be included in the notes to the financial statements, the sale has to be closed as of the end of the year under audit. Additionally, if the sale is in process at year-end, it can still be an event that the company should disclose. The disclosure requirement rests on how material (significant) getting rid of the tennis shoe segment is to the overall company function.

  • Completeness: The financial statement notes include all the relevant information that users need to properly analyze and understand the financials. No disclosures are missing, either by mistake or on purpose. Using the tennis shoe segment as an example, the complete terms of the sale are disclosed.

  • Classification and understandability: The disclosures are understandable to users of the financial statements. They can’t be vague or ambiguous. For example, the company can’t merely disclose that it’s selling a segment; it has to identify the segment and explain the current impact on the business, as well as the potential future impact.

  • Accuracy and valuation: The disclosures are accurate, and the proper amounts are included in the disclosures. Using the tennis shoe segment as an example, the correct dollar amount of the sale is listed, and major balance sheet and income statement categories that are affected are identified.

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