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.
Accounting Glossary
accounting equation
The equation Assets = Liabilities + Equity, which demonstrates the two-sided nature of accounting and is useful for explaining the concept of double-entry accounting (or double-entry bookkeeping).
Accounting Glossary
accounting period
The time period for which financial information is being tracked in a business, such as monthly, quarterly, or annually.
Accounting Glossary
accounts receivable
An account that records the amounts that customers owe to a business.
Accounting Glossary
adjusting entry
A correction made to a bookkeeping account that adjusts for accounting errors or other necessary changes at the end of the accounting period.
Accounting Glossary
cash flows
Used to describe the source or sources of cash or how cash is used.
Accounting Glossary
Chart of Accounts
A list of all the accounts used by a business, including what types of transactions go into each account.
Accounting Glossary
debit
An accounting entry that increases an asset or expense account, and decreases a liability or income account.
Accounting Glossary
dividends
A portion of a company’s profits paid by share of common stock on a quarterly or annual basis.
Accounting Glossary
FASB
Financial Accounting Standards Board. FASB is the highest-ranking authority in the private (non-government) sector of the U.S. for making pronouncements on GAAP and for keeping accounting standards up-to-date.
Accounting Glossary
Federal Unemployment Tax
In the U.S., the fund that used to be known simply as Unemployment. Employers contribute to the fund, and states also collect taxes to fill their unemployment fund reserves. (The acronym FUTA means Federal Unemployment Tax Act.)
Accounting Glossary
fidelity bonds
A type of insurance — typically carried by employers for their employees — that helps guard against theft and reduce the risk of loss.
Accounting Glossary
FIFO
First-in, first-out. A method for costs of goods sold in which a business charges out product costs to cost of goods sold expense in the chronological order in which the goods were acquired.
Accounting Glossary
fungible
Describes a product that is interchangeable and virtually indistinguishable from another product.
Accounting Glossary
General Ledger
A summary of all of a business’s accounts and transactions.
Accounting Glossary
IASB
International Accounting Standards Board. The IASB (based in London) is the main authoritative accounting standards setter outside the U.S.
Accounting Glossary
Journals
The location in which bookkeepers keep records (in chronological order) of daily company transactions.
Accounting Glossary
LIFO
Last-in, first-out. A method for costs of goods sold that selects the last item you purchased first, and then works backward until you have the total cost for the total number of units sold during the period.
Accounting Glossary
LLP
Limited liability partnership. A legal structure that state laws offer to qualified professionals in which all the partners have limited liability.
Accounting Glossary
PC
Professional corporation. A legal structure that state laws offer to qualified professionals who otherwise would have to operate as an unlimited partnership liability.
Accounting Glossary
petty cash
A cash account that businesses keep on hand for unexpected expenses.
Accounting Glossary
revenue
Monies that are collected in the process of selling a company’s goods and services.
Accounting Glossary
salvage value
The amount that an asset is worth after it has been fully depreciated.
Accounting Glossary
statement of cash flows
A financial statement that summarizes a business’s cash inflows and outflows during an accounting period.
Accounting Glossary
transactions
Economic exchanges between a business or other entity and the parties with which the entity interacts and makes deals.
Accounting Glossary
worker’s compensation insurance
A type of insurance carried by employers that covers its employees in case they are injured on the job.
