Skip to main content. Search for:. Additional Notes on Disclosures. Learning Objectives Summarize why a company would have a disclosure on the financial statement. Key Takeaways Key Points All relevant information must be disclosed. Types of disclosures include, accounting changes, accounting errors, asset retirement, insurance contract modifications, and noteworthy events.
Key Terms disclosure : The act of revealing something. In recent years, organisations in India have adopted the practice of including a separate statement of accounting policies followed in their annual reports to shareholders. Many organisations list the accounting policies followed by them in the notes to their financial statements, but there is no consistency in the disclosures among organisations. In other words, the disclosure forms part of accounts in some cases, while in others it is given as supplementary information.
The purpose of this standard is to promote a better understanding of financial statements by establishing the practice of disclosure of significant accounting policies followed and the manner in which they are disclosed in the financial statements. Such disclosure would also facilitate a more meaningful comparison between financial statements of different organisations.
Certain assumptions are used in the preparation of financial statements. They are usually not specifically stated because they are assumed to be followed. Disclosure is necessary only if they are not followed.
The following have been generally accepted as fundamental accounting assumptions: Going Concern : The organisation is normally viewed as a going concern, that is to say, it will be in continuing operations for the foreseeable future. It is assumed that the organisation has neither the intention nor the necessity of shutting down or reducing the scale of operations. Consistency : It is assumed that accounting policies are consistently followed from one period to another. In other words, the revenue received for one company needs to be recognized in the same manner as the revenue for another company in order to compare the financial results accurately.
By having a standardized process for disclosure and reporting, investors can make more-informed investment decisions. Investing Essentials. Career Advice. Financial Statements. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page.
These choices will be signaled globally to our partners and will not affect browsing data. We and our partners process data to: Actively scan device characteristics for identification. I Accept Show Purposes. Your Money. Personal Finance. Your Practice. Popular Courses. With a greater understanding of the application of critical accounting policies, we believe that investors would be in a better position to assess the quality of, and potential variability of, a company's earnings.
Finally, as we have noted previously, the less technical language customarily used outside the financial statements may be conducive to a clearer explanation to investors of the effects of estimates, assumptions, methodologies and initial accounting policy adoption on a company's financial reporting. Our proposals address estimates that a company makes in preparing financial statements using accounting policies under GAAP and the initial adoption by a company of an accounting policy under GAAP that has a material impact on its financial presentation.
Our proposals do not, for example, alter disclosure requirements regarding a company's change from an accounting policy it has been using to another policy acceptable under GAAP.
Discipline surrounding a company's changes in accounting policies is provided under GAAP and the federal securities laws. When a company changes an accounting policy, the company must determine that the alternative principle is preferable under the circumstances. In addition to the existing disclosure requirements in the financial statements, scrutiny over management's discretion and judgment in applying accounting policies occurs on a number of different levels.
Auditors are required to inform audit committees about management's "initial selection of and changes in significant accounting policies or their application" and about management's judgments and estimates. We recognize that the circumstances where a company may exercise discretion over its accounting policies under GAAP could yield significantly different financial results.
Companies should provide complete, transparent disclosure under the applicable requirements. While we believe the proposed disclosure may be sufficient to achieve our currently stated objective, we may revisit the other circumstances where a company may exercise discretion over its accounting policies under GAAP at a later date.
We solicit comment with regard to broadening the scope of our proposals to achieve a more expansive objective. Unless otherwise stated, the discussion would cover the financial statements for the most recent fiscal year and any subsequent period for which interim period financial statements are required to be included. A number of circumstances can require a company to make accounting estimates.
For example, a company typically will estimate the net realizable value of its accounts receivable and of its inventory. An accounting estimate would be a critical accounting estimate for purposes of the proposed disclosure only if it meets two criteria.
First, the accounting estimate must require a company to make assumptions about matters that are highly uncertain at the time the accounting estimate is made. Second, it must be the case that different estimates that the company reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on the presentation of the company's financial condition, changes in financial condition or results of operations.
For purposes of the first criterion, a matter involves a high degree of uncertainty if it is dependent on events remote in time that may or may not occur, or it is not capable of being readily calculated from generally accepted methodologies or derived with some degree of precision from available data.
Accordingly, a matter that is highly uncertain requires management to use significant judgment in making assumptions about that matter. The application of management's judgment in those circumstances typically results in management developing a range within which it believes the accounting estimate should fall.
The second criterion focuses the proposals further on two types of accounting estimates involved in the application of accounting policies. First, it includes accounting estimates for which a company in the current period could reasonably have recorded in the financial statements an amount sufficiently different such that it would have had a material impact on the company's financial presentation.
Second, it includes any accounting estimate that is reasonably likely to change from period to period to the extent that the change would have a material impact on the company's financial presentation. Thus, whether management's judgment has an impact primarily in the current period or on an ongoing basis or both , the estimate would qualify.
Under the proposals, a company would discuss any accounting estimate that it determines to be critical. We believe that few of a company's accounting estimates generally would meet those thresholds. We do not currently propose an outside limit to the number of accounting estimates that a company must discuss under the proposals. As the term "critical accounting estimate" implies, however, the disclosure should not encompass a long list of accounting estimates resulting from the application of accounting policies which cover a substantial number of line items in the company's financial statements.
The number could be at the high end of the range, or be slightly higher, for companies that conclude that one or more critical accounting estimates must be identified and discussed primarily because of particular segments. Investors, however, will not benefit from a lengthy discussion of a multitude of accounting estimates in which the truly critical ones are obscured.
If we adopt the proposals without a maximum number, we may monitor disclosure to determine whether disclosure would be improved if a maximum number were set. A company first would have to identify and describe each critical accounting estimate in such a way that it gives the appropriate context for investors reading that section and reflects management's view of the importance of the critical accounting estimate.
It also would have to disclose the assumptions underlying the accounting estimate that reflect matters highly uncertain at the time the estimate was made as well as other assumptions underlying the estimate that are material. We recognize that a critical accounting estimate may involve multiple assumptions. The proposed disclosure would focus in the first instance on those that are about highly uncertain matters because they have the greatest potential to make the accounting estimate highly susceptible to change.
If applicable, the company would have to describe why different estimates could have been used in the current period and why the accounting estimate is reasonably likely to change from period to period in the financial statements. For example, a critical accounting estimate related to a significant portfolio of over-the-counter derivative contracts may require that a company estimate the fair value of such contracts using a model or other valuation method.
In that case, the company would disclose the methods it employs to estimate fair value, e. A company also would have to explain known trends, demands, commitments, events or uncertainties that are reasonably likely to occur and materially affect the assumptions made or the methodology used.
Disclosure would not be required if management could affirmatively conclude that the trend, demand, commitment, event or uncertainty is not reasonably likely to come to fruition or that a material effect is not reasonably likely to occur. For each critical accounting estimate, a company would have to explain its significance to the company's financial condition, changes in financial condition and results of operations and, where material, identify its effect on the line items in the company's financial statements.
Thus, this disclosure would provide additional information and clarity for investors. Second, the proposals would require quantitative disclosure relating to historical changes in a company's critical accounting estimates in the past three years.
We propose to require that a company present quantitative information about changes in its overall financial performance and, to the extent material, line items in the financial statements that would result if certain changes relating to a critical accounting estimate were assumed to occur.
The company would identify the change being assumed and discuss quantitatively its impact on the company. Because the point of the disclosure is to demonstrate the degree of sensitivity, the impact on overall financial performance would be discussed regardless of how large that is. As proposed, a company would have two possible choices of changes it would assume for purposes of the sensitivity analysis.
First, the company could choose to assume that it changed the most material assumption or assumptions underlying the critical accounting estimate and discuss the results of those changes. Second, the company could choose to assume that the critical accounting estimate itself changes. In addition to providing two choices of methods to demonstrate sensitivity, we allow a company to determine the amount of the change that it assumes for this analysis rather than attempting to standardize those amounts.
Under the first choice, a company could select the alternative material assumption or assumptions to use as long as the alternative represents a change that is reasonably possible in the near term. It would substitute the upper end of the range for the recorded estimate and discuss the results. It would do the same for the lower end of the range. We believe the most informative disclosure about sensitivity would result if we allow companies significant flexibility to customize these analyses.
Our approach would accommodate different types of companies, different critical accounting estimates and different types of underlying assumptions. The parameters selected for the sensitivity analysis must, however, be realistic and meaningful measures of change. Under the first choice for demonstrating sensitivity, we would provide that a company choose its most material assumption underlying the critical accounting estimate and alter it at least twice 65 to reflect reasonably possible, near-term changes.
It would also have to complete the analysis assuming a negative change. In some cases, a company may not be able to select a single most material assumption to use for purposes of these analyses, or it may believe that using a single assumption would not provide meaningful sensitivity information for investors. If that were to occur, a company either could select the second choice for analyzing sensitivity i. If the company chooses the latter course of action, it also would have to disclose clearly the separate effect of each changed assumption.
In general, we believe the impact of a positive change and the impact of a negative change would both have to be disclosed where a company is assuming changes in its most material assumption or assumptions.
There may be cases, however, where both types of changes would not be applicable. In some instances, an increase in an assumption, but not a decrease in an assumption, or vice versa, would have no effect on the line items or the overall financial performance and therefore would not have to be discussed other than noting that fact. With the proposed analysis, a company would demonstrate sensitivity of reported results to changes that affect its critical accounting estimates. Investors would have a better understanding of the extent to which there is a correlation between management's key assumptions and the company's overall financial performance.
Investors also would understand better which particular line items in reported results would be materially affected and how much. In addition, a company would be required to state whether those assumed changes could have a material effect on the company's liquidity or capital resources.
From the proposed disclosure, the average investor should be able to ascertain the general degree to which the company's results of operations, liquidity and capital resources are susceptible to changes in management's views relating to critical accounting estimates. Along with the other provisions in the proposal, this quantitative and qualitative disclosure conveys information about the impact of management's subjective assumptions on current and future financial results.
We recognize that a company will change its accounting estimates over time as new events occur or as management acquires more experience or additional information. This type of information required under the proposal would give investors a clear understanding of a company's recent history of those changes.
A company other than a small business issuer would have to include the proposed quantitative and qualitative discussion of any material changes in those accounting estimates under the proposals during the past three fiscal years. Companies also would be required to describe the reasons for those changes. If no material changes in the critical accounting estimates were made in the prescribed time period, or if a company did not make that estimate during any part of that period, a company would only be required to disclose that fact.
Although the period covered for the proposed disclosure of past changes in critical accounting estimates would be two years for small business issuers and three years for other companies, our proposed requirement relating to past changes would be put into effect in stages. Thus, when a small business issuer or other company files its first covered report, registration statement or proxy or information statement following adoption of the proposed rules, the rules would require it to provide the proposed specific past changes disclosure only for the past one or two years respectively.
In the first annual report, registration statement or proxy or information statement filed by a company more than one year following the effective date of the rules, it would have to provide that information for the past three years two years for a small business issuer.
We solicit comment on the proposed disclosure of past material changes in critical accounting estimates. Independent auditors discuss accounting estimates with management in order to conduct an audit, and the auditors may discuss them with the audit committee.
In , following the recommendations in the Report of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees, we adopted a rule that would require an audit committee report in proxy or information statements connected to board of director elections.
With respect to accounting estimates, SAS 61 states, "[t]he auditor should determine that the audit committee is informed about the process used by management in formulating particularly sensitive accounting estimates and about the basis for the auditor's conclusions regarding the reasonableness of those estimates. The discussion should include items that have a significant impact on the financial statements for example, estimates, judgments and uncertainties, among other items.
In addition to the disclosure relating to SAS 61 as amended , the audit committee report must state whether the audit committee has reviewed and discussed the audited financial statements with management. The existing audit committee report also requires audit committees to state whether, based on discussions with management and the auditors, the committee recommended to the board of directors that the audited financial statements be included in the company's Form K or KSB for the last fiscal year.
This item too does not require any specific discourse between management and the audit committee about critical accounting estimates. We believe that senior management should discuss the company's critical accounting estimates with the audit committee of its board of directors. This type of oversight would have the potential to improve the quality and the transparency of disclosure.
We therefore are proposing to require such disclosure. We do not propose to require disclosure of the substance of the discussions between senior management and the audit committee. We believe that such a requirement could deter the type of open discourse that we expect to take place in those discussions.
We request comment on the proposed disclosure about discussions between senior management and the audit committee regarding the development, selection and disclosure of critical accounting estimates. Under the proposals, if a company operates in more than one segment 92 and a critical accounting estimate affects fewer than all of the segments, the company would have to identify the segments it affects.
A company also would have to determine whether it must include, in addition to the disclosure on a company-wide basis, a separate discussion of the critical accounting estimates for each identified segment about which disclosure is otherwise required.
A company would have to provide a discussion on a segment basis to the extent that discussion only on a company-wide basis would result in an omission that renders the disclosure materially misleading.
Rather, a company would have to disclose only that information necessary to avoid an incomplete or misleading picture. We request comment regarding identification of the segments affected and the proposed additional disclosure of the critical accounting estimates on a segment basis. The examples are illustrative only. Alphabetical Company manufactures and distributes electrical equipment used in large-scale commercial pumping and water treatment facilities. The company operates in four business segments.
The company's equipment carries standard product warranties extending over a period of 6 to 10 years. If equipment covered under the standard warranty requires repair, the company provides labor and replacement parts to the customer at no cost. Historically, the costs of fulfilling warranty obligations have principally related to providing replacement parts, with labor costs representing the remainder.
A liability for the expected cost of warranty-related claims is established when equipment is sold. The amount of the warranty liability accrued reflects the company's estimate of the expected future costs of honoring its obligations under the warranty plan. Because of the long-term nature of the company's equipment warranties, estimating the expected cost of such warranties requires significant judgment.
Alphabetical's products are covered by standard product warranty plans that extend 6 to 10 years. The amount of the warranty liability accrued reflects our estimate of the expected future costs of honoring our obligations under the warranty plan.
We believe the accounting estimate related to warranty costs is a "critical accounting estimate" because: changes in it can materially affect net income, it requires us to forecast copper prices in the distant future which are highly uncertain and require a large degree of judgment, and copper is a significant raw material in the replacement parts used in warranty repairs.
The estimate for warranty obligations is a critical accounting estimate for all of our four segments. Historically, the costs of fulfilling our warranty obligations have principally related to replacement parts, with labor costs representing the remainder.
Over the past 10 years, the price of copper has exhibited significant volatility. Our hedging programs provide adequate protection against short-term volatility in copper prices, as described in "Risk Management," but our hedging does not extend beyond 5 years. Accordingly, our management must make assumptions about the cost of that raw material in periods 6 to 10 years in the future. Management forecasts the price of copper for the portion of our estimated copper requirements not covered by hedging.
Our forecasts are based principally on long-range price forecasts for copper which are published by private research companies specializing in the copper markets. Each quarter, we reevaluate our estimate of warranty obligations, including our assumptions about the cost of copper. In contrast, during , long-term price forecasts were essentially unchanged, so we made no adjustments to our estimated cost of unhedged copper purchases over the next 10 years.
Long-term prices also reflected increases in prices over those projected in A very significant increase in our estimated warranty obligation, such as one reflecting the increase in copper prices that occurred in , could lower our earnings and increase our leverage ratio leverage refers to the degree to which a company utilizes borrowed funds.
That, in turn, could limit our ability to borrow money through our revolving credit facilities described in "Liquidity and Capital Resources. MQB Corp. MQB distributes its products primarily through third-party distributors, resellers, and retailers customers. Like many companies in the software industry, MQB has a product return policy and has historically accepted significant product returns.
MQB permits its customers to return software titles published and distributed by the company within days of purchase. Therefore, legal title to the products passes to the customers upon shipment, and the company has no legal obligation for product damage in transit.
Accordingly, MQB recognizes revenue upon shipment of its software products, provided that collection of payment is determined to be probable and no significant obligations on MQB's part remain. Payment is due from customers 30 days after shipment. At the time revenue is recorded, MQB accounts for estimated future returns by reducing sales by its estimate of future returns and by reducing accounts receivable by the same amount.
MQB receives weekly reports from distributors and retailers regarding the amount of MQB products in their inventory. A historical correlation exists between levels of inventory held by distributors and retailers together, the distribution channel and the amount of returns that actually occur.
The weekly reports from distributors and retailers provide the company with visibility into the distribution channel such that MQB has the ability to estimate future returns.
The company's products are, however, subject to intense marketplace competition, including several recently introduced competing products. If actual returns significantly exceed the previously estimated amounts, it would result in materially lower sales and net income before taxes in one or more future periods.
Our recognition of revenue from sales to distributors and retailers the "distribution channel" is impacted by agreements we have giving them rights to return our software titles within days after purchase. At the time we recognize revenue, upon shipment of our software products, we reduce our measurements of those sales by our estimate of future returns and we also reduce our measurements of accounts receivable by the same amount.
For our products, a historical correlation exists between the amount of distribution channel inventory and the amount of returns that actually occur. The greater the distribution channel inventory, the more product returns we expect.
For each of our products, we monitor levels of product sales and inventory at our distributors' warehouses and at retailers as part of our effort to reach an appropriate accounting estimate for returns. In estimating returns, we analyze historical returns, current inventory in the distribution channel, current economic trends, changes in consumer demand, introduction of new competing software and acceptance of our products.
In recent years, as a result of a combination of the factors described above, we have materially reduced our gross sales to reflect our estimated amount of returns. It is also possible that returns could increase rapidly and significantly in the future.
Accordingly, estimating product returns requires significant management judgment. In addition, different return estimates that we reasonably could have used would have had a material impact on our reported sales and thus have had a material impact on the presentation of the results of operations.
For those reasons, we believe that the accounting estimate related to product returns is a "critical accounting estimate. We are aware of several recently introduced products that compete with several of our significant products. These new competitive factors have not, to date, materially impacted returns; therefore, we have made no adjustment as a result of these factors in our estimated returns for In our highly competitive marketplace, these factors have some potential to increase our estimates of returns in the future.
The introduction of new competing products has impacted our estimate of returns in the past. From to , products introduced by two of our competitors in lost market share to our products and our sales increased. If we were to change our estimate of future product returns to the high end of the range, there would be no material impact on our liquidity or capital resources.
Betascott Company manufactures and sells data storage devices including computer hard drives.
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