Chapter 9

1. Chapter 9 Uniformity and Disclosure

2. Lecture • Choice among accounting methods • Uniformity • Relevant circumstances • Nature of finite and rigid uniformity and flexibility • Extent that standards are using finite uniformity, rigid uniformity, or flexibility • Disclosure • Items providing important information to users

3. What causes a firm to choose one accounting method over another where a free choice can be made? Three reasons… • Minimizing agency costs • Signaling information that management wants to send to outside parties • Attempting to “influence” outside parties

4. Uniformity • Uniformityis seen as the concept that influences comparability. • Comparability is not an inherent quality of accounting numbers in the sense that relevance and reliability are, but instead deals with the relationship between accounting numbers.

5. Relevant Circumstances • Are economically significant circumstances that can affect broadly similar events • Two types of relevant circumstances • Present magnitudes, conditions known at the time of the event • Future contingencies, factors that can be known only at a later date • Are an extremely important aspect of the uniformity issue

6. Management & Relevant Circumstances • Selection of accounting methods might be affected by motives different than those dictated by the relevant circumstances • maximize reported income... management compensation based on reported income • Minimize reported income...fear of government intervention on antitrust grounds • Smoothing income...less fluctuation = less risk • Potentially capable of distorting income measurement

7. Uniformity • Finite uniformity: Equates prescribed accounting methods with the relevant circumstances in generally similar situations • Rigid uniformity: Prescribes one method for generally similar transactions • Generally, if finite uniformity can be attained, it is superior to rigid uniformity for the standpoint of decision making

8. Broad Event Class Simple Event Complex Event Measurementand/or CostConstraints Measurable And Cost Effective Rigid Uniformity Finite Uniformity Rigid Uniformity

9. Approaches to Uniformity • Rigid uniformity • Finite uniformity • Flexibility • applies to situations in which there are no discernible relevant circumstances • but more than one possible accounting method exists • prevalent in GAAP

10. Disclosure • Is related with information in both the financial statements and supplementary communications-including • Footnotes • Post-statement events • Management’s analyses • Additional information beyond historical costs • Refers to the whole area of financial reporting and not simply to the financial statements

11. Disclosure Function of SEC • Protective disclosure • Informative disclosure...the emphasis since early 1970s

12. U.S. Securities and Exchange Commission • The SEC is managed by five (5) commissioners, 5-year appointments made by the President and confirmed by the Senate. • A maximum of three commissioners may be from the same political party. • Consists of a headquarters in Washington D.C., nine regional offices, six branch offices, and a $600M+ annual budget.

13. The Disclosure Process Today • Differential disclosure • Annual 10-K • Quarterly 10-Q • Aimed toward professional financial analysts • Additional disclosure? • Information overload • Information asymmetry (selective disclosure) • Signaling theory • Cost of disclosure for big vs. small firms

14. Items Providing Important Information • Summary Annual Report (SAR) • Condensed financial statements that omit or boil down the detail contained in traditional audited financial statements • Evolved from 1983 FEI study concerned with the readability of annual reports • Jenkins Committee Report (1994) • AICPA study 1991-94 • Concerned with helping users understand a company’s business

15. Key Jenkins Report Disclosures • Segmental disclosures • Core and non-core activities, separate then in the financial statements • Interim reporting • Secondary recommendations

16. Jenkins Secondary Recommendations • Balance sheet items with low verifiability • Innovative financial instruments (derivatives) • Adequate data for user to make forecast • Disclosure about alternatives and methods selected • Valuing internally generated intangibles frowned upon • Eliminate less relevant disclosures

17. Jenkins Committee Report • Does not tangle with FASB’s mission of standard setting • Recommends significant increase in disclosure & changing format of financial statements, at odds with SEC which would like to decrease disclosures in corporate annual reports • Consistent with conceptual framework

18. Jenkins Committee Report • Adopts the user outlook of SFAC No. 1 • Appears to be cognizant of market efficiency and its ability to absorb new disclosures • International implications...American firms would be at a disadvantage relative to foreign firms

19. Summary • Choice among accounting methods • Uniformity • Relevant circumstances • Nature of finite and rigid uniformity and flexibility • Extent that standards are using finite uniformity, rigid uniformity, or flexibility • Disclosure • Items providing important information to users